瓦萊羅能源 (VLO) 2008 Q2 法說會逐字稿

Good morning.

My name is Christy, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Valero Energy to announce second quarter 2008 results conference call.

All line have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer session.

(OPERATOR INSTRUCTIONS).

Thank you, Mr.

Smith, you may begin your call

Thank you, Christy.

Good morning and welcome to Valero Energy Corporation's second quarter 2008 earnings conference call.

With me today are Bill Klesse, our Chairman and CEO, Mike Ciskowski, our CFO, and other members of our executive management team.

If you have not received the earnings release and would like a copy, you can find one on Valero.com and there are also attachments to the earnings release, which provide additional information on our business settles.

If you have any questions after reviewing these tables, please feel free to contact Investor Relations after the call.

Before we get started, I would like to direct your attention to the forward-looking statement disclaimer contained in the press release.

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

There are many factors that could cause actual results to differ from our expectations, including those we described in our filings with the SEC.

Now I will turn the call over to Mike.

Thanks, Ashley, and thank you for joining us today.

As noted in the release, our second quarter 2008 earnings came in at $1.37 per share.

Second quarter 2008 operating income was $1.2 billion, compared to $3.2 billion reported in the same period last year.

The decrease in operating income was obviously due to the company's lower throughput margin per barrel of $10.82, which was down $7.32 per barrel, or 40% versus the second quarter of 2007.

The key driver of the decline was lower margins for gasoline and secondary products, such as asphalt, fuel oils, petroleum, coke and petrochemical feed stocks.

Similar to the first quarter of 2008, these margins remain compressed in the second quarter, as the prices for those products did not increase proportionately with the increase in feedstock costs.

However, throughput margins benefited from strong margins on distillates and on wide different useless for the heavy and sour crude feed stocks.

Second quarter 2008 operating income was also affected by $148 million increase in refinery operating expenses from the second quarter of 2007.

This increase was mainly due to higher energy costs from the increase in the cost of natural gas and electricity.

Second quarter throughput volumes averaged around 2.7 million barrels per day, which was 48,000 barrels per day lower than the second quarter of 2007, but nearly 140,000 barrels per day above the first quarter of 2008.

The increase in volume from the previous quarter was primarily due to higher operating rates at Port Arthur, where we completed the coke drum repairs and also at Aruba where the vacuum tire repairs were completed.

General and administrative expenses, excluding corporate depreciation, were $117 million.

The $18 million decrease from the first quarter was mainly due to decreases in expenses for environmental and legal reserves, and incentive based comp expense.

For the second quarter, total depreciation and amortization was $369 million, and interest expense, net of capitalized interest, was $83 million, both in line with our guidance.

Our effective tax rate on continuing operations was 33%.

Regarding cash flows for the quarter, capital spending was $741 million, which includes $100 million of turnaround expenditures.

In the second quarter,we continued our stock buy back program by spending $182 million to purchase 3.8 million shares of our stock.

We have also purchased 2 million shares in July, which takes our total purchases to nearly 15 million shares for the year.

We currently have approximately $3.6 billion of repurchase authorization in addition to our ongoing antidilution program.

With respect to our balance sheet at the end of June, our total debt was $6.5 billion.

We ended the quarter with a cash balance of about $1.6 billion our debt to capitalization ratio net of cash was 20.5%, an improvement from the first quarter ratio of 21.7%.

As to third quarter operations, the following guidance assumes that except for the closing of the Cross Spring transactions, which I'll discuss in a moment, no other divestitures are expected to close in the third quarter.

So for modeling purposes, you should expect Gulf Coast refinery throughput of approximately 1.45, to 1.5 million barrels per day.

Midcontinent throughput should be about 430,000 barrels per day, West Coast throughput should average between 280 and 290,000 barrels per day.

And the Northeast system should average in the range of 540 to 550,000 barrels per day.

On refining, cash operating cost, they are expected to be about $4.60 per barrel.

For some of the other items for the third quarter, we anticipate G&A expense to be around $135 million, net interest expense should be around $75 million, total depreciation and amortization expense should be around $370 million, and for the third quarter, we estimate a 34% tax rate, which excludes the effects of the gain on the sale of Cross Spring.

After reviewing our capital plans, we are reducing guidance for our 2008 and 2009 expenditures on capital and turnaround costs.

We estimate 2008 expenditures will come in around $3.8 billion, down $400 million versus our previous guidance of $4.2 billion, and down $700 million from our original estimate of $4.5 billion.

And although we are still developing our 2009 numbers, an early estimate is that next year's capital spending and turn arounds will be in the $4.5 billion range.

This estimate includes work associated with the hydrocracker projects at our St.

Charles and Port Arthur refineries.

The sale of the Krotz Springs refinery was effective July 1, and due to the long-term product supply agreement between Valero and Elan., the disposition does not constitute discontinued operations and our prior year period results for the Krotz Springs operations will not be reclassified as such.

Now I am going to turn the call over to Bill.

Thank you, Mike.

As Mike said we ended the quarter with the balance sheet in excellent shape and an excellent cash position.

Our operations continue to improve.

At Port Arthur we have repaired the crack in the coke drums and we are pleased with the results.

This should allow us to defer replacing these drums until late 2009, or early 2010.

Repairs to the Aruba Vacuum Tower were also completed and we completed the turnaround of the Delaware city coker.

With strong distillate margins and reasonable addition counts for heavy sour crude feedstocks the return of our complex coking refineries is helping our earnings.

Also, as crude oil prices have been falling recently, the differentials or losses we incur on other products of these secondary products, about 20% of our output, are also narrowed.

There is no question that gasoline margins continue very weak.

Clearly, gasoline demand in the United States has slowed, reflecting the weak economy, the general feeling of less wealth, the high prices and the impact of ethanol.

Interestingly, ethanol has had very little impact on crude oil prices.

But it's having a significant impact on refiners and a huge impact on food prices.

This growth demand in the United States is lower in the United States as well, but world demand primarily in Europe, South America and Asia is more than offsetting the weak domestic demand.

Lower refining operating rates, especially in cat crackers, will continue.

With an economic recovery, lower pump prices, and a stabilization of the housing and financial industries, we expect gasoline and diesel demand domestically to recover.

Concerning our strategic review process for (inaudible) methods we have not received an acceptable proposal that would justify a sale.

We will not undertake a transaction that is not in the best interest of our shareholders and employees.

We continue to evaluate our options.

For Aruba, we continue to pursue a potential transaction.

Clearly, we have not met our own schedule, as the asset strategic alternative effort is going slowly for a number of reasons, some of which are the general economic situation, the availability of debt financing, and the current financial situation of some of the other independent refiners.

We have already sold two refineries at values that are in our shareholders' interests and will continue to review our asset portfolio to maximize long-term shareholder value.

Given our healthy balance sheet and proven earnings power in a tough margin environment, we, as you, are disappointed that our Valero stock is trading at an equity market cap of about $17 billion; about our inventory and cash values.

Adding our debt, we estimated our assets are being valued for less than 20% of replacement costs.

If our refineries had the same complexity adjusted value that we received for Krotz Springs our stock price would be twice as high.

Our current valuation appears very low.

Also, the world oil demand continues to grow, with expected growth of around 1 million barrels per day this year, which requires additional refining capacity.

As always, location, configuration and a commitment to excellence are keys to success.

Our product and value to society may improve the standard of living for all people around the globe.

We will now open the call for questions.

(OPERATOR INSTRUCTIONS).

Your first question comes from Paul Cheng from Lehman Brothers.

Your line is open, sir.

Good morning, gentlemen.

Mike, can you give me some quick balance sheet numbers, the working capital, long-term debt and market value of your inventory in excess of the book value?

Our current assets are a little over $15 billion, and if you exclude the cash of about 1.6, that would be about 13.6 in current assets, current liabilities 12.8, a little under $13 billion.

And we have current maturities of $200 million.

Net working capital is 2.4 but if you exclude cash and current debt it's right at about $1 billion, net working capital.

And what is the equity excluding the intangible value, intangible goodwill?

Goodwill is, what, about four.

$4 billion.

$4 billion is our goodwill.

14.7 would be our equity without the goodwill.

14.7.

Yeah.

You asked about the debt.

Our total debt is $6.5 billion.

And you say that 200 is in the short term, right.

That's right, we only have 200 in --

Long-term is 6.3?

That's correct.

How about market value of your inventory in excess of the book value?

Okay.

It's about, at June 30 it's about $10 billion in excess of our book value.

Great.

Thank you.

I think also going -- is there any meaningful inventory gain or loss or trading or hedging gain or loss that in the quarter we should be aware?

No, Paul, there's not.

And Bill or Mike, you say that for next year that (inaudible -- heavy accent) is about $4.5 billion.

I think that was from what you guys have been saying.

Let's assume under the worst case scenario the market conditions doesn't really improve much from here.

What is the minimum type of spending that we maybe talking about?

I mean what is already committed and what can be cut?

Well, we are in the middle of our strategic planning process right now and so the $4.5 billion is what we would call our guidance going into 2009 and it has been what we've been saying.

Our stay in business or maintenance capital is somewhere between 2 and $2.5 billion a year.

Next year is a little higher turnaround year for us.

And then you get into a question, we have to do a scrubber at the Venetia refinery which is a large product, that's a have-to regulatory project.

So we get up around $3 billion.

After that, there are projects that have economics and if it's as you said we are going to look at everything we are doing.

Most important thing that we will do is we will maintain our credit rating with the agency.

Bill, how much is the, with maintenance spending in 2009 related to the Port Arthur hydro cracker?

The spending this year on the hydro cracker?

For 2009.

For 2009 -- do you know?

For Port Arthur hydrocracker that total project is $2.4 billion.

I'm going to guesstimate something like $600 million.

So that means that in theory if we just look at what needs to be spent for the hydro cracker and your maintenance and the scrubber you are talking about 3.6, 3.7, that's probably the minimum that you need to spend?

We are also doing a hydro cracker at St.

Charles, so to finish through your question, but it depends on the economics.

Our cash flow next year.

We look at everything.

The most important thing to us is we are going to maintain our credit rating.

Just so you know, Paul, we still are running our balanced approach here.

We have bought so far this year as Mike said, 15 million shares and we intend to keep the balanced approach going forward.

That's the right thing to do.

Bill, you talk about Aruba.

I think previously you were hoping to close the deal in the second quarter.

Can you give us maybe a little bit more insight in terms what have is holding up?

Is there any major issue between you and the buyer that still needs to be negotiated or that is just --

Well, we did hope to close it in the second quarter and we've been unable to do that.

We are still in discussion with the potential buyer that's gotten so much right up in everybody's press and we are discussing the transaction.

Is there anything that sticks out, is the major hurdle at this point or it is just in general?

I think many of the articles that have been written have looked at the potential buyers domestic refining versus foreign refining, future oil production, where it gets consumed, have been issues that have been for them to decide.

Okay.

All right.

So it's not because of the price or anything that you guys are negotiating?

Well, I don't know, we haven't closed it.

I see.

Okay.

Very good.

Thank you.

Your next question comes from the line of Paul Sankey with Deutsche Bank.

Good morning, guys.

You mentioned maintaining your credit rating.

At the same time, you have $1.6 billion in cash at the end of the quarter.

Are you going to continue to run that kind of cash balance or do you expect that work that down a little bit and could you roll that -- could you answer that question forward into an expectation for buy back, let's say all thing being equal in the second half given that you started Q3 quite strongly on that front.

Thanks.

We've been running a cash balance that's been in this range and so to be specific to you we will maintain cash that's in this 1 billion to $1.5 billion range.

And further to that, the buy back expectations?

We intend to continued to do the balance.

We are also funding our projects because we believe these projects generate long-term shareholder value.

And so we are going to do just what we've been doing.

First quarter we paid off $375 million of debt.

We are going to keep this effort going forward, paying off some debt, returning cash to the shareholder, maintaining some cash on our balance sheet, and funding these long-term projects that really have a lot of value.

So I know what you're asking us, but we are going to just keep going, doing what we've been doing.

Is it fair to stay that the step up in July of the buy back was the function of Krotz Springs completing so we can expect any larger buy back amounts in the second half to be related to transactions as opposed to just redeploying free cash flow?

Krotz Springs did close and so we've deployed the proceeds for the uses I just got through saying.

We also had our stock price fall in the early part of July and our window here for legal was still open so we stepped into the market.

So basically, you're saying that you are going to try to complete the program by the end of the year?

Well, I'm going to continue to do a balanced approach.

The program I'm not sure what program we're talking about.

We have 3.6 billion of authorization from our board.

We do not intend to buy that much stock this year.

A second one if I could.

It's noticeable that the heavy light spread has narrowed specifically as we start Q.

three.

At the same time you have announcements about obtaining Canadian heavy crude longer term.

Could you just talk about the dynamics that caused the heavy light to get so wide Q2 and the extent to which that helped your numbers, and really how you see that continuing, whether or not you think the tightness that we are now seeing in that spread is going to continue?

And how it's going to behave over the interim between where we are now and the first Canadian crude coming, which I guess is beyond 2010, isn't it?

As the heavy sour differential has narrowed, what has happened is that Mexico has stepped into the fuel oil market to buy fuel oil for its electric utility business.

That has strengthened fuel oil markets on the Gulf Coast significantly.

They've been in that market in July, and they are in that market again here in August.

So we see it more as a spot short term situation, with that differential narrowing and also it narrows seasonally with the asphalt business.

As we get later in the year, we would expect that differential to open back up.

Now long-term to your question, clearly, the mild production over the next five years appears to be declining quite rapidly.

You can get that from any consultant that publishes online.

And when we look strategically long-term we believe that Canadian crude oil, heavy Canadian crude needs to come to the US Gulf Coast and that's why Joe Garder and Jane Edwards have worked on a project here to bring Canadian crude with a couple other companies to the U.S.

Gulf Coast and why our Port Arthur refinery will be configured to run heavy Canadian sour.

And that's like a four-year out project.

Are you still there, Paul?

Yes, I'm sorry, I was on mute.

Just to sum it up very quickly you expect the current tightening that we've seen in the spread to widen out towards the ends of the year.

Perhaps start retightening as we go into 2010 and then open up wider when we get more Canadian crude coming down in the future.

Yes.

I'll leave it there.

Thanks a lot.

The next question, comes from Roger Read with Natixis, your line is open, sir.

Good morning, gentlemen.

Going off the commentary that was in the press release regarding, and I think anybody that looks in the futures market can see it the weaker gasoline margins in the back half of the year.

Is that something more of a comment about what the industry has to do, what Valero would do maybe as something of a leader on this?

Do you see it as a geographic or as across the nation kind of cut on the run side?

Well, clearly the crack spreads in the market are very weak going forward through the rest of the year for conventional.

There is a premium, remember, for R-Bob, C-Bob and all the rest of them.

But you're exactly right and so Europe is very low on gasoline, you can see that looking at the East Coast cracks, so quite frankly there is a lot of gasoline around.

As we move into the fall, vapor pressure restrictions lessen and there is more supply as butane gets back into the gasoline pool.

So I think it's fair to say that cat crackers, as I said, will continue to have reduced operating rates and I also, you can make your own judgment as to the industry.

What would that mean in terms of distillate production given that's been the one true bright spot in the industry in terms of how much can you improve the yield there if you're overall having to make cuts on the gasoline side.

Sure, I can make some comments about that.

If you look at our performance second quarter versus first quarter, we increased distillate production by about 110,000 barrels per day.

Now some of that is throughput relate because we had higher volumes in the second quarter.

But we can readily identify a distillate yield shift of about 3% on input.

It would represent about 75,000 barrels a day.

We think that we can extends that in the near term to about 100,000 barrels per day of increased distillate.

Full potential may be as high as 200,000 barrels per day, but getting that second hundred thousand will require some capital retrofits which will take sometime to implement and take some economic valuation.

We are pretty well positioned particularly with some of the capital assets we brought on stream last year to increase distillate produced.

Okay.

And say capturing an additional 25,000 barrels per day would be more of a 2010 event or something like that?

To take it from the 75 to 100 I think that's capturable in the near term within the next six months, let's say.

But then the additional 25 beyond that would be more of a 2010, I mean, trying to think about a maximum ability to take advantage of current market conditions.

We can see it go to 100, and 125 is more of a 2010 event or something like that?

No, I would think that is going to extend into 2009.

Some of what we have planned is we have some of our refineries that actually are configured hardware wise to make large volumes of gasoline, this would pertain to Corpus Christi and to Venetia, there are retrofits that we have retro fits that we have under consideration for 2009 turn around that can give us another boost of distillate producibility, so the way to look at this is, we are going to chip away of this total potential of around 200,000 barrels per day and we are going to just continue to make progress.

When you get out to late 2010 is when we expect to bring on these new large hydrocrackers at Port Arthur, and St.

Charles and that will be another large proof in our distillate producibility.

Okay.

Thank you.

Next question comes from the line Jeff Dietert from Simmons.

Your line is open, sir.

Good morning.

I was hoping you would talk a little bit about the expansions at St.

Charles and Port Arthur.

I think if you look at these expansions on a dollar PPD a day capacity or dollar per complex is the barrel they were more expensive than your stock nine months and are much more expensive than your stock at this point.

Trading as Bill talked about at 20% of replacement cost.

Obviously your current portfolio and the feedstock and yield associated with the St.

Charles and Port Arthur refineries are not the same.

Could you talk about how those economics have evolved over the last six to nine months and why it's a better alternative to invest in the expansions at St.

Charles and Port Arthur than buy back your own stock?

Let me speak to the economics on these projects and what I would say is reflecting back on the last year, we feel even better about these projects than we did when we requested approval for them.

Now, just bear in mind when we looked at these projects we were in a $65 per barrel crude environment.

Now we are much higher.

These projects, since they are hydrocracker based result in significant volume gains.

So as a result, they are far more attractive from a return on investments point of view than we even considered about a year ago.

So we continue to view these as key projects to support earnings growth and position us well into the future.

I think if would you add to or add to go what rich says if you think about a hydro cracker you take natural gas and you make hydrogen.

The hydrogen then becomes liquid in the hydro cracker so that's it's volume gain.

If you look at the relative pricing of everything, and the way to think about it, it really becomes a gas to liquids project.

Also, we are configuring these refineries which are key flagship refineries of ours along with a couple of others, so that to be configured to do make products to the marketplace we think we are dealing with.

And because they are hydro crackers and, of course, the coker customer at Port Arthur running the Canadian crude oil will have 150,000 barrels per day of coking capacity at Port Arthur, combined with this new hydrocracker and the same as St.

Charles, we'll have 80,000 barrels per day of Coking capacity combined with a new hydrocracker that will increase our distillate yields.

So the economics for these projects are very good.

The lead time is huge.

I think some of you know that we ordered these reactors for the hydrocracker, these are these 10.5, 11-inch wall reactors.

They've been ordered now for, say, 18 months at least.

Because the delivery is so long and they are going to add tremendously to the future of our company.

So when you stack this up with a $32 stock price I understand the issue very clearly.

We've done a balanced approach here.

We've already spent on almost $800 million this year buying our stock.

We'll continued to what I mentioned in the question earlier from Paul.

But we think these are key projects to the future of Valero and add tremendous value for our shareholder.

Now if -- I'm sorry -- I'm sorry, were you finished, Bill?

I a.m.

the other thing I would add is we are eliminating a lot of things and delaying a lot of things in our budgets to manage this capital spending with our cash flow and all the demands on it and to maintain a buy back program.

So I'm done, Jim.

Okay.

And so these two projects are to your high two of your highest priority projects and you are pushing other projects out of the mix in order to maintain positive cash flow or cash flow -- positive free cash flow for this year, '09 and 2010, factoring in the potential for asset divestitures and the margin environment over time.

That's correct.

And we as I said very clearly, we still are looking at strategic options or alternatives for some of our refineries and if the environment improves and this is, and some asset action is clearly in our shareholders interests we are interested.

If it's not, we do not have to do it.

Our refineries are improving every day in reliability, safety and performance.

You issued some maintenance activity for the second half of the year.

Were all these projects planned maintenance or is there some unplanned maintenance or accelerated maintenance incorporated here with specific interests on the hydrocrackers?

It looked like there are a fair number of those and those are your main distillate units.

Rich?

Yeah, Jeff, we really are executing our base plans on turn around so there really isn't anything new.

There aren't any new issues that have crept up so we are implementing the program we anticipated in turnarounds in 2008.

Our turnaround activity level will ramp up in 2009 but we have been projecting that for quite some time.

Thank you for your comments.

Your next question comes from the line of Neil McMahon with Bernstein.

Hello, just a few questions, first of all maybe you commented on this, it took me awhile to get on the line, what parts of the capital program are you declining this year?

And is there any follow on into the 2009 budget?

Well, we haven't declined so much this year except we are just, things are a little bit behind.

It tax longer to get equipment now from permitting equipment to labor, productivity continues to be a problem.

So we are, that's why we are issuing lower guidance because we are going to spend somewhere in this $3.8 billion that we said.

But more importantly, we are not starting projects at some of our facilities.

For instance, we had a project in Quebec to upgrade our bombs.

We are now pushing that project out.

We have a pipeline project in Canada that we are reassessing when that should be done.

We have a paraxylene project at St.

Charles that as we're developing our strategic plan here we are going to do certain extraction aspects of it but we may not necessarily enter the paraxylene business this year, we are just deferring it.

We are in the middle of strategic planning and also looking at obviously the real world of the current cracks and maintaining them or looking at our cash flows and what our, and maintaining our strategic efforts here.

So we are going through it project by project, and in this particular case, Rich Marcogliese, Mike Ciskowski and I are directly involved in going through our capital budget line by line and then our strategy meeting is in October with our board.

Just a second question is to be honest I know we've talked about minute nausea and details around operating performance and what can be going on and frankly and I don't know if you would agree it pretty much needs an uptick in the refining environment for a that will get the stock price moving again.

What do you think is going to differentiate you over let's say if we go through a sustained reasonably weak period going forward?

And in particular I'm looking at your diesel strategy which seems to be totally differentiated versus all the other independent refiners and frankly versus most of the integrated refiners in the U.S.

Is that something you think is going to really make you stand out versus others as well as your exposure to the light heavy and things like that?

It's a very good question.

I think that we differentiate ourselves right now showing we are still making money.

We have earnings power in our assets.

If you actually look at our, what I will call our reliability starting january through to today once we got past this coker program we had at Port Arthur here and that major repair we did that stretched out for almost four months, our reliability has improved tremendously.

So I do believe that we are excellent operators.

We bought a lot of refineries that were under invested, under maintained for years.

And you can see us constantly improving our performance.

But clearly, we have some refineries that can compete on the world mark.

If you look at some of the action that is I just mentioned we are taking we also have export capabilities.

People don't like to talk about exports but the facts are it's a world market.

This is a global business: We've been sending distillate all over the place to Europe, to South America.

Our facilities along the U.S.

Gulf Coast are gearing up to do that.

So being a good operator, spending our money wisely, we maintained a balanced program here.

We've increased our dividend, we've been buying shares, we are trying very hard to only spend money on projects that clearly add shareholder value, and we continue to look at our portfolio.

Some people criticized us two years ago when we got out of there looking at disposing of some of our refineries yet I don't think too many people are second guessing that action today.

So I think we are demonstrating that we can profitable in this business and we will be going forward.

And to your diesel question, we see the growth in the world on diesel fuel.

And so thus, our efforts as Rich just articulated to make more diesel, to export diesel and also to add to our facilities to make more in 2010.

Great, thanks, maybe just a comment, Bill, thanks for your comments in the press release today on what Congress should do in terms of energy policy in the U.S.

If there actually is an energy policy in the U.S., I think it's about time somebody stood up and talked about it,

I appreciate your comment but you know all of us are taxpayers.

Why they don't, and we do not drill.

So we feel very like we are not compromising here.

All we want to lower oil prices.

We think it's good for our company, good for the shareholders, good for the consumer.

The government gets money selling leases.

People go to work drilling.

Steel mills go to work making more pipe.

This whole thing is unbelievable.

Your next question comes from the line of Michael LaMotte with JPMorgan.

Your line is open, sir.

Thanks, good morning, guys.

I was hoping you could provide some comment on the glow patterns that you are seeing in distillate exports today and how that's changed over the last few months, particularly as we start to come out of the winter season in the southern hemisphere?

This is Joe Gorder.

We have seeing excellent exports here over the last several months really through all of this year but right now we are averaging over 20 cargoes a month.

We do have significant export activity.

We knew that Chile was the original recipient of a lot of that and that was true.

We are exporting now on a consistent basis also to northwest Europe.

France is taking distillate.

Italy is taking distillate.

So we have a lot moving out.

We've exported some to Turkey.

So we are seeing continued strong demand abroad not only in South America but also in northwest Europe in the med.

With Reliance fully up and running at year end and a couple refineries coming online in China, do you, are you fearful at all that we could see some backing out of some of that demand around the world satisfied by more local capacity and some of those flows backing up into the U.S.

potentially next year?

I don't know if that will back up into the U.S.

but your observation is correct, you are bringing on more refining capacity.

Assuming it all starts up as-planned.

And, for instance, Reliance puts 200,000 barrels per day of low sulphur diesel on the market, it will clearly have an impact.

But the world continues to grow.

And it's very important to remember that whether it's 1 million barrels this year, 900,000 barrels per day this year, remains to be seen but the world is still growing and also in the United States, we shouldn't forget that diesel demand is down over 2% this year, and gasoline is down depending on how you calculate ethanol, is down somewhere between three and 4%.

That with a better economy, so you might say, yeah, well, you guys are hoping for an improved world economy.

But clearly our products do, diesel fuels, economic growth, thing like that, we need a better economy, it always comes down at the end of the day about demand because refineries typically can put out enough product so it's always about demand.

But your observation is correct, as supply comes in, we need demand to keep growing or we'll do what you said.

We are optimistic, though, that demand is going to keep growing.

Which raises a question, Bill, on sort of the whole notion of creative destruction with demand declining here domestically but overseas growth still looking good and the need for capacity, particularly complex capacity overseas.

I'm wondering if you've taken a look at some of the grassroots Greenfield projects that have cropped up in the Middle East or parts of Latin America where you can invest and maybe shed some light on your thoughts on expansion overseas potentially?

Well, we are still interested.

I mean, this is our business.

When you buy our stock you buy refiners.

And so we are interested in those kinds of transactions.

Bullet we are also, understand risk.

And these projects in the Middle East, the capital cost has gotten very, very high.

And so it boils down to at the end of the day, what are the economics really look like?

Or is it just going to be a straight stand alone refining project in the Middle East.

If it's that, it's probably not a play for Valero.

If it's something else that comes with it, Valero could be would be interested in the right transaction.

The world gross and the Middle East is resourced advantaged just line the Far East is consumer advantaged.

Petrobras in particular are stepping up their CapEx on the downstream in the next few years and have looked to do I guess joint ventures or projects or partnering of some kind outside of Brazil and I know obviously Aruba, that aside, I'm wondering if there isn't something to be done with them either in Brazil or aside from Aruba.

I think your observation on them is right.

They appear to have a lot of oil production that's going to come on over the years and they are a dynamic, well managed company.

So I think it just remains to be seen.

Okay.

Thank you.

(OPERATOR INSTRUCTIONS).

Your next question comes from the line of Chi Chow from Tristone Capital.

You talked a little bit about 2008 but can you give us your outlook for the gasoline market in the U.S.

for 2009?

You tell me where the price of oil is.

Well, let's assume oil stays kind of where it's at and we've seen demand destruction here in '08.

Do you expect that to continue on the gasoline side in '09?

If you say the price of oil is going to stay $125 a barrel I would say that gasoline is going to be declining.

I also have to throw in there, though, ethanol is in this mix.

Ethanol this year is going to average 590,000 barrels per day under the RFS And that is taking market share from refiners at a huge cost to the world.

And to the U.S.

taxpayer.

I think we'll see what the new administration does when they get in there, if they have the wherewithal to look at a poorly conceived policy.

But what happens with ethanol remains to be seen.

But it has taken significant market share from refiners.

Because as you know, the U.S.

is still importing over 1 million barrels per day in gasoline.

At what oil price do you think we avoid demand destruction going forward?

I don't know for sure.

Why don't you let me philosophize and say, we started the year at a much lower price, what was it?

Whatever we started the year.

$100 in January.

$100, start thinking back when gasoline was $3 or less than $3.

We lost the front page effect.

It was no longer an issue.

But don't lose track of the fact that people are out of work.

They don't feel as well there.

Gasoline has or gasoline as a percentage of disposable income is still not at the same level as it was in 1981.

Our products really do give you tremendous mobility.

I think we need prices to come down and I'm the first person to admit: It's good for the consumer and it would be good for the refiners.

Back on Jeff's other question on the Port Arthur and St.

Charles projects, how sensitive are the projects economics to the Canadian crude oil.

They are not.

I can answer you this way.

We are basically looking at a Gulf Coast heavy sour crude price any way.

As you look at your economics we are basically doing that.

Remember, the coking, coking today has good economics as we all know.

And hydrocracking as we've already gone through the economics are terrific.

On the project in the Gulf Coast, if you total up all your competitors, their expansion projects as well, we are probably talking about 800,000 to 1 million barrels a day of new expansion capacity down there between 2010 and 2012, is that a concern on placing all that product into the market?

I don't think it will all be placed in the United States and I'm not sure about the number.

Completely Motif is 300,000, and Garyville is 200 rounding off.

But remember our projects aren't increasing crude charge a tremendous amount.

We are really working much harder on the home product side.

They don't go up but they don't go up a tremendous amount.

I only get adding those three projects together about 600 to 650 so there must be some other ones you are referring to.

It remains to be seen how much of that comes online.

Regardless it's a big number.

It's so when you look at it as strategically, we are making sure, because we are on the U.S.

Gulf Coast and you don't think of U.S.

refining as being in a sense of an export center, but this business is global and we will have excellent capability to put our products on the market [inaudible].

And that's part of our project also.

I've got one more quick one, maybe this is for Mike.

any further thoughts on repatriating proceeds in the event of Aruba's divestiture?

We are in the process of implementing a plan to return that money in the event that the divestiture goes ahead and happens .

We are in the process of putting that that mechanism

Any guidance on what sort of tactics you may take there.

I would say that we will probably be able to bring that amount of money back at a 25% tax rate.

We would save roughly 10%.

Okay.

Great.

Thanks for your comments.

Your next question comes from the line of Faisel Khan with Citigroup.

Your line is open.

Good afternoon.

Just a follow-up question on Aruba.

While you continue to wait for the possible sale of that plant can you comment on the level of profitability in Aruba right now?

I don't think we get specific refinery details on profitability but since we repaired the vacuum tower and in late May of last year, the plant ran very profitably in the month of June.

That has narrowed some with the narrowing of the light heavy differential, but we are profitably operating the plant.

Thank you.

Your next question comes from the line of Anne Kohler with Caris.

Your line is open.

Yes, good morning, gentlemen.

My question is kind of tied to a number of the previous caller's questions, and that pertains to one, the additional product that Chi alluded to with some of the expansions occuring, and then certainly, Bill, from the press release, you certainly indicated that the passage of the CO2 legislation would likely negatively impact the industry from both a gasoline and I would assume, from a diesel demand as well.

When you put all of that together, how do you look at your business, and how do you look at capital spending, and just the overall refining environment and fundamentals as we move into the next decade as that legislation comes to pass?

Well, on the CO2 legislation, we don't know what it looks like.

If it's a cap and trade program, it's just basically a tax, and long-term, the reason I flagged these climate issues, when I speak, it's because long-term, it's just going to export refining jobs, and these are good jobs for people who want to work in our plants, but it just raises our costs, depending on what the legislation looks like.

We have a lot of opportunities to reduce CO2 emissions, there's no question that we have all the heaters, boilers, furnaces, that as we go through, we can improve upon.

We're looking to expand our operations off our cap, so we have opportunities to reduce CO2, and that's why we mentioned earlier in the year, if we use some incentives for all industry, doesn't have to be refiners, you'd see CO2 drop significantly instead of just taxing stuff.

Now, as far as the business, the business is growing in the world.

Chi's question, was, well, give me the forecast.

I think it has to do with pricing.

Our products are just like any other products in people's monthly budgets, if our prices get down, a lower percentage of disposable income, people are working, you got to get to work, we get you to work in the most efficient way, so that you can leave when you want to leave.

I'm optimistic about our business.

But I also as you've heard from the management here, we are preparing ourselves at our key refineries to make sure that we can also play in the export business.

Because the refinery is sunk and yet at the same time it's very, very efficient.

So that's how we are doing this.

We see total oil consumption still increasing, but I've answered and said we wouldn't be roaring bulls here on gasoline oil demand.

So we are optimistic about the business but you have to be lean, mean, tough, competitive.

As the business that I've really known my whole career except for the last four, five years.

So basically I mean I guess in sort of summarizing, you are basically looking at hunkering down in an environment if CO2 legislation comes to pass and that would certainly have a negative demands gasoline impact in an environment where you are basically prepared to position yourself with export refineries that are capable of moving product to the best available margin environment in the world?

That's right.

The only thing I would tell as you we don't know what the CO2 legislation looks like.

And the other thing is it takes a long time to pass.

And if people are out of work, and the housing business is still in the dumps, and people start talking about this, they better make sure what it's going to do to the economy.

Okay.

Thank you very much.

Your next question comes from the line of Arjun Murti with Merrill Lynch.

Your line is open.

I will try to be brief.

I don't want you to have to belabor this point but in your statement you talk about the impact on industry utilization for the second half of the year and into 2009.

I know the focus on the call has been on demand.

I'm trying to give a sense from you, what do you think can happen to supply, what needs to happen to supply in the U.S.

over the next 18 months, if nothing happens to demand, if demand doesn't recover?

Do you expect competitors to be forced to take capacity off-line either on a semi permanent basis as well as a seasonal basis and is the scope for the industry to improve distillate yields along the lines of what you have done and continued to?

Well, I don't know what others will do and that's up to them.

I will tell you that no one pays us to lose money and there's no law that says we have to lose money.

So the refiners, some of the other guys, integrators have reported big earnings, some of the other refiners today are depressed.

We manage our business here to make money.

We are a business that 's purpose is to make money for our shareholders.

And so as the cracks are out there, we will make our own determination as to maximize our profit.

But the key point would be, we, there is no law or regulation that says we have to make a product at a loss.

Okay.

Thanks.

(OPERATOR INSTRUCTIONS).

Next question comes from the line of Mark Gilman, with Benchmark Company, your line is open.

Guys, good morning.

Had a couple of things.

Bill, what would determine whether or not you would take an equity position in the Keystone Pipeline?

Probably if we get a look at it long term, but one is the rate of return, at the end of the day, what we really think the equity return is going to be, and secondly, if we have a structure here that takes advantage of the tax benefits for owning that type of asset, and Mark, I would like to leave it there.

If you want to talk about this, if you call the guys, they'll talk some more about it.

Okay.

Bill, what were the volumes that you ran in the second quarter and what specific crudes have you identified for the system as being satisfactory alternates?

Joe Gorder will answer that.

We ran about 450, 460,000 barrels a day in bios.

As far as alternate crudes, Mark, you know that there's a lot of heavy sour crudes available in the Gulf.

We've got a lot of Venezuelan crudes that we've brought and add to the system, we've got Colombian crudes and then Brazilian.

We really haven't had any problem at all as far as securing heavy sour crudes, and frankly at prices that are superior to the discounts we're getting on (inaudible).

We also increased the volume of Canadian Crude that we ran during the quarter, we were running some 25,000 barrels a day of Canadian heavy sour crude now.

As oil refiners, we run our LPs on all of these plants, so we obviously buy a lot of the M-100s besides Moray out of Venezuela.

We've got some Napa, but we run our LPs, and we work the whole thing, combined with a couple of our contractors.

Bill, on the West Coast, it seems to me that Alaskan and San Joaquin heavy have gotten to be comparatively expensive crudes.

How much of that are you running out there, and have you done anything about trying to change that crude slate over?

We're running more foreign trees out there, Mark, as we go.

I'll tell you what.

I need to look and see what the exact volumes of those crudes are, though.

We'll get back to you.

We've been, I can give you some flavor there, Mark.

We've been reducing our A&F volume, and we'll continue to do that, because you're exactly right, A&F is, half of the time it's selling at a premium to WTI.

So we have that under way.

The long term, our long term strategy, if you look at it today, is Middle East crudes or maybe some of the Venezuelan or even Brazilian crudes are going to wind up on the West Coast, and that's what we've been doing to get our crude costs down at both Venetia and Wilmington.

We no longer run Maya crude on the west coast at Wilmington as that crude's been -- it's not on the West Coast anymore, it's all on the Gulf Coast.

So your point is correct, those are high priced crudes, and we are strategically continuing to go to alternates.

We have a contract on A&F and there's another date that comes up later in the year here, as to volume.

Based on my comments, you can figure out what went on there.

We're also building two crude tanks at our Venetia refinery that will be operational at the end of this year or the first of January.

These are large tanks, 650,000 each, which will give us 1.3 million barrels of additional crude storage at the Venetia refinery so that we can execute the strategy I just was articulating.

Does that still apply to San Joaquin, also?

Yes, we're not as familiar, we don't run that much there, is it 25?

25 to 40,000 at that plant, but A&F has been the high-priced crude.

That's still an attractive crude relative to A&S, so we typically maximize it to SJV.

How does your radiant crude priced?

You price it FOB with price delivered.

Where there any timing effects in this quarter that might have impacted the northeast margins in particular, or was the northeast margin effect that we saw almost exclusively the impact of the coke return at Dell City?

We're going to say there is no impact, and the coke return at Delaware City was an extremely long turnover.

We had -- you had the proper, you can criticize us for execution here.

The turnaround itself lasted about 35, 40 days, but then we had a waste deep boiler problem, and it took us basically 60 days to get that coker up, and that negatively impacted us tremendously.

Now, in defense of our people who worked diligently to get it up, this is a fluid coker, and when you do these, it's complicated, but we couldn't run without getting the waste deep water up, so it took us -- we had one leak after another on the tubes, but it did take us 2 months to get the coker turned around and back up.

So on the pricing of the Arabian, is it FOB, or delivered?

Delivered.

Do you hedge it at all?

Only above our LIFO.

And there was no adverse impact on results associated with the procedure in that regard?

No, and I've got to correct one thing.

Don't we buy when it comes in to San Astasia, and then we do ship it up to the East Coast where we use Arabian crudes on the East Coast, but it's only a couple a day, and we have not changed our policies on how we manage our price risk.

Mark, if you're also looking for another element, and looking at the Northeast profitability, the other factor associated with Delaware City is when the coker's down, you don't run the coke gasifier, and the coke gasifier has a major impact on energy pricing at the refinery, so in a sense, the Delaware City profitability has a double whammy.

It's not only the coker that you lose, but you can not run the coke gasifier when the cokers in turnaround.

Okay, Rich, thanks.

I have one more.

It seems to me, to achieve the increase in the distillate year, what it did principally was lower Brazilian and heavy sour in favor of Arabian light and medium.

Is that accurate?

Maybe some cutpoint changes as well, I don't know.

Mark, I can talk about our general approach about how we are increasing distillate yield across all of our plants, and we actually look at it this way: Some of this relates to cutpoint maximization, put as much front end naphtha in the distillate pool as you can and pull as much heavy material off the cat crackers as you can.

And you generally do that to a cetane limit and to a sulphurization limit.

So we've done that.

Additionally, your cat crackers are usually fine tuned to make gasoline.

We have detuned them largely through catalyst formulation changes, to have them favor distillate yields over cat naphtha yields.

We have done that.

thirdly, new higher treating capacity that we put in place to meet the original sulphur diesel regulations.

We already bottlenecked the new hardware, much of which was installed last year.

So we've done a number of things to increase different distillate yields.

We always try to maximize our margins by running the heaviest, most discounted slate, so we have not appreciably lightened up in order to maximize distillates.

This is distillation, cat cracking operations, and distillate hydrotreater debottlenecks.

We are going to further look at whether certain of our hydrocracker operations such as Corpus and Venetia, whether we can change the conversion levels of those to continue to increase distillate yields.

And the two main hydrocrackers Rich mentioned, hydrotreaters, which we call mild hydrocrackers, at Houston and St.

Charles, have had a major profit impact on us.

Okay.

Guys, thanks an awful lot.

We have no more questions in queue.

Thank you, Christy, and to everyone who listened to our call.

Thank you for listening.

Please contact our Investor Relations department if you have any other questions.

Thank you.

This concludes your Valero Energy Corporation conference call for today.

You may now disconnect your line.