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Operator
Good morning.
My name is Thea and I will the conference Operator today.
At this time, I would like to welcome everyone to the Valero Energy Corporation's third quarter earnings release conference call.
All lines have been placed on mute to prevent any background noise.
After the speakers' remarks, there will be a question-and-answer period. [OPERATOR INSTRUCTIONS] Thank you.
I will now turn the call over to Mr. Eric Fisher, Vice President Investor Relations.
Sir, you may begin your conference.
- VP Investor Relations
Thank you, Thea.
Good morning.
Welcome to Valero Energy Corporation's third quarter 2005 earnings conference call.
With me today is Bill Greehey, Chairman and Chief Executive Officer, along with other members of senior management team.
If you've not received the earnings release and would like a copy you can get one off of our Web site at valero.com.
There are also tables attached to the earnings release which provide additional financial information on our business segments.
Note in those tables that the information presented there provides our quarterly results excluding the impact of the LIFO charge described in the press release and also provides a reconciliation to the GAAP reported number which includes the LIFO charge.
If you have any questions after reviewing those tables please feel free to give me a call.
Before I turn it over to Bill, I would like to direct your attention to the forward-looking statement disclaimer that's claimed in the press release.
In summary it says that statements in the press release and on this conference call that state the Company's or management's expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provisions of the federal securities laws.
There are many factors which could cause our results to differ from our expectations including those that we've described in our filings with the SEC.
With that, I'll turn it over to Bill.
- Chairman, CEO
Thank you, Eric.
Before I talk about our third quarter's earnings and outlook for the remainder of the year, I would like to take a few minutes to discuss my decision to transition out of my role as CEO to focus on my position as Chairman of the Board in January.
I think it goes without saying that after almost 32 years as CEO I have a strong personal attachment with our employees.
So I plan to remain actively involved in the strategic direction of the Company.
I also plan to stay actively involved in the employee, governmental and civic initiatives.
I'll continue to serve as Chairman of Valero LP, the logistic partnership which Valero serves as general partner.
I will also remain an outspoken advocate for Valero and for the refining industry.
But I would like a little more free time to spend with family and to work on a number of philanthropic initiatives.
The timing couldn't be better.
At no point over the past 25 years has Valero achieved greater success than it has this year and the outlook for the future is just as bright.
Also, I've never felt more difficult in Valero's leadership team.
I've worked closely with Bill Klesse for a number of years now as our Chief Operating Officer.
He has great business judgment and will do a great job in his new role as CEO.
Over the last few years Bill has learned firsthand how the Valero culture contributes to our success.
He's committed to preserving it as I am.
As Executive Vice President and COO, Bill's done a great job of overseeing our operations as our refining system has grown from two million barrels a day at the time of the UDS acquisition to 3.3 million barrels today.
With almost 37 years of industry experience, he's held leadership positions in many different areas including commercial operations, refining, development, new ventures, planning and marketing, and logistics and strategy.
Bill also serves as Chairman of the NPRA and is a recognized leader in our industry.
In addition to serving as CEO, Bill's been elect to Valero's Board of Directors and will serve as Vice Chairman.
Of course, Greg King will now take on an expanded role as President.
Greg's done a great job in his current role overseeing the finance, administration and legal divisions.
As you know, over the past 12 years with Valero he's served in key positions including COO and general counsel.
Prior to joining the Company he was a partner in the Houston law firm of Bracewell and Giuliani.
So Greg's strengths and areas of expertise are very complimentary to Bill's.
I feel like they'll make a great team.
And Bill and Greg are backed up by the strongest leadership team in the history of Valero so I'm confident that this is a good time for this transition.
All great companies have orderly succession plans.
And I feel like this transition is important for the long-term success of Valero.
I look forward to working with Bill Klesse in his new role and the outlook for Valero could not be better.
Now that we've got that out of the way, let me turn to our third quarter's results and our outlook for refining going forward.
Obviously, despite the challenges we faced operationally this was an outstanding quarter financially.
Net income was 1.3 billion, or $4.37 per share which excludes the special non-cash LIFO adjustment of 620 million.
Net of tax that's $1.43 per share.
The LIFO charge relates to the purchase accounting and LIFO accounting rules as they are applied to the Premcor purchase.
Basically on the day of acquisition, purchase accounting rules require that we initially record Premcor's inventories at their September 1st market values.
As you recall, crude and product prices were an all-time high around this time period due to Hurricane Katrina.
Under the LIFO accounting rules, the inventories were then adjusted to the value of our year-to-date purchases which are significantly lower, and therefore resulted in the LIFO charge.
However, the final year-end values will be readjusted on December 31st.
If the prices continue to climb we'll end up getting a large portion of the charge back at year-end.
Using the current outlook that benefit would be almost 250 million of operating income for the fourth quarter.
Based on this quarter's clean earnings and our earnings in the first two quarters of this year we've already earned $9.42 per share in just nine months.
I'll discuss in a moment the fourth quarter's results, which should be even better than our third quarter's results.
During the third quarter, three major events affected our results.
First, we completed the acquisition of Premcor on September 1st.
We thought this was a great acquisition when we first announced it back in April, and today it looks even better.
On a stand-alone basis, the former Premcor refineries earned 330 million of operating income in just one month, and that's despite having the Port Arthur refinery down for nine days.
This resulted in accretion of around $0.44 per share for the quarter.
The second major event this quarter was Hurricane Katrina, which shut down our St. Charles refinery for about nine days.
In addition, crude supply and power outages resulted in reduced rates at Krotz Springs, Ardmore, Lima, and Memphis.
In a few weeks after Katrina hit we had Hurricane Rita.
Since it happened at the end of the quarter the impact will be felt more in the fourth quarter than the third.
As you'll recall, Rita's path shifted from Corpus Christi, Texas, all the way to the Texas-Louisiana border.
As a result, hurricane preparation called for us to reduce rates at Corpus Christi and ultimately we shut down our Houston, Texas City, and Port Arthur refineries.
The hurricanes also had a negative effect on our wholesale and retail operations.
This was because spot prices increased dramatically and we made the decision to lag the market to keep prices lower than market for the consumer and our branded jobbers.
For the quarter our wholesale operations lost 27 million, while our U.S. retail made only 5 million.
Since branded wholesale and company retail volumes only account for about 20% of our total gasoline sales, this did not have a significant impact on us as some other competitors that sell a larger percentage of their production through these markets.
In addition, the hurricanes drove up natural gas prices by more than 30% over the quarter.
As we now consume about 400,000 MMBTUs per day of natural gas across our system, that obviously drove up operating costs.
That works out to be about $0.30 per share annually for each dollar change in the natural gas price.
Also affecting our earnings in third quarter was the forward sale of roughly 23% of our distillate production at NYMEX price of $5.15 per barrel.
While the NYMEX heat crack averaged $13.79 per barrel, that generated a loss of around 150 million in the third quarter.
For the fourth quarter we have about 18% of our distillate production hedged at that $5.15 per barrel after including the Premcor volumes which did not have any forward sales.
Today the NYMEX forward curve for the fourth quarter heat crack is about $19 per barrel which would result in the hedge loss for the fourth quarter of approximately $220 million.
Our third quarter G&A expenses excluding depreciation were 129 million.
The increase from the second quarter was primarily related to the addition of Premcor and the impact of the higher stock price on our variable compensation.
As I noted earlier, however, the higher product margins caused by the significant amount of refining outages on the Gulf coast more than offset these negatives.
In fact, the storms demonstrated the competitive advantage Valero has in having 18 geographically diverse refineries.
Finally, looking at our balance sheet, continues to be in great shape.
For the Premcor acquisition we assumed 1.8 billion in existing Premcor debt and took out a 1.5 billion term note.
In the third quarter alone, we paid down 700 million of the term note and redeemed an additional 173 million of Premcor bonds.
In October we paid down an additional 300 million of the term note and expect to have completely paid off by year-end.
Also in October we redeemed the Premcor notes of $161 million.
Our debt-to-cap ratio at the end of the third quarter was 29% net of 737 million in cash.
The margin and the environment we experienced following the hurricanes is a reflection of the situation we've been describing for some time.
That the balance between refining capacity and demand has gotten tighter and margins are going to be higher and subject to more frequent spikes than in the past.
Finished product inventories were already tight heading into the third quarter as a result of several years of demand growth outpacing supply growth.
Unfortunately, it took two tragic hurricanes to focus attention on the need to expand refining capacity in the United States.
Rebuilding inventories will take time, especially when you consider that roughly 1.3 million barrels per day of refining capacity still remains off line.
Margins will need to remain high in order to attract enough incremental imports to keep the U.S. market supplied.
Some of you expressed concern about demand destruction.
Though we agree that demand appears to have slowed as a result of the price spikes following the hurricanes, we believe that this was a short-term phenomenon.
When you consider the fact that demand normally drops off in October, the bad weather we've had in many parts of the country, and the high pump prices, we are actually encouraged by the current strength of gasoline demand.
In fact, week after week following Hurricane Rita, gasoline demand has increased to the point now where we're back above last year's level.
As pump prices continue to decline, demand will continue to show year-over-year gains.
We also believe that market concern over capacity creep is significantly overblown.
It took a long time for to us get into the tight situation we are today, and it will take a long time to get out of it.
As you know, the integrated oil companies have historically chosen to invest in upstream because the returns have been better.
And the massive investments in regulatory and Tier II spending, which diverts capital dollars away from expansion projects, continues.
Lead time for major construction projects are long in this industry.
Permitting for projects can take 18 to 24 months.
Just to give you a recent example, it took nearly four years to complete our Texas City coker project from permitting to start-up.
Understandably, there's a lot of talk by both refiners and investors right now about capacity creep, but the reality is if the economy continues to be strong, as it's expected to be, global demand for refined products will continue to grow so we don't think the tight balance will change significantly over the next several years.
Turning now to the outlook for the fourth quarter, which we'll have another record quarter again.
After averaging $13 a barrel in October, the Gulf coast gasoline market is trading around $4 a barrel for November and December.
Distillate margins in October averaged over $20 per barrel, and we're seeing November and December margins trade around $17 per barrel in the Gulf coast.
Mid-Continent margins also continued to be at above-average levels.
As for sour crude discounts, the discounts have been slowly widening from third quarter levels, much like they did last year at this time.
With winter demand serving as catalyst, the incremental supplies are heavy sour crude which pushes the discounts to a much higher level.
The Saudi discounts for November deliveries are at $9.35 per barrel for Arab medium, and Arab heavy discount is $13.50 per barrel.
The Maya discounts also are wide at more than $15 per barrel, and November is currently pricing around $17 per barrel.
In addition, we'll have Premcor assets for the full quarter which should allow our throughputs to exceed 3 million barrels per day for the first time in our history.
As to our earnings outlook for the fourth quarter I know that you won't be surprised to hear me say that your fourth quarter estimates are significantly too low.
In October alone, we've already earned $2.30 per share, which is nearly 65% of the current estimate.
In fact, if the market conditions indicated by the forward curve continues as expected we will be in good shape to have the best quarter in Valero history.
Looking ahead to next year, shaping up to be another great year for Valero as supply will continue to be a challenge in 2006.
We're likely to enter the year at very low inventory levels, particular physical we get cold weather in the Northeast this winter.
Furthermore, the industry is facing tougher regulatory challenges next year that are expected to keep refined product supplies tight.
As you know, the Tier II specs will make both gasoline and diesel tougher to make.
On top of that MTB is coming out of the market as a result of the Energy Bill.
Without MTB in the U.S, gasoline pool, our estimates as well as EIAs and others, put the lost U.S. gasoline production volume in the range of 145,000 barrels per day initially.
To put that into perspective that's the equivalent of losing the gasoline production of two large U.S. refineries permanently.
But demand will be met, so refinery runs and imports will have to continue to be at very high rates next year, and that should lead to continued high margins.
The futures market has already recognized this.
Currently 2006 Gulf coast distillate margins are trading over $13 per barrel, while the 2006 gasoline margins are trading around $8.50 per barrel.
As for next year's sour crude discount, we think the fundamentals is good in2006 as they've been this year.
Demand for sweet crude should remain high relative to the lower quality grades as refiners work to make a lower sulfur product and increase shields of light products given the strong margin outlook.
At the same time, global supplies of medium and heavy sour crudes are growing while the capacity to process them is not keeping up.
Next year, Valero also benefits from the full-year contributions of the Premcor acquisition and the projected 280 million of additional operating income from our strategic capital projects coming on line this year and next.
At Ruba we're nearing completion of a project to recommission an idle 37,000 barrel per day visbreaker which is a bottoms upgrading unit that is projected to add 30 million to next year's operating income.
We will also get the benefit of next year's crude and coker expansions at Aruba.
Another key strategic project benefiting next year's operation is the 75,000 barrel per day expansion of the crude unit at Port Arthur which should be completed by mid-year.
You'll recall that last year Premcor expanded the coker to 105,000 barrels a day in anticipation of this.
One other thing to keep in mind is that we won't have significant losses from forward sales of distillates that we've had this year which could mean as much as an additional 580 million in operating income versus 2005.
All in the future continues to look great for Valero.
Quarter-after-quarter we've reported record earnings because of our industry leading leverage to gasoline margins, distillate margins and sour crude discounts.
The acquisitions and investments that we've made have been perfectly timed and have exceeded our expectations.
And with 18 refineries throughout North America, no other refining company benefits from better geographic diversity.
Yet despite the great outlook for the Company and our compelling track record of solid results, our PE multiple is only around seven times 2006 First Call earnings estimates.
Year-after-year Valero has delivered on what we have promised and more.
Our track record of outstanding acquisitions and operational excellence speaks for itself and will continue.
Even though we've only owned the Premcor assets for a couple of months, I'm very optimistic that we will far exceed our original expectations.
The earnings power of having these assets in our system is something that I'm certain the street does not yet fully appreciate.
For these reasons I believe the market will reward with us a higher multiple in the future.
With that we'll open it up for questions.
Operator
[OPERATOR INSTRUCTIONS] We'll pause for just a moment to compile the Q-and-A roster.
The first question is from Doug Terreson with Morgan Stanley.
Please go ahead with your question.
- Analyst
Congratulations, guys, on your record results.
Bill, between the effects on the hedging program and also strategic investments I think that you mentioned that the profits would rise up on an apples-to-apples comparable basis by around $580 million for the hedging program and $280 million for strategic investments versus 2005.
Just wanted to make sure that those were projections for earnings before interest and taxes and whether or not that is operating income and whether or not they were net of any lost profits related to any MTBE effects?
- COO, EVP
No, these are all operating profits before taxes for next year.
- Analyst
Okay.
And how have you adjusted those numbers for any MTBE effects, or are they already included, or are they not meaningful enough to matter?
- COO, EVP
Well, other than the big unit, we're going to be doing isooctane at the smaller refineries, but it will have an impact, but I don't think it's going to be a material impact.
- Analyst
Okay.
Great.
- COO, EVP
Not at these numbers.
- Analyst
Thanks a lot, guys.
Congratulations.
Operator
Your next question is from Paul Cheng with Lehman Brothers.
Please go ahead with your question.
- Analyst
Thank you.
Good morning, gentlemen.
Bill, congratulations that you decide to take time with your family so I mean well deserved and Bill, also congratulations on the promotion to be the CEO.
Several quick questions.
Bill on the, just for modeling, any number that you can share with us what the fourth quarter footprint may look like by system?
- Chairman, CEO
Paul, I'll take care of that.
In the Gulf Coast region we're expecting to run between 1600 to 1650.
These are all in thousand barrels a day.
West coast run 300 to 3 10.
Mid-Continent, probably 550 to 575.
And then in the Northeast, 575 to 600 a day.
I'll point out there there's a fairly substantial turnaround at Delaware City where we're turning around a coker and a hydrocracker and that's about a 35-day event.
So those are, that's what I'd note there.
- Analyst
You go into January with quite a lot of free cash next year.
What's the priority of the free cash flow used I mean so far that you have a [inaudible] pretty minor share buy back program you [inaudible] just for anti-dilution.
Is there any plan that you may want to expand or become a bit more aggressive, particularly that when you look at and believe your stock is undervalued?
- Chairman, CEO
You know, we've got a pretty aggressive capital plan next year, and we still want to continue to pay down debt, but after that, you know, the priority would be buying back stock.
- Analyst
Bill, what kind of debt or absolute debt level that you want to reach before you would contemplate a more aggressive share buy back program?
- Chairman, CEO
These are actually, you know, what the rating agencies are telling us.
Mike, you want to comment on that?
- CFO
Yes, we're continuing to pay down our debt.
So far this year we've paid down 1.8.
- Chairman, CEO
He's asking for kind of a target.
- CFO
Yes.
The target, it's hard to pinpoint, but we need to continue to pay down a little bit more debt.
So as far as an absolute number, it's hard to target that.
- Chairman, CEO
Paul, the problem we have is, you know, the rating agencies take every long-term lease and then they count that as debt.
So when you look at our balance sheet and you look at a low debt-to-cap ratio of 32%, then you add back all the leases, and it gets us up to about 40%.
- Analyst
Right.
But even that said, I mean, the cash flow would be phenomenal for the next couple of years.
- Chairman, CEO
I'm glad you said that because this is the first time everybody's been talking about everything being great for a couple of years.
The test everybody uses, includes rating agencies looking back.
That's the problem we face in this buy back stock.
You know, we don't have any leeway right now to buy any.
- Analyst
So you [inaudible] rating agencies saying you cannot buy back stock and you don't know when that they would be satisfied, either.
- CFO
So we can buy back about 200 million in total in the fourth quarter which we've already done 50, and then after that, you know, the term loan should be paid off and then we will owe what our commitment was to get the term note reduced significantly, then we have the leeway to purchase more stock.
And obviously we have reduced the term loan significantly.
- Analyst
Bill, can you give us what, I know this may be a little bit [inaudible], what the Cap ex may look like for 2006 and 2007?
Is it still at the 3 billion, or that gives them the strong cash flow that you may opt to spend a bit more?
- CFO
Yeah, Paul, this is Mike.
Right now our 2006 is about 3.4 billion, is our number.
- Analyst
Mike, I think previously that the number is about 3 billion, about 1.5 related to the maintenance capital.
The increase is all related to incremental growth or general just because of cost inflation?
- CFO
No, a lot of, some of this is due to the addition of Premcor, and the 3 billion that we had, we had a little bit lower number for Premcor, and now the 3.4's a little bit higher.
- Analyst
Is that because of cost inflation or just because that you have more projects you want to pursue?
- Chairman, CEO
Paul, part of it has to do with we are seeing some increased costs in steel.
When you go through all the specialty types of steel, et cetera, we're seeing about a 10% increase in steel costs.
When you multiply this through on a 2 billion, $3 billion capital budget you can see it's 200 to $300 million.
Also, a couple of the projects, as we've gotten into the Premcor projects, are going to cost us a little more money on the Tier II and on the scrubber project at Delaware City.
So when you get all said and done our capital budget for next year is this 3.4 billion, and this year it's about 2.6.
- Analyst
Perfect.
Two final questions.
I know I took up a lot of time.
What is the cap ex expense per quarter going forward and that number that we may use for the fourth quarter?
And also, Bill, wondering if you can give us a rough estimate, given the negative impact from Katrina and Rita on the operation, what's the opportunity cost that you lost on those?
- CFO
First, I'll answer the corporate expense G&A number.
This is fourth quarter guidance only.
I'm expecting that number to be about 150 million.
Presently we're integrating obviously the two companies, the Greenwich office is still open, and we have commitments to those people up there through the end of March.
And so we will be transitioning from Greenwich to San Antonio.
But the number should be about 150 million in the fourth quarter only.
Then it will start trailing off next year.
- COO, EVP
For your second question on the hurricane, roughly Katrina and Rita cost us about 75,000 barrels a day in the third quarter.
That was mostly at St. Charles, Port Arthur, and Texas City, but I will tell that you we did have, as Bill mentioned in his notes, some supply issues at a couple of our other refineries because of Nederland, which is by Beaumont which is in St. James over in Louisiana.
To the amount of money, if you take the margin, so how you calculate this, but it's about $200 million it cost us in the third quarter, and it breaks down in the sense of Port Arthur is about 75 million, St. Charles about $30 million, Texas City 20, and as Bill mentioned, we actually did cut back at Port Arthur, but we had a coker issue in the third quarter.
So I'm mixing both the hurricanes and some of our own planned down time.
- Analyst
Perfect.
Thank you.
- Chairman, CEO
Paul, we talk about this 200 million, but again, you're talking about margins that went out of sight when the hurricane hit.
- Analyst
Right.
- Chairman, CEO
And so, you know, we may have lost 75,000 barrels a day, but we sure in heck made it up in volume with our other refineries.
- Analyst
Understand.
Understand.
Operator
Your next question is from Doug Leggate with Citigroup.
Please go ahead with your question.
- Analyst
Thank you.
Good morning, everybody.
Bill, you must be, I guess, a little bit tempted to hedge some of these heating cracks.
Just wondering what your latest thoughts are there?
And my only other question relates to the upgrade project at Lima.
I just wondered if you could give us your latest thoughts on whether or not you're still happy under the original terms that were put forward by Premcor to go ahead with the EnCana supply agreement?
- Chairman, CEO
Let me do the first and I'll have Bill Klesse talk to you about EnCana.
We have very little hedged next year, almost practically nothing.
The margins are, for distillate, better than they are this year, which is a record year, but we continue to think there's more upside than downside so we're not hedging.
- Analyst
Thanks.
- COO, EVP
On the second question with EnCana, we are still in discussions with EnCana.
Some of the initial, or the initial description of the transaction, there were many things that needed to be articulated and discussed and agreed upon.
We are talking to them still about the whole concept from crude supplies all the way through to project work.
We're in the middle of those discussions and we're still trying to target some conclusion here during the fourth quarter.
- Analyst
I guess I don't want to push the point too much, but for obvious sensitivities, but if I may just ask, would you be prepared to give away equity in the refinery?
- COO, EVP
That was how the Premcor transaction was discussed with the market, but we are looking at all the options with EnCana, and EnCana has lots of opportunity in the upstream also.
- Analyst
Okay.
Thanks very much indeed.
Operator
Your next question is from Mark Flannery with CSFB.
- Analyst
I have a question on Aruba, as well as the smaller upgrading and the fix 'em up projects you have out there.
There is still the mega upgrade option for that refinery.
I'm wondering where we are with that?
Is that still being studied?
Is it still being discussed, or is it really dropped away again now?
- Chairman, CEO
You know our strategic planning, which we've discussed a couple of times, we had numerous projects throughout the system that we're looking at.
We've actually disclosed to the media that we could spend as much as $5 billion and expand capacity to around 400,000 barrels a day.
The project that we talked about earlier where we had this, quote, mega expansion in Aruba has pretty well been replaced to looking more, once we get the visbreaker up we'll be up at the 275 to 285,000 barrels a day.
Now we're looking at reformers and the capability to make some finished gasoline which we do not make there.
The other projects that are in this mix we're still studying here to decide what we really want to do.
As Bill mentioned we have a very large capital budget for next year.
- Analyst
So really there's nothing sort of hanging around on the edge waiting to drop on to the capital budget?
Certainly nothing like that, you know, that theoretical $5 billion mega project?
- Chairman, CEO
Not that project at the moment but we are looking still at St. Charles and at Texas City and Port Arthur, as Bill mentioned.
- Analyst
Great.
Okay.
Thank you very much.
Operator
Your next question is from Jeff Dietert with Simmons.
- Analyst
Good morning.
Bill, you've been an outspoken and colorful leader, I hope you don't fade away too quickly.
You'll be missed.
I wanted to follow up on Mark's question.
What all are the projects in the mix?
You talked about St. Charles.
Is that the same big expansion you talked about previously, or have you adjusted your thoughts there?
And tell us more about Texas City and any other projects that may be in the mix.
- Chairman, CEO
Well, you know what we're doing in the sense of these large hydrocrackers at St. Charles and Houston, which are very large projects.
Both are over $400 million.
And those are taking care of the ultra low-sulfur diesel, but in the sense we're going to also hydrocrack the light cycle oil.
Other projects, we have a crude expansion in Quebec that I think you're familiar with that starts up in '07.
That is actually in our budget.
We have in Houston a CCR project that is in '08, it is a large project.
In '07 at Texas City we have a crude coker and cat cracker expansion.
These are, it's not an extremity expansion but obviously coker economics are excellent today.
It's about a $70 million project with a return over 30%.
At Wilmington we have a minor crude expansion that we're looking at in '08 also.
And then of course it's the Port Arthur crude coker which we have capacity, there's a project underway takes it to the 325, but Premcor had built the crude tower to 400,000 barrels a day, so we're also analyzing that to see if that is an attractive project to utilize that shell capacity.
Those are the projects that -- the significant ones that we have in the budget.
Obviously, like some of the other companies have announced, we're looking at these other type projects around these refineries, and they're all in study.
- Analyst
How big an issue is the capacity at the engineering and consulting firms relative to the industry's expansion plans here?
- Chairman, CEO
Hey, Rich, you want to answer that?
- SVP Refining Operations
Yes.
What we hear from the industry, there is quite a bit of activity in coker studies going on, but in our system we're not having any difficulty whatsoever getting engineering contractors to support our business.
So not a problem.
- Analyst
Very good.
Thank you.
Operator
Your next question is from Nikki Decker with Bear Stearns.
- Analyst
Good morning.
First of all, Bill and Bill, congratulations to both of you.
We wish you each well in your new role.
On the operating costs, wonder if you could just tell us what are the hurricane-related costs embedded in this quarter's operating costs?
- Chairman, CEO
Rich?
- SVP Refining Operations
Just in general, looking quarter-on-quarter, third quarter versus the second quarter, we would say the hurricane impacts are about $0.13 a barrel overall.
Now that does have a denominator impact as was mentioned because there's about 75,000 barrels a day of lost throughput.
That accounted for about $0.04 a barrel and then we had direct costs that were about $0.09 a barrel.
I think as you know, we mounted a significant effort towards the restart of both the St. Charles and Port Arthur facilities, including lots of residential support for employees and contractors, meals, portable generators, et cetera, so there's quite a bit of direct refining costs to support the refinery restart and, in fact, the repairs that were more extensive in the Port Arthur refinery from the wind damage.
- Analyst
So would you be able to give us some guidance for average fourth quarter per barrel operating costs?
What's the run rate here?
- VP Investor Relations
Rich, let me answer that one.
Nikki, it's Eric.
I can tell you, pretty much it's flat with the exception of two regions, meaning flat with where the third quarter levels were.
But in the West coast I'd expect cash operating cost per barrel to probably be up about 10% there.
Natural gas, the sensitivity is pretty high there to natural gas price changes and with this environment I think there will be higher costs there.
In addition, the Northeast I think there you'll see, you know, probably cash operating costs in maybe the 350 per barrel range.
Couple reasons there, we'll have Delaware City for the full quarter.
They have a bit higher operating cost structure and they've also got the turnarounds going on there that I mentioned which will impact the throughput somewhat, and also natural gas as well impacting those.
But in the Gulf coast and in the mid-continent we expect to be pretty flat with the third quarter level.
- Analyst
Eric, are you expecting to incur more hurricane-related costs in the fourth quarter?
- VP Investor Relations
Rich, do you know?
- SVP Refining Operations
Yes, I mean, we will since part of the Port Arthur the down time extended into October so we'll see some repair-related costs and restart costs in the fourth quarter.
- Analyst
Okay.
Thank you very much.
Operator
Your next question is from Ann Kohler with Delman Rose and Company.
- Analyst
Good morning, gentlemen.
You guys have really significant exposure on the natural gas side, and certainly with those prices being so extremely high, is there anything that you're looking at to try to reduce those costs, if you can, or looking at different systems to reduce your exposure to natural gas or any sort of hedging?
- Chairman, CEO
We do not, on the natural gas, we consume about 400 million a day now with Premcor, and, yes, you're exactly right, we're exposed to that.
We basically are buying it monthly.
What we are doing is obviously all our energy projects, energy conservation projects, look very attractive, but they all take lead time here.
But we're working on those.
Longer term, we're actually looking at what we can do with petroleum coke, as you know, is a very low valued energy source.
But otherwise, it's energy conservation projects, fixing stream traps, making sure we have our heaters fired properly.
We also look at alternate fuels where we can.
We run that analysis almost daily to see if we should be fueling propane or butane.
But we are very exposed, as you said.
- Analyst
Is there any time frame in any thought as to your ability to bring that number down?
Is that a year or two years, or longer term than that?
- Chairman, CEO
The answer is yes, it's over time.
It's very much part of our strategic plan.
We use the Solomon Energy Intensity Index like a benchmark for our operation.
Over time we are, have demonstrated and continue to demonstrate a reduction in that number, but it takes us -- we'll work all the projects, as I mentioned it just takes us a couple of years.
You'll see a gradual decline, though, in the energy intensity.
- Analyst
Thank you.
Operator
Your next question is from Chi Chow with Petrie Parkman.
- Analyst
Thank you.
Regarding the Premcor refineries, now that you've had them for a couple of months are you finding any more or less energy opportunities at each of the respective plants?
- Chairman, CEO
I think we're right on target.
We had, what, 200 for next year?
So we're right on target.
- Analyst
Are you seeing more of the --
- Chairman, CEO
Right now, we're seeing what we saw.
We don't have a bigger number.
- Analyst
Okay.
Are more of the benefits going to flow through the margins or op costs?
- Chairman, CEO
Well, we certainly are getting the crude synergies.
We had an example the other day.
We're moving products from sweet gas all from Memphis down to St. Charles which was one we hadn't really focused on.
We talked quite a bit of taking some of Krotz Springs material North to Memphis, so we are finding those type of items.
We've incorporated the Mexican, or PMI, Maya crude contracts, where we are a big consumer of that on the Gulf coast, we now have Port Arthur, and working with PMI we have the ability to move those cargos around as long as we honor our overall demand.
So those type of things are happening.
In the East coast at Delaware City and Paulsboro we're very actively looking at how we can reduce our crude costs.
So answering you today, we're working very hard on the commercial side of this.
And as we get into this more and more, we'll work on the capital project side and the expense side, and, of course, don't forget the gasifier at Delaware City.
We've actually hired two coke gasification experts that have joined the Company here and they're stationed there at Delaware City, and with the help of the Delaware City people we've been able to improve the run rate already on that gasifier which is a huge financial opportunity for Valero.
- Analyst
Do you see differential performance in 4Q versus 3Q with the gasifier at Del City?
- Chairman, CEO
Well, we have the coker down but the answer would be yes, we expect to show the gasifier normalized for all of this to be a better operation as we go forward with our target to get it up to 1800 to 2,000 tons a day, and that will require some capital as we disclosed to everybody.
- Analyst
Great.
And do you have an outlook on your turnarounds in the first half of next year?
Yeah.
Bear with me just a second, Chi.
- Chairman, CEO
Do you have that sheet in front of you, Rich?
- SVP Refining Operations
I do.
Let me cover it.
First of all, it was summarized for the fourth quarter.
We have Delaware City's coker down and hydrocracker.
We also have [Mckee's] cat cracker down currently.
Both those turnarounds will wrap up between mid and late November.
We do go into a number of turnarounds going into the first quarter.
First at Aruba, we're going to take a crude and coker train down.
This will be for the purpose of doing maintenance and installing the expansion project that we have in our plan.
That will be about a 20-day outage.
It takes about 110,000 barrels a day of crude capacity off line.
We'll also take down the Corpus East plant.
This is the portion of the refinery we acquired from El Paso.
About a 100,000 barrel a day crude unit and about an 18,000 barrel a day coker.
That will be down for 28 days.
We're also going to take the crude unit down in our Krotz Springs refinery.
It's about an 80,000 barrel a day unit.
That will be about an 18-day outage.
Later on in the quarter we'll take the small cat cracker down in Corpus Christi.
It's about a 20 a day plant.
That also is part of the old El Paso plant.
That will be a 21-day turn-around.
We'll take the Lima cat cracker down, it's a 40,000 barrel a day unit, and also it's a 23,000 barrel a day coker, in March.
That will be followed by, also in the former Premcor system, the Memphis refinery will do a plant-wide turnaround in March.
That will be about 21 days.
And then finally in the first quarter we're going to be taking down some of the crude capacity in Texas City.
We'll take about 130,000 barrel a day off line in March, and that will provide an opportunity for to us do our DHT revamp, part of our ULSD strategy.
That will be about a 21-day outage.
- Analyst
That seems like a pretty heavy schedule.
Have things moved from 4Q into 1Q due to the hurricanes?
- SVP Refining Operations
No, not really.
We did see some movement within the fourth quarter, but nothing really has moved forward into the first.
- Analyst
Okay.
Great.
And I have one final question.
With the ongoing tight supply demand situation and the focus on the high fuel prices by regulators, do you expect any pressure to waive or delay the low-sulfur diesel specs next year?
- Chairman, CEO
We have proposed that they should delay those because we did lose a month or so of construction.
We lost it at many of our plants, including even the Texas panhandle plants where many of the contractors had to go back to the Gulf coast, however, it's driven, the feedback we have from the EPA is it's driven by the engine manufacturers needing the ultra low-sulfur diesel for the '07 engines, and so as of this point in time, we would expect a ultra low-sulfur diesel program to continue.
- Analyst
Thanks a lot.
Operator
Your next question is from Paul Sankey with Deutsche Bank.
- Analyst
Hi.
Good morning, gentlemen.
The demand side of the equation you've talked about it in the release but it almost reads a little bit more like an opinion than a fact.
I wondered if there's any actual data behind the idea that demand will recover?
And if I could ask you a follow-up after that please.
- Chairman, CEO
Hey, Gene?
- SVP Retail and Specialty Products Marketing
Yes, the demand on the last two weeks for gasoline in the U.S. has been closer to the nine million barrels a day number which is actually a little bit above where it was for the same period last year.
If you look at the four-week average which had had nearly [inaudible] obviously in there, that was more affected by the hurricane, so we think a lot of the demand destruction is because the supply wasn't there at the terminals and people had to wait in line and everything.
There was some demand destruction just from that.
Now that we've seen plenty of supply at all the terminals, we've seen pump prices moderating, which continue to moderate, we're seeing demand pick right back up to where we were on the same period last year, or a little bit better maybe.
- Analyst
Sure.
Great.
Thanks.
In terms of the shape of the demand barrel, can you talk a little bit about how that may be affected by the natural gas problems we're facing and obviously I'm talking about demand for the heavier end and how that may impact fuel margins going through winter?
- SVP Retail and Specialty Products Marketing
I know on Paulsboro we already see distillate prices being lower than natural gas so we're already looking at substituting diesel up there.
According to one of the consultants that follow us very closely, they think there's going to be about 200,000 barrels a day of distillate being burned in place of natural gas because of the high natural gas prices.
- Analyst
Are you seeing anything at the very heavy end I mean res fuel-type level in terms of actual demand as well?
- SVP Retail and Specialty Products Marketing
I think generally fuel oil value, [fix] oil are cheaper than natural gas but they always are so I think we're seeing a lot of low-sulfur resist demand but we see that pretty much every year this time of year, though.
- Analyst
Great.
Thanks.
Further to all of that your resale operations notably did fine actually through the quarter.
Can you talk a little bit firstly about how you managed that, which is very much in contrast to some of the other results we've seen, and secondly talk a bit more about the outlook for both Q4 and next year in that area?
Thanks.
- Chairman, CEO
Retail?
Gary?
- SVP Retail and Specialty Products Marketing
Yeah, this is Gary.
We manage it, as Mr. Greehey said, we try to be very conscious of the rising costs that we saw as a result of the hurricanes, and, of course, we like the refineries, had to respond to the hurricanes.
We saw, you know, some very significant swings in demand over that period, but it looks like, as Gene said, with prices, they're off $0.40 a gallon on the streets just since the first of October across our network, so it looks like that demand is coming back.
October is going to be a good month for us and we think we're going to finish up the fourth quarter will be a good quarter for us as well.
And, you know, we're forecasting 2006 to be certainly better than we saw in 2005, and that's largely because of -- we think we'll see street prices more moderate than we saw this year where we saw street prices and costs were really under a lot of pressure throughout the year because of the rapid rise in crude costs.
- Analyst
Okay.
Great.
That's it for me.
Thank you.
Operator
Your next question is from Jennifer Rowland with JP Morgan.
- Analyst
Thanks.
Just a quick question on your insurance policies.
Can you comment whether or not you expect to be receiving any insurance proceeds as a result of the hurricane impacts, or how your insurance policies work?
- President
Jennifer, this is Greg.
We are looking into that now.
We've notified our carriers about possible claims with respect to Rita.
Nothing on Katrina, but just on Rita.
And I think there will be some coverage but I think it's a question of how much at this point.
- Chairman, CEO
Again, this is business interruption right, property.
- Analyst
You do have business interruption insurance?
- Chairman, CEO
Yes, we do.
- President
Chances are we'll have a claim.
- Analyst
Does it kick in after a certain amount of days, the business interruption insurance?
- President
Yes, there is a deductible or self-insured retention of about $100 million, and that is the number.
And we think we exceeded that just given the number of days we were down, and that's how it works.
I mean, there's a 45-day, or --
45 days with a minimum 50 million and a maximum of --
- Analyst
I'm sorry, the minimum was 50, and maximum was?
- President
The minimum's 50, the max is 100, on the retention.
- Analyst
Thank you.
Operator
Your next question is from Ted Izati with Bear Stearns.
- Analyst
Hi.
Congratulations on your quarter, everyone.
First of all, where do you see your debt ending up at the end of the fourth quarter?
- CFO
Well, we do not have any, we will pay off most likely the term loan in the last two months.
And then we don't have any maturing debt so we'll be roughly on a debt to cap basis probably around 24, 25%.
- Analyst
Okay.
Then your leases would just sort of come down a little bit, or how does that work?
- CFO
The operating leases or capitalized leases?
- Chairman, CEO
He's talking about operating.
- CFO
The operating leases will be pretty much constant quarter-to-quarter.
- Analyst
Okay.
And then the second question I had is, are you still or would you be considering any other strategic-type activities outside of the United States in terms of acquisitions in Europe or anything like that?
- Chairman, CEO
Not at this time.
We're still studying it, but not at this time.
- Analyst
Okay.
And then my last question has to do with your credit ratings.
Do you, I think it could be very, very credibly argued that you're severely under rated here.
And I guess the question I have is, given the fact of what you said about where you think your stock price valuation is and about the stock buy backs and so forth, do you at some point sort of say, you know, we can't do anything more about our ratings, we're just going to go ahead and do something, or are you going to wait until you get to a certain rating level or what is your goal in that regard?
- Chairman, CEO
I tell you, we would never say that about ratings with all the credit that we have for refining, you have to be investment grade, and you have to be concerned about what they think.
So we work closely with the rating agencies.
- Analyst
So where do you ultimately want your rating to be?
Just investment grade, or mid BBB, or do you have a target?
- Chairman, CEO
Mike is saying BBB stable.
I'm saying A.
- Analyst
Okay.
Well, maybe you're saying where it is, he's saying where he wants it to be.
Thanks very much.
Operator
Your next question is from Mark Gilman with Benchmark Company.
- Analyst
Guys, good morning.
I know the third quarter is a little bit to get one's, difficult to get one's arms around, but nonetheless in looking at the throughput volumes and crude feedstocks in particular, it just seems to me to be a little bit of an unusual pattern, trying to factor in one month worth of the Premcor units, particularly in terms of a much greater intake of sweet than I would have thought given the inclusion of Lima and Memphis.
Any changes made in the crude slate on the basis of either yours or Premcor legacy units from what they've been running in the past?
- Chairman, CEO
No, Mark.
What happened is, if you think about where we were shutting refineries down, we shut down all the refineries, it was Houston, Texas City, Port Arthur, Katrina with St. Charles.
But we've been running sweet, the increase is Lima, Memphis.
We might have had a little more sweet in the mix at Ardmore only because of asphalt pricing but otherwise we just run the LPs and let them go.
- Analyst
Okay, Bill.
Thank you.
Operator
Your next question is from John Zaringer with Loomis Sales.
- Analyst
Thanks.
A couple of quick ones.
Could you update us on the status of negotiations with EnCana regarding the Lima facility or the redesigned Lima facility?
- COO, EVP
I spoke to this a few minutes ago, but we are still talking to EnCana about all the options that are on the table.
The only thing I would add is that obviously there was a memo of understanding, memorandum of understanding, but there was a lot of undefined terms.
And so we're looking at all the options based on Valero's strategy relative to EnCana's strategy, each company going forward.
And so we're talking, and we're trying to find the right arrangement between the Company.
- Analyst
So it sounds as if a much broader set of issues and concerns is on the table now than was the case six months ago.
- COO, EVP
I don't think there's more, per se.
I think we're trying to make sure everyone understands all the options as it wasn't that defined.
- Analyst
Okay.
So you're just doing all the heavy-duty due diligence before you make one decision one way or another?
- COO, EVP
That's right.
We're working with them also relative to their strategy and what they really want to do.
- Chairman, CEO
Okay.
- Analyst
I don't think we really can go much further than that.
You just have to do your work and they have to do theirs and see how it works out.
- COO, EVP
That's right.
- Analyst
Thank you.
Operator
[OPERATOR INSTRUCTIONS] Your next question is from Jeff Davies with Wachovia Securities.
- Analyst
Good morning and thank you.
Now I'm just wondering again on the debt wondering, you know, you've talked about paying down the term loan here in the fourth quarter and obviously talked about the desire to be higher rated.
There's some higher coupon Premcor debt out there.
Is there any motivation to take those out, perhaps in tender offers or would you just wait until the call dates in those?
Well, we will be evaluating that.
We have taken the [inaudible] out which had a high interest rate, those were taken out in October.
- Analyst
Sure.
So we will continue to evaluate, you know, all of our debt to see if it makes sense to tender for some of it or prepay it or whatever.
We'll be doing that next year.
- Analyst
Okay.
If I could ask just a big picture question here.
You touched on, you know, the capacity creep being overblown and granted, most of these projects are multi-year lead times, but, you know, I see the Marathon announcement, potentially something coming out of Motiva here.
Is there an inflection point in your mind where enough cat capacity comes on line that return hurdles start to come into question?
- Chairman, CEO
Well, the projects that I discussed earlier are in our budget, and they're really the bottlenecks or underway, and they have good return.
Going forward on these larger projects, what we're doing is analyzing them, too, and we look at what's happening in the industry just like everybody else.
And one of the companies even said they would make a decision in the first part of '07 on their project and I suppose many of us are in the same boat as looking at how much they're going to cost, what we think the rate of return is, and what our competitors are doing.
Our internal numbers show that in the next several years demand is going to exceed supply on a worldwide basis in the U.S.
- Analyst
And that's for how long?
Well, we've got a five-year plan, and two, three years it shows a shortage and then it shows it coming closer into balance.
- Analyst
I guess just one last one piggy-backing on that question as well.
I don't know if you would care to comment on any of the windfall profit tax groundswell that clearly perhaps being politicized a little bit much.
Bit I don't know if you care to make any comments.
I don't think it's going to happen.
I mean what they're trying to do, the administration's trying to get people to invest in refining, and if you're going to put a windfall profit tax on the profit you make in one given year, kind of defeats the purpose of what you're trying to do.
We visited with the Secretary of Energy and, you know, if you look at the returns Valero has had from '97 even through this year, on our investment, it's been like 8%.
And I think with prices coming down, you know, that will gain less and less steam in Congress.
- Analyst
I agree.
Thank you.
Operator
Your next question is from Edward Okine with Basso Capital.
- Analyst
My question has been answered.
Thank you.
Operator
There are no further questions at this time.
- Chairman, CEO
Okay.
Thank y'all very much for your interest and if you have any questions give me a call at the office.
Thanks.
Operator
This concludes today's Valero Energy Corporation third quarter earnings release conference call.
You may now disconnect.