瓦萊羅能源 (VLO) 2015 Q3 法說會逐字稿

Welcome to the Valero Energy Corporation reports 2015 third-quarter earnings results conference call.

My name is Ethan and I will be your operator for today's call.

(Operator Instructions)

Please note that this conference is being recorded.

I would now like to turn the call over to John Locke.

Mr. Locke, you may begin.

Thanks, Ethan.

Good morning and welcome to Valero Energy Corporation's third-quarter 2015 earnings conference call.

With me today are Joe Gorder, our Chairman, President and Chief Executive Officer; Mike Ciskowski, our Executive Vice President and CFO; Lane Riggs, our Executive Vice President of Refining Operations and Engineering; Jay Browning, our Executive Vice President and General Counsel; and several other members of Valero's senior management team.

If you have not received the earnings release and would like a copy, you can find one on our website at valero.

com.

Also attached to the earnings release are tables that provide additional financial information on our business segments.

If you have any questions after reviewing these tables, please feel free to contact our investor relations team after the call.

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've described in our filings with the SEC.

Now I will turn the call over to Joe for a few opening remarks.

Thanks, John.

And good morning, everyone.

We had another strong quarter as our team operated safely and efficiently.

Favorable product margins, which were supposed by strong demand during the quarter, incentivized us to run at high utilization rates.

While we are seeing some seasonal pressure on product margins today, demand for our products remains strong, and crude oil markets continue to be well supplied.

So, we maintain our favorable outlook for 2016.

We continue to focus on our priorities of maintaining safe and reliable operations, investing in our business and returning cash to stockholders.

Regarding strategic investments, we continue to grow our business.

We expect to see contributions in the fourth quarter from our recently completed Mckee crude unit expansion, partner with our hydrocracker expansion, and from delivered crude of Enbridge Line 9B.

Additionally, we are making good progress on our two crude unit projects.

The Corpus Christi crude unit is ahead of schedule and is expected to start with a start-up state of December 1. We expect startup of the Houston crude unit around the end of the first quarter of 2016, as scheduled.

We also executed another drop-down transaction earlier this month of Valero Energy Partners, which is our sponsored MLP.

And, finally, regarding cash returns to stockholders, over the first nine months of this year, we have delivered a 73% payout of net income.

So, we are on track to hit our 75% target for 2015.

Additionally, the Board of Directors approved a 25% increase in the regular quarterly dividend, which is the second increase approved this year.

So with those highlights, John, I will turn it back over to you.

Thank you, Joe.

Moving on to the quarterly results, we reported net income from continuing operations of $1.4 billion, or $2.79 per share, versus the third-quarter 2014 earnings per share of $2.00.

The refined segment generated operating income of $2.3 billion.

Refining throughput volumes averaged 2.8 million barrels per day, which was in line with the third quarter of 2014.

Our refineries operated at 96% throughput capacity utilization in the third quarter of 2015, in spite of unplanned downtime including the refinery-wide outage at our Texas City refinery due to a lightning strike.

Refining cash operating expenses of $3.80 per barrel in the third quarter of 2015 were also in line with the third quarter of 2014.

The ethanol segment generated $35 million of operating income in the third quarter of 2015 versus $198 million in the third quarter of 2014.

General and administrative expenses, excluding corporate depreciation, were $179 million in the third quarter of 2015.

Also in the third quarter, net interest expense was $112 million.

Depreciation and amortization expense was $482 million.

The effective tax rate was 32.4%.

With respect to our balance sheet, at quarter end total debt was $7.4 billion, and cash and temporary cash investments were $5.3 billion, of which $51 million was held by VLP.

Valero's debt to capitalization ratio, net of $2 billion in cash, was approximately 20%.

Valero had over $5 billion of available liquidity excluding cash.

The cash flows in the third quarter included $467 million of capital spending, of which $109 million was for turnarounds and catalysts.

We returned $1.3 billion in cash to our stockholders in the third quarter, which included approximately $200 million in dividend payments and $1.1 billion for the purchase of 17.2 million shares of Valero common stock.

Year to date, we purchased 35.5 million shares for $2.2 billion.

For modeling our fourth-quarter operations, we expect through-put volumes to fall within the following ranges.

US Gulf Coast at 1.55 million to 1.6 million barrels per day.

US Mid-Continent at 420,000 to 440,000 barrels per day.

US West Coast at 235,000 to 255,000 barrels per day.

And north Atlantic, at 480,000 to 500,000 barrels per day.

We expect refining cash operating expenses in the fourth quarter to be around $3.80 per barrel.

Our ethanol segment is expected to produce a total of 3.85 million gallons per day in the fourth quarter.

Operating expenses should average $0.38 per gallon, which includes $0.05 per gallon for noncash costs such as depreciation and amortization.

We expect G&A expenses, excluding corporation depreciation, for the fourth quarter to be around $200 million, and net interest expense should be about $100 million.

Total depreciation and amortization expense should be approximately $475 million.

And our effective tax rate is expected to be around 30%.

Ethan, we have concluded our opening remarks.

In a moment we will open the call to questions.

During this segment we continue to ask that our callers please limit each turn to two questions.

Callers may rejoin the queue with additional questions as time permits.

(Operator Instructions)

Our first question comes from Neil Mehta from Goldman Sachs.

Neil, please go ahead.

Good morning, guys.

Joe, can you talk about, and you alluded to it, the outlook for product margins as Valero sees it?

It sounds like the decline we are seeing, in your view, is more seasonal than structural.

There has been a lot of talk about gasoline versus diesel.

And anything you could comment on the demand type.

So, just broadly some commentary on the product margin outlook would be helpful.

Neil, if you're okay, we will let Gary Simmons talk about that.

Neil, this is Gary.

I certainly do see that what we have this year is the seasonal nature of our business.

We start to get out of gasoline season and you see the gas cracks begin to soften.

And typically we go through a period of time where we find margins are squeezed until heating and oil demand begins to kick in.

I think the surprise this year is actually the gas cracks were much stronger for a longer period of time than what we typically see.

Even today, a light sweet refinery in the Gulf has a $9 crack spread.

If you're running medium sour, it is around $12.

And a heavy sour refinery in the Gulf has a $15 crack spread.

To us, those numbers don't look bad at all for this time of the year.

We see good product demand on the distillate side.

Our export markets remain strong.

And then on the gasoline side, as the markets in the Gulf have softened some, it's opened up the yards to start gasoline exports, as well.

So, we feel pretty good about the markets going forward.

Thanks, Gary.

And then the follow-up question is around the dividend.

You guys raised your dividend by 25%.

Can you talk a little bit about what drove the decision and how are you are thinking about the allocation of capital between dividends, buybacks and organic growth?

Okay, Neil, this is Mike.

We went ahead and increased the dividend this quarter.

We are having a great year and we thought it was appropriate to increase it at this time.

Going forward, ultimately, we would like to get to the position of increasing the dividend annually.

And our intention is to pay a dividend at the top end of the range for our peer group.

And then, Mike, between buybacks, and dividends, any thoughts there?

On the dividend payout, our intention is to be at the top end of the range of our peer group.

And then as we increase that, buybacks would be a little bit less of the total pie.

Neil, the only thing I would add to what Mike said is, in the investor presentations we made -- and management made the commitment at the beginning of the year -- that we'd look at the use of our cash in a non-discretionary and a discretionary way.

And clearly we view the dividend as something that is non-discretionary.

So, when we commit to doing the dividend, we believe we need to maintain the dividend.

As Mike said, it was a good time to do it.

We have had a great year.

We want to reward our shareholders.

And we will continue to look at it going forward.

When you look at the total payout ratio, it is based on net income.

And we have been very forthright about that.

All we are doing, really, in this case is altering the makeup of that payout ratio, and increasing the percentage that would be made up of the dividend.

Great.

All right.

Thank you so much.

Our next question comes from Evan Calio from Morgan Stanley.

Evan, please go ahead.

Good morning, guys.

Let me tie your macro comments in the prior answer to the return policy, to connect the two.

you raised the dividend, had a large step-up in the buyback in the third quarter.

I know you have the annual payout guidance, which you are closer to your target, but you also have significant room in your net debt to EBITDA guidance.

So, how do you adjust the buyback between these two metrics, according to the margin environment?

Meaning, given your macro views, should we expect a continued pace of buybacks, even in a seasonally weaker quarter?

We increased the payout target from 50% to 75% on the last call.

We had to pick up the buybacks quite a bit.

We made our commitment to our shareholders and payout to 75%.

Evan, as Mike said, I think you can expect that we are going to hit the 75% target.

That is our objective.

So, if you are trying to gauge pace of buybacks in the fourth quarter, they're probably going to be a somewhat slower pace than they were in the third quarter, as we made up ground during the third quarter.

And then going forward, as Mike's talked about, we want to maintain a dividend at the high end of the range of the peers.

We will continue to look at it.

It is based off of net income, and so we are not providing earnings guidance here on what the fourth quarter would be.

So if net income comes in very strong, we will be buying back a lot of shares.

Got it.

That makes sense.

Let me ask you a different question, my second question, on the midstream side.

I know you funded the last drop to VLP.

If that market remains closed, would you do that again in 2016?

Or can you talk about how you are thinking about that going forward?

This is Mike again.

The last drop on October 1, our plan was all along to self fund that drop.

On the capital markets, based on our discussions with the bankers, we do not believe that the capital markets are closed.

We believe that they are open.

The equity markets have been challenging.

There's not been a lot of activity the last six weeks or so on the equity side.

But we do believe that the markets are open.

I will leave it there with two, guys.

And our next question comes from Edward Westlake from Credit Suisse.

Edward, please go ahead.

Hi, it is actually Johannes here playing stand-in for Ed at the moment.

A couple of quick questions.

First one, I was wondering what your West Coast outlook is given that it was so strong over the last quarter going into next year.

And do you have a view on what turnaround activity in 2016 would be, and how that may impact that particular crack?

Yes, I think we definitely see a lot of turnaround activity in the fourth quarter of this year, which will probably keep the West Coast market fairly tight.

As you move into next year, I think we have seen a good demand response as a result of the lower flat price on the West Coast.

That will certainly keep that market tighter than what we have seen in the past couple of years.

So, we are fairly optimistic on our West Coast operations for next year.

I don't really have any insights to turnaround activity.

I don't know, Lane, if you --.

This is Lane.

I think it was fairly public knowledge you had a very heavy turnaround season, And it's currently going on and into the very beginning of the fourth quarter.

But I don't have any insight into where the turnaround activity is going to be on the West Coast first half of next year.

We don't give any forward guidance for Valero in that respect, either.

Okay.

And, generally, over the last year, there has been a reasonable amount of M&A, either outright M&A and/or acquisition of assets.

And that is in the midstream and in the downstream segments.

Is there a reason you haven't participated in it?

Or is there a way you are thinking about M&A and growth that we could use to see through your eyes, so to speak.

We do look at the opportunities as they do become available to us.

We have not been able to consummate an acquisition during this time.

And, again, our attention to M&A hasn't changed.

We continue to look at everything that is out there.

And obviously there have been a couple of deals that have been done, there's a couple of refineries that have transacted this year.

And, as Mike said, we look at them and if they are of interest to us, we pursue them, and if they're not, we don't.

Obviously in this case, they weren't of enough interest to us for us to be aggressive.

And when you look at the space that might be more rich with opportunities going forward, it seems to be more of the midstream business.

Again, we look at the opportunities out there.

But we have been pretty clear about what we want to do.

To the extent we transact there, we would like for it to be for assets that are supportive of Valero's core business.

So our view on M&A really hasn't changed, nor has the level of activity that we pursue internally.

We just haven't pulled the trigger on anything.

Is there a framework you use to evaluate the value proposition when it comes to those businesses that might be related to your core business?

Yes.

But I don't think we are going to get into what our acquisition criteria is with you.

No offense.

Okay.

No problem.

Thank you.

And our next question comes from Ryan Todd from Deutsche Bank.

Ryan, please go ahead.

Hi, guys.

This is Igor Grinman here, actually, chiming in for Ryan.

I had a quick question on the crude slate in the quarter.

It seemed like the light sweet mix was around record levels, or as far as I could see here.

Just curious as to what drills that preference for light sweets in the quarter given the relative widening seen on the sour dip side.

Was it running max gasoline mode related, or some other drivers there?

And along the same context, it would be great to hear your latest outlook on light versus sours differentials for 2016.

Yes, you're correct, we did run record levels of domestic light sweet crude during the third quarter.

That was somewhat tied to where the crude differentials were.

But we also see a rate lever that we get from running a lighter crude diet, so that pushed us in that direction.

And then also, with the strength in gasoline, we get a higher gasoline yield off those types of crudes.

So, that pushed us to the domestic light sweet, as well.

As we transition into the fourth quarter, the crude markets remain very volatile.

We have definitely transitioned to where we are running a lot more sour crudes in the system today than what we did in the third quarter.

I think as you move to 2016, as long as we are in this market that the crude markets are oversupplied, you are just going to see a lot of volatility between the grades.

So, we are just going to be responsive.

As the markets move, we will run the diet that is most economic in our refineries.

Great.

Maybe just as a quick follow-up, what are you guys generally expecting out of the 1Q turnaround season?

I know you brought up maybe some color on the West Coast side but just overall, US-wide color would be great.

This is Lane.

We obviously have a dialogue with all of our contractors.

We have a large business with them.

And the outlook that they are telling us, it'll be a fairly heavy -- the first half of 2016 will be heavier than the first half of 2015.

All right.

Great.

Thank you, guys.

And our next question comes from Phil Gresh from JPMorgan.

Please go ahead.

Good morning.

Not to beat a dead horse on the dividend but you had a big step-up in the first quarter, and this is another sizable step-up.

So, just wondering how you thought about this one in terms of whether it was a bit of a catch-up still going on here as you get it to the spot where you wanted, as a percent of cash from operations, or something along those lines, or whether the increases, moving forward, would be more ratable over time.

I think if we looked at it, we were behind the peers.

Mike laid out what the objective was, Phil.

And it is to pay out towards the higher end of that.

So, I guess you could look at it as a makeup.

In fact, the whole year.

I think when we looked at it, we were behind, going into the year and we felt that we needed to try to get caught up.

So, obviously that was the case.

And I think as we get closer to the peers, I think this thing, that the perspective increases would be at a more moderate level.

Okay.

Second question is, with Line 9B now ramping up, how soon would you expect to see a benefit?

To what magnitude do you think you can get access to all of the crude that you are hoping to get through Line 9B?

Or is there any kind of delay in getting any of those barrels to Quebec?

And how do you think about the impact that this would have on margins for the refinery?

This is Gary again.

We purchased pretty much our full volume on what we have committed on Line 9 for November injection.

So, those barrels will begin to start showing up Montreal in December and making its way to the refinery.

In terms of the barrels that are available to us, it is pretty much what we had planned.

We have a mix of Bakken and MSW and syncrude from Western Canada.

With the [arb] being narrower, the economics are not quite as strong as what we had envisioned, but Line 9 barrels are still at or better than what we can do from a US Gulf Coast source domestic light sweet barrel.

Okay.

Got it.

Thank you.

And our next question comes from Jeff Dietert from Simmons.

Jeff, pleased go ahead.

If you could, you talked a little bit about some of the outages during the quarter, with emphasis on Texas City with the lightning strike.

But also I believe you had some FCC and alkylate unit downtime during a period when octane was tight.

I was hoping you could talk about the influence those had on 3Q.

Jeff, this is Lane.

Our unscheduled downtime during the third quarter cost us about $116 million, with the big event being the lightning strike knocked out our substation in Texas city.

And were there meaningful FFC and alky units down during the quarter?

Did that have a meaningful influence, as well?

I quantified the impact on our results.

I'm not going to comment on the impact that might have had on the market, if that is what you are looking for.

I'm just saying, I'm giving you what happened to us.

All right.

And when you think about the tightness in the octane market and the premiums we saw there, is your view from an industry perspective that is transient or structural?

We did have some industry FCC outages in reformer and aklylation unit downtime, and very strong, high octane retail gasoline demand.

Could you talk about that issue?

Yes, Jeff, this is Gary.

At least my view is, it is more structural in nature.

We did have some refinery downtime, but I don't think that was the key driver.

I think that as the Gulf Coast refineries are running lighter crude diets, that we were out of reforming capacity.

You become long naphtha.

And as long as you have a strong gasoline market there is an incentive to blend that naphtha into the gasoline [cool].

And to do that it takes high octane blend components.

In addition to that, some of the big growing export markets have specifications that require high alkylate blends, not necessarily even for octane.

And then, finally, I think one of the things that we have seen this year, is with where aromatic pricings have been, both toluene and xylene have been under their blend value which has allowed both of those components to be in the gasoline pool.

Assuming we have some strengthening in the aromatics pricing moving forward, you could see that both of those high octane blend components actually get pulled out of the pool, and octane premiums remain strong.

Thanks for your comments.

And our next question comes from Paul Cheng from Barclays.

Hey, guys.

Good morning.

Two quick question, actually.

One, Mike, do you have a guidance or a target for the cash payout to your shareholder for 2016 and 2017 yet?

No, we don't.

We are not prepared today to give the payout target for 2016.

But I would anticipate that we will do that early next year.

Okay.

And, secondly, maybe for Joe -- Joe, on the last six months, the MLP sector had been under tremendous pressure.

Just curious, the changing market conditions, in any shape, have changed the management view how you are going to manage VLP, and what that means in terms of the drop down pays or organic or inorganic investment in that business and how that relates to the [seecall].

That is a good question, Paul.

Let me let Mike fire away first and then if there is anything to add.

Obviously, the capital market tapped in very volatile.

We continue to market that.

But our plan is to continue to execute upon our previously communicated drop-down guidance for 2016.

And that's around $1 billion of assets.

Thank you.

And our next question comes from Paul Sankey from Wolfe Research.

Paul, please go ahead.

Hi, guys.

It was a little bit of a follow-up, or somewhat asked by Paul already, but I was wondering about this 75% of net income target.

At the highest level, I was wondering why you use net income?

It seems like a bit of a bouncy denominator, if that's the right word -- or numerator, I guess.

Paul, we are in a volatile business, right?

And whether you use net income or cash flow, I think you just pick one.

And we picked net income.

It was one that is very easy for everybody to look at and identify the number.

So, it seemed to provide the most transparency, from our perspective.

Fair enough.

And now, I guess what you are saying, given that we are new to this, is that your intention is early every year to provide a guidance of approximately how much net income share you intend to return?

I think you could probably assume that is the case.

Paul, I think we did it at your conference last year, right?

That is where we laid out the 50% targeted payout ratio.

It is our objective to have a stated payout ratio.

Again, this is the first year we did it.

We set one out there.

We viewed it as a target that we wanted to hit.

Things went well this year.

We were able to raise that target.

So, philosophically, I think we are going to always look at our cash flows and our free cash flow and decide what to do with it.

And certainly we've set our priorities with the dividend now and with the share buyback program and we will continue to pursue it.

Well, if I wasn't excited enough about our conference in January, I am super excited now.

(laughter) So, I look forward to your announcement on January 6. Just on a really important thing for us is my second and final question.

This whole thing of a view that global distillate is weak, oversupplied, really doesn't come through in your commentary at all.

Is this just the strength of Latin America?

Or could you just provide more detail as you see it on where this distillate is going and why you can succeed in exporting so much more when there is this perception that the market globally is weak?

Thanks.

Paul, this is Gary again.

The way we are viewing the distillate markets, we have seen six straight weeks of draws in the stats here domestically.

Export demand remains very robust.

You have some seasonal maintenance that is coming in.

So, I think the combination of seasonal maintenance and exports will keep the domestic inventories in check.

And then, really, the wild card is what happens with the weather and heating oil demand.

As you look globally, I think a lot is being made of the stocks in the ARA, and there is just not a lot of tankage over there.

So, when we talk about inventory being very high, it is 8 million barrels above where it was last year.

I think some of the things that we are seeing is that the Rhine river levels are low and hindering some of the typical demand pulls we see out of the ARA.

So, to some degree I think we feel like some of the inventory in Europe may be understated or overstated.

But we continue to see very good demands, both Latin America and Europe for our diesel, and feel pretty good about those markets.

Interesting.

Thank you very much.

And our next question comes from Chi Chow from Tudor Pickering Holt.

Chi, please go ahead.

Following up on Paul's question there, could you give us your export volumes for the quarter on both diesel and gasoline?

Sure, this is Gary.

Gasoline, we did 89,000 barrels a day of export, primarily in Mexico and Latin America.

And then on the diesel side we did 241,000 barrels a day of export.

It was a 65/35 split between Latin America and Europe.

On the distillate, if you include kerosene, it brought us to about 285,000 barrels a day of total distillate.

Okay.

Thanks, Gary.

And then just one semantic question here.

Your noncontrolling interest line was a loss in the quarter.

What is the detail behind that?

Yes, that is primarily Diamond Green diesel.

The loss has nothing to do with VLP.

Okay.

It was just a loss incurred at Diamond Green?

Yes.

Okay, thanks, John.

And the next question comes from Brad Heffern from RBC Capital Markets.

Brad, please go ahead.

Good morning, everybody.

Joe, I think in the past, you certainly had a stated goal of narrowing the multiple discount that Valero trades at versus peers.

I think you have done the obvious things on that front with the dividend increases, all of repurchases, certainly showing more CapEx discipline.

I'm curious as we move forward here how you see the best path towards narrowing that further.

Is it just continuing to execute?

Is it buying back more shares?

Any color there would be helpful.

Brad, that is a good question, and it is one that we continue to wrestle with as we look at the strategy going forward.

It is hard to really understand what drives the multiple.

We look at some of the parts and clearly our portfolio is more levered towards refining perhaps than the peers.

So, clearly, a more diversified set of earnings streams for the Company would be something that might lift that multiple.

The other thing that we really couldn't factor in entirely is where, having a payout ratio, certainly the dividend that was below the peers, might affect us from a multiple perspective.

You address what you can in a timely manner.

And we have addressed now the fact that we have lagged on the payout in the dividend.

And we are continuing to look for the opportunities to grow different earnings streams within the business.

The drops from Valero to VLP clearly is targeted at trying to do this.

And then we will continue to look for projects to grow the refining business, the renewables business, and then we'll look for other business lines that we might be able to get into.

The objective would be to do it with a stronger currency.

We continue to have this as a major point of focus.

But I just don't know that there is a silver bullet that you could fire that is going to immediately get the stock re-rated and have you up to where your peers are.

But we are taking the actions that we can that we think will help drive that way.

Okay.

That's fair.

Thanks for that.

And then maybe for Gary Simmons, just thinking about spreads, both Bakken and LLS are relatively tied to WTI.

Is that a symptom of declining US crude production?

Is it a symptom of too much midstream?

Or is it just that maybe people haven't been able to arb things on the import side particularly quickly?

No, I think, you really hit the nail on the head.

We have a combination of overbuilt logistics, in light of flat to declining domestic crude production.

With the current market, the US Gulf Coast bound pipeline from Mid-Continent have tariffs that are greater than where actually the market is today.

So, you're just seeing people with take or pays going ahead to ship even though it doesn't look like they have economics on paper, and that is what is really driving the differentials.

Okay.

Is that something that you think is going to persist until we see a turnaround in US production?

For instance, have you guys changed your behavior and you're importing much more at this point and you expect that to widen the arb back out?

I think, the tariff and the midstream situation is here until we get some recovery in production.

I would tell you on the imports, that is more the volatility between grades.

I think what we saw is that as people started to see that production was falling, it was very supportive of the domestic light sweet pricing.

At the same time, medium sour production in the Gulf was growing and medium sour exports in the Middle East were increasing.

So, all of a sudden we saw a fairly wide differential between medium sour and light sweet.

And it incentivized us to bring in a lot of imports of medium sour into our system.

Okay, thank you.

And our next question comes from Sam Margolin from Cowen and Company.

Sam, please go ahead.

In the press release, you guys updated the topper progress.

As Brad just pointed out, LLS is below Cushing right now.

Maybe the topper has fixed that.

What do you make of what looks like everybody trying to flood the Gulf or avoid Cushing on the marketing side for crude right now?

And does that change the economics of the toppers at all?

Are you more excited about them or less excited than you might have been six months ago?

I think weak LLS market is actually supportive of the toppers.

Where we were, the economics for the toppers assumed LLS Brent flat.

So, as LLS has discounted to Brent, it actually improves the economics of those toppers fairly significantly.

Two things causing the LLS to WTI spread being where it is today.

One is it's overbuilt logistics and people shipping even though the economics don't appear to be supportive.

And then, secondly, we have a lot of imports coming into the Gulf.

So, ultimately you can't keep having these inventory builds of domestic light sweet.

We're going to have to see those differentials come off and incentivize refineries to go back to a lighter diet at some point in time.

Okay, thanks for the color.

And just revisiting the October drop and VLP in general.

It is true that MLPs have been really volatile.

VLP has seemed to be a lot of more stable.

I don't want to make you repeat yourself on the thinking behind sponsoring that drop in October maybe to a greater deal than people expected, but just to your view -- it's sort of a chicken and the egg question -- but how much of VLP stability is a function of the strength of the sponsor and you demonstrating that?

Or how much of the structure of that drop was really pre-empted and maybe just more cautious and preserving your outside capital for another time?

Our plan was to self fund the drop.

With this particular drop, though, we are now at a debt to EBITDA of about 3.5 times.

We would likely not want to be longer than that on a long-term basis.

With the next acquisition, we are going to have to go get our investment grade credit rating, which our plan is to do that late this year or next year, have the ability to go to the debt and capital market.

And then with the ratio being 3.5, or approximately 3.5, the next acquisition also might require an equity component -- or will require an equity component.

So, from this point forward, I think you would anticipate capital markets.

Okay.

All right.

Thanks very much.

And our next question comes from Blake Fernandez from Howard Weil.

Blake, please go ahead.

Thanks.

Just a point of clarification.

Mike, you mentioned being at the top end of the peer group for dividends.

I just wanted to double check -- I'm assuming you're using the metric as a percentage of net income and not yield or some other metric like that?

Yes, we are using payout, that's correct.

Okay.

And then going back to Line 9, Gary, I don't know if you can help us a little bit here, if you could just remind me, we are seeing Cushing obviously been fairly depleted and the spread between WTI and Brent's been compressed.

Can you remind me of the metrics we should maybe look at as far as what is economical to actually ship those barrels on Line 9 over to Quebec?

Should we be looking at Gulf Coast versus Brent, or Brent versus Cushing?

Just any help you can have there to help us understand it.

Line 9 for us is primarily fed with Western Canadian light sweet and Bakken.

So, you are really looking at that spread and comparing it to a US Gulf Coast supply, or a foreign light sweet alternative.

Okay.

And are there any specific numbers you can give to us, where it covers transport or where it makes sense to actually move it?

I don't think we can talk about the tariff we are paying on Line 9.

Okay.

Fair enough.

Thanks, guys.

And our next question comes from Doug Leggate from Bank of America.

Doug, please go ahead.

Good morning, everybody.

Joe, one of the advantages you guys have had over the years was obviously your heavy crude diet on the Gulf Coast.

And I think obviously you have now seen US production, it seems, go into decline, at least on the domestic side.

What are you thinking is the prognosis of the outlook for how you move you choose to run your crude in 2016?

What's at the back of our mind -- it's really more of a macro question --Iran potentially coming back onstream, one would expect US production tightens up a little bit.

It seems to us that the advantage might move back in your favor.

I'm just wondering what your thoughts are in terms of that heavy oil advantage.

Doug, we will let Gary speak to that.

Doug, I think the way we see it is there is just going to be a lot of volatility between grades.

And it certainly is an advantage for someone like us with the quality of refining assets that we have that can swing to a light diet, medium diet, and a heavy sour diet.

That's the way year shaped up and I don't think we see it much differently next year.

There's times when it's certainly been an advantage to run a very light diet, and then there's other times where we see very good value in Canadian heavies or heavies from Mexico or South America.

But speaking more broadly, Gary, I think if you look at Iranian crude coming into the market, mean obviously the more sour crudes that are in the market, I think it is certainly to Valero's advantage because we definitely have the ability to process it.

And as Gary is pointing out, we always are optimizing the sweet slate, Doug, as you know.

But having the more availability of sour crudes, whether they be mediums or heavies, is certainly to our advantage in the Gulf.

Thank you.

Two other quick ones, if I may, Joe.

The second one is also on macro.

You are aware, we've made no secret of our concerns over what we have described as exacerbated volatility on margins in the winter time.

And I just wanted to get your perspective.

It goes back to your earlier question on gas, the [seeniles] of gasoline.

As we see it, we are sitting with higher inventories of gasoline, and the cut on light sweet crude in the US seems to be significantly higher.

So, I'm just wondering if you've got any view as to why we've seen such wide swings on gasoline margins in the winter for the last two or three years, and whether you think that repeats again this year once the current maintenance period comes up.

And then I've got a quick follow-up.

Yes, I think we definitely see the increased demand with the lower flat price.

Certainly there is seasonality to gasoline.

The gasoline cracks have remained stronger longer than they typically do.

But I think the things that we see in the market that are supportive of gasoline going forward is the price of gasoline in the Gulf now has opened up our exports.

Certainly in our system we are seeing a significant increase in the volumes we are exporting.

Imports to the New York harbor have fallen way off, which is supportive of gasoline.

Naphtha economics have changed to where, really, we are not putting naphtha into the gasoline pool now.

We are exporting naphtha to the Far East.

We have seen FCC margins fall off some, to where you will see some sparing of FCC capacity.

And then some seasonal maintenance.

So, I think all of those things, we feel like, are supportive of the gasoline markets going forward.

Right.

But my point is that when refinery maintenance comes to an end, if you take the exports out of the equation, think of those as a relief valve, if you like, do you think the Gulf Coast of the US in general is now oversupplied gasoline in the winter time or not?

Certainly, if we run at very high utilization rates and aren't allowed to export, you could become long.

But I don't think we see that will happen.

Okay.

My final one -- Joe, this is really more for you -- the big step-up in the buybacks, whether everyone agrees or not, it seems that margins have been somewhat artificially supported by everything that has gone on this year starting in the West Coast.

Why would you choose this step-up to such a big level of buybacks in such a seasonal sector, at least in terms of how share prices have particularly traded in the past?

Doug, we had free cash flow available, and we did what we said we were going to do.

It is what it is.

I think as we look at this going forward, we laid out a target, we are going to hit it.

We are not here to build cash.

We are here to grow our business and to reward our shareholders.

And we thought this was the right time to do it and it was the way to do it.

So, that is what led to the timing.

If we had reduced margins this year, you probably wouldn't have seen us step up the target.

But here again, we are owned by firms out there and individuals that are looking for return, and for us to use the cash prudently, and we think that's what we did.

All right.

Appreciate the answer, Joe.

Thank you.

And our next question is a follow-up from Brad Heffern from RBC Capital Markets.

Brad, please go ahead.

Yes, thanks.

Just a couple quick follow-ups.

I was curious on CapEx, it appears that you are way ahead of the budget for 2015 based on the first three quarters.

And it would be something like $1 billion in spending in the first quarter to actually reach the target.

Is there a particular reason for that?

Is it the crude topper spending ramping up perhaps?

Or why would you not be able to come in meaningfully below it?

For our capital expenditure guidance for 2015 we do remain unchanged at $2.65 billion.

Now, when we provide this guidance, just to clarify, we mean capital expenditures turnaround costs as well as investments in joint ventures.

September year to date, our total is $1.7 billion, so we are trending below the guidance.

However, as you all know, we have an option to become a 50% owner in the Diamond pipeline and we may exercise that option in this quarter.

Okay.

Got it.

That's good color.

Thanks for that.

And then looking at the throughput guidance for the quarter, both Mid-Con and West Coast look to be maybe a little weaker than what we would have expected.

Is that just turnaround related?

We don't really give forward guidance on turnarounds but when we set the guidance volumes, we do take turnarounds into consideration.

I think if you look in the aggregate, the guidance for this quarter is similar to the fourth quarter last year.

Okay.

I will leave it there.

Thanks.

And our next question is a follow-up from Chi Chow from Tudor Pickering Holt.

Chi, please go ahead.

Thanks.

Just I want to follow up on the heavy crude markets.

It looks like Canadian producers now, we know they have pipeline access all the way from Alberta to Houston, and it looks like the volumes of deliveries have ramped up into pad three to about 300,000 barrels a day-plus pretty ratably year to date from Canada.

How much of a structural change do you think this is, with this dynamic on pipeline flows in?

How are you seeing Middle East and Latin America producers react on the pricing of their sours and heavies?

I would say we've definitely seen greater variability of Canadian heavy in the Gulf.

We ran record volumes of Canadian heavy in the third quarter.

Really, the medium sour pricing, it seems to be what is setting the price of the heavy sours.

All of heavy sour producers know they have to compete with an [askey] or marked barrel in the Gulf so they price their barrels to be competitive on a quality-adjusted basis with that medium sour barrel in the Gulf.

And the Canadian is certainly that same way.

Gary, do you prefer to run a Canadian heavy barrel through the cokers?

Or would you rather go with a maya or --?

Each barrel presents their own operating challenges.

Lane may be better to answer that.

But there are certainly some challenges with Canadian that we don't see with some of the south American barrels that we run.

So I don't know.

Lane, do you want to add anything to that?

You did a fine job answering that.

(laughter)

Thanks.

Appreciate it.

And we have no further questions at this time.

I would like to turn the call back over to John Locke for any closing remarks.

Great, thanks, Ethan.

We appreciate everyone joining us today.

If anyone has any additional questions, please contact me or Karen Ngo after the call.

Thank you.

Thank you, ladies and gentlemen.

This concludes today's conference.

Thank you for participating.

You may now disconnect.