Good morning.
My name is Don, and I will be your conference operator today. At this time, I would like to welcome everyone to the Delek US Holdings Inc. Q2 Earnings Call. All lines will be placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer Thank you.
Mr. Johnson, the floor is yours.
Thank you, Don. I'd like to thank everyone for joining us on today's conference call and the webcast to discuss Delek S' Q2 2018 financial results. Joining me on today's call is Uzi Yemin, our Chairman, President and CEO Kevin Kremke, VP and CFO as well as other members of our management team. As a reminder, this conference may contain forward looking statements as that term is defined under federal securities laws. For this purpose, any statements made during this call that are not statements of historical fact may be deemed to be forward looking statements.
Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward looking statements. You are cautioned that these statements may be affected by important factors set forth in our filings with the Securities and Exchange Commission and in our latest earnings release. As a result, actual operations or results may differ materially from results discussed in the forward looking statements. We undertake no obligation to publicly update any forward looking statements whether as a result of new information, future events or otherwise. In addition to reporting financial results in accordance with generally accepted accounting principles, we report certain non GAAP financial results.
Investors are encouraged to review the reconciliation of these non GAAP financial measures to our comparable GAAP results, which can be found in the press release, which is posted on the Investor Relations section of our website. On today's call, Kevin will begin with a review of the financial performance of the quarter before turning it over to Uzi, who will offer a few closing strategic comments. With that, I'll turn the call over to Kevin.
Thanks, Keith. For the Q2 2018, Delek US reported net income of $79,100,000 or $0.89 per diluted share compared to a net loss of $37,900,000 or $0.61 per basic share in the Q2 of 2017. On an adjusted basis for the 2nd quarter, Delek US reported net income of $89,000,000 or $1.03 per diluted share compared to an adjusted net loss of $25,000,000 or $0.40 per basic share in the prior year period. Our adjusted EBITDA was $199,100,000 in the Q2 of 2018 compared to $4,200,000 in the prior year period. A reconciliation of reported results to adjusted results is included in the financial tables of our press release.
During the Q2 of 2018, results were affected by approximately $60,300,000 or $0.52 per share after tax of non cash items. This consisted of approximately $38,500,000 or $0.33 per share after tax related to a non cash inventory timing effect between the purchase price of Permian Basin crude oil and when it is realized as finished products are sold. In addition, results were reduced by a noncash charge of approximately $21,800,000 or $0.19 per share after tax related to a mark to market of our RINs inventory position. This net long inventory position was the result of the previously announced waiver received for the El Dorado and Krotz Springs refineries in March of 2018. Taking these amounts into consideration, results would have been higher by $60,300,000 or $0.52 per share, which would equate to approximately $259,000,000 of EBITDA and $1.55 per share.
On a consolidated basis, line items such as operating expenses, G and A and interest increased on a year over year basis, primarily due to the addition of Elan. I would like to note that G and A expense included approximately $2,600,000 of transaction costs. Our income tax rate excluding the non Q2 of 2018. For full year 2018, we expect the combined annual effective tax rate to be in the range of approximately 21% to 23%. Turning now to capital spending.
Our capital expenditures during the period were approximately $54,700,000 compared to $15,000,000 in the Q2 of last year. During the Q2 2018, we spent $33,700,000 in our Refining segment, dollars 2,300,000 in our Logistics segment, dollars 2,100,000 in Retail and $16,600,000 at Corporate. Our 2018 CapEx forecast is right at $228,000,000 This amount includes $176,500,000 in Refining, dollars 18,900,000 in Logistics, dollars 19,500,000 in Retail and $13,100,000 at the corporate level. This amount for 2018 does not include approximately $75,700,000 of midstream projects to enhance our position in the Permian Basin. We ended the 2nd quarter with approximately $1,100,000,000 of cash on a consolidated basis and $910,000,000 of net debt.
Excluding net debt at Delek Logistics of $732,000,000 we had net debt of $178,000,000 at June 30, 2018. We had great financial performance during the Q2 of 2018, but I do want to point out that cash from operations was affected by a combination of both price changes during the quarter and increased sales volumes resulting in a working capital headwind during the period. We actually had improvement in cash from operations in Q2, which would have been even higher without these working capital headwinds, which we expect to revert and come back to us in Q3. Our disciplined capital allocation program includes returning cash to shareholders, prudently investing in the operations and exploring opportunities for growth. We balance this program with the goal of maintaining a strong balance sheet through the cycle.
To further strengthen our balance sheet, we will reduce our leverage with the upcoming $150,000,000 convertible debt maturity in September. We plan on settling the principal amount in cash and the premium amount with DK shares, for which we have a hedge in place that will result in 0 dilution. You will note that our diluted share count for the Q2, there was approximately 2,600,000 shares associated with this note. Next, I'd like to discuss our results by segment. In our Refining segment, which was just beginning to feel the benefit of the wide, middle and differential in the Q2 of 2018, we reported a contribution margin of $177,000,000 compared to a contribution margin of $16,900,000 in the Q2 of last year.
The year over year increase in the contribution margin is primarily due to the addition of the Big Spring and Krotz Springs refineries from the Elan transactions in addition to improved market conditions. As mentioned previously, there was approximately $38,500,000 headwind related to an inventory timing effect between the purchase price of Permian Basin crude and when it is realized as finished products are sold. Market conditions, as measured by the Gulf Coast 5.32 crack spread, increased on a year over year basis to $14.37 per barrel for the Q2 of 2018 compared to $10.86 per barrel for the same period last year. In addition, the refining system benefited from the Midland WTI crude differential to Brent crude that was an average discount of $15.03 per barrel compared to $3.48 per barrel in the Q2 of last year. On a lag basis, the Midland WTI crude differential to Cushing was an average discount of $5.14 per barrel in the Q2 of this year compared to $0.83 per barrel in the Q2 of last year.
During the Q2 2018, we estimate that the realized Midland differential in our reported results was approximately $3 per barrel due to this inventory timing effect. Our Logistics segment contribution margin was $45,400,000 in the Q2 of this year compared to $31,700,000 in the prior year period. On a year over year basis, improved performance was primarily due to the Big Spring dropdown that was effective March 1 this year and improved West Texas wholesale business and improved performance from the Payline pipeline. Contribution margin in the Retail segment was $18,600,000 Merchandise sales were approximately $90,200,000 with an average margin of 31.7 percent and approximately 54,100,000 of retail fuel gallons were sold at an average margin of $0.24 per gallon. As a reminder, there is no year over year comparison for this segment as it was acquired in the Elan transaction on July 1, 2017.
Contribution margin for the CorporateOther segment was minus $11,800,000 in the Q2 of 2018 compared to negative $37,800,000 in the prior year period. Included in these results was a net hedging loss of $400,000 for the Q2 this year compared to a loss of $30,900,000 in the prior year period. Again, as a reminder, the prior year period includes a hedging loss of approximately $31,700,000 related to a realized loss on a crude oil inventory hedging strategy associated with Delek U. S. Supply and offtake agreement.
Before I turn it over to Uzi, I wanted to provide some guidance on our crude oil throughput for modeling consideration. During the Q2, our total refining system crude oil throughput was approximately 290,600 barrels per day, which was an increase from 261,350 barrels per day in the Q1 of this year. For the Q3, we expect crude oil throughput in the refining system to be approximately 290,000 barrels per day, so essentially flat from Q2. In addition, based on the forward curve on August 6, we expect to purchase our Midland crude at approximately $13 discount to Cushing in the Q3. Taking into consideration the inventory timing effect we discussed, we estimate based on the forward curve that our realized Midland discount and our gross margin will be approximately $10.80 per barrel.
I also want to note that backwardation has increased in the market, and we estimate that it will be approximately $1.30 per barrel, which increases our crude oil cost. With that, I'll turn the call over to Uzi.
Thank you, Kevin, and good morning. It has been just over a year since we completed the acquisition of Alon USA. During that time, the team has done a great job to achieve the objectives we laid out at the beginning. 1st, we simplified the corporate structure with the acquisition of Alon USA Partner in February 20 18. 2nd, by utilizing our strong balance sheet, our average interest rate was reduced through the refinancing completed in March 2018.
3rd, value was unlocked by divesting approximately $162,000,000 of non core assets on the West Coast and completing the drop down of the Big Spring Logistics assets. Finally, our team capture approximately $131,000,000 of synergies on an annualized basis through the Q2. We are on track to capture approximately $130,000,000 to $140,000,000 of annualized synergies from this transaction, which has significantly exceeded our original guidance of $85,000,000 to $105,000,000 We build the premier premium basin refining company with access to approximately 75,000,000 barrels annually or 207,000 barrels per day of Midland crude oil, which accounts for approximately 70% of our crude slate. We continue to make progress on our initiatives to get closer to the wellhead as we gather more barrels to control our crude oil quality and lower our costs. We've added more Midland barrels to the Krotz Springs Crude slate as far as in previous quarters, which has improved overall performance.
When we include the expected benefit of the Alky unit that is under construction, expected operating results from Croats should further support the future potential logistics asset drop down to DKL. We ended this great quarter with a cash balance of approximately $1,100,000,000 During the 2nd quarter, we purchased $20,000,000 of our stock and have the total remaining authorization of approximately $160,000,000 On a year to date basis, we have returned approximately $153,000,000 through June 30, 2018 through dividends and share repurchases. We remain focused on creating long term value as we balance returning cash to our shareholders, investing in our business and aggressively exploring opportunities to develop the next stage of our growth. With that, Don, would you please open the call for questions?
Our first question comes from the line of Mr. Brad Heffern from RBC Capital Markets. Mr. Heffern, you may ask your question.
Hey, good morning, everyone.
Hey, Brad.
Uzi, Plains yesterday announced slightly earlier timing for Sunrise and Cactus II. Can you just give your thoughts in general on how you see spreads trending and when you think that the transportation issues in the Permian might resolve themselves?
Okay. Obviously, we are familiar with what planes are trying to do. And let me take it in a couple of stages. First of all, people were thinking that trucks or railcars can help eliminate some of the problem. Well, based on our own experience, we tried ourselves to truck some and tried to maybe use our facilities to rail, well, it's almost impossible to do so.
So the idea of we can track millions of barrels probably doesn't exist. The second part is that, to my knowledge, producers hesitate to because of what happened in 2015, 20 16 hesitate to sign up for a big take or pay commitment. So I do think we do think that we will see great spreads at least to the end of 2019. Now if you look at the forward curve, even 2020, Q1 is starting to get weaker. In the last few days, we saw it actually a week ago, we saw it already at minus 2.
Now is it going to stay at minus 17? No. But I want to remind everybody that this quarter was based on realized of minus 3. So the EBITDA we achieved is based on realized of minus 3. So we think we are very well positioned to a situation that the differentials will come in, even though we don't see it happening this month, the trading month for September is showing on the screen now minus 17 between minus 16 and minus 17, and 4th quarter is getting weaker.
Okay. I appreciate that color, Uzi. Thanks. And then I guess just thinking about cash usage, you talked about it a little bit in your prepared remarks, but pretty modest repurchase number this quarter, just given the amount of cash generated. Should I read into that that you're seeing a lot of opportunities on the M and A front or just how do you think about balancing building cash for a potential acquisition versus repurchases?
Well, Brad, we were very aggressive and this is something we need to balance. We were very aggressive. We did the repurchase of the shares beginning of or the Q1, then we increased dividend, then we need to continue to feed this thing. This quarter, we decided that we're going to look take it on the conservative side and run with it a little bit on the lower side. It doesn't mean anything for the future.
For us, at America, we're looking at our thinking of increasing more or getting more cash to the shareholders, if you will.
Okay. Thanks.
Thank you.
Our next question comes from the line of Manav Gupta from Credit Suisse. You may ask your question. Hey,
Uzi. So I'm just trying to wrap myself around the clean cash flow from operations number excluding working capital and any inventory issues? I think I'm getting to about $230,000,000 in clean cash flow from operations. I just want to know how much I'm off by?
You are in the ballpark, Kevin. I don't know if you want to take that, but you are in the ballpark. Go ahead, Kevin.
Yes.
That's about right, Manav. So we actually have we have a cash flow from operations improvement in Q2. If you look at where we ended in Q1 versus what we had in the earnings release last night for Q2, showing an improvement in cash flow from operations. And like we said in the prepared remarks, we did have some working capital changes in the quarter, really driven by increased prices and increased sales volume. So that number was about $80,000,000 So yes, dollars 175,000,000 to $200,000,000 is probably about the right ballpark for sort of a clean cash from operations for the quarter.
So let's say it's $200,000,000 and then I take out about $50,000,000 from your CapEx, that's like 150,000,000 dollars in free cash flow in this quarter on a $3 barrel realized Midland Cushing differential, right? I mean, am I thinking about it right, $150,000,000 free cash flow just on $3 differential?
On $3 realized, that's exactly right. Right.
So the question which I'm struggling with there is, now if I take that to 15 and what are your internal models telling you that if I keep that differential at 15 till Cactus II actually comes online because what Plains is saying is Cactus II is only partial service in 4Q 2019, right? So if the spread remains at 15, how much cash are you guys generating for the next 6 quarters in your internal models?
Well, Manav, don't need even to project something. We just told you that 3rd quarter, very simple. This is realized. This is not this is after the inventory effect. For the 3rd quarter, it traded $13 We already calculated the inventory effect because we are we can do that.
We already told you it's $10.80 for the Q3 and we are telling you now that for September, it's at 17% and September is October because there's 1 month delay. So the free cash flow is obviously going to be a very big that's the reason we are so optimistic that the numbers will continue to come in very strong. So if we're looking at the Q4 right now, it's showing $15 but September is even better than the 4th quarter right now. September is trading so far for the year and we have another 2 weeks to go, dollars 17 So enormous free cash flow.
I agree. And our projections on both buy side and sell side are indicating that you could exit 2019 with $2,300,000,000 to $2,500,000,000 of cash on your balance sheet. That's just too much cash for a person who is known to acquire very strategically in downturns. We are not in a downturn. So why is this such a big cash flow build for the next 6
months? Well, first, it needs to build. 2nd, look what we're doing. We repurchased $153,000,000 in the 1st 6 months. We increased dividend.
We will continue to be aggressive giving cash to shareholders and we will continue to look at opportunities. I want to emphasize one thing. As we are getting bigger and bigger on the premium side, more opportunities coming to us in the premium area. So don't be surprised if we are looking at other opportunities in the premium.
Perfect. Thank you so much, Uli. Thank you for taking time and answering my questions.
Thank you, Manav.
Our next question comes from the line of Mr. Roger Read from Wells Fargo. Mr. Read, may I ask your question?
Yes, good morning.
Hey, Roger.
Hey, guys. I was just wondering, maybe along the lines of Manav there. Uzi, you've talked about on the logistics side a lot of opportunities that refining is probably not where the asset values really line up right now. Relative to the last kind of 2 conference calls where that's been discussed, can you talk about maybe how valuations there either better or worse or there's more or less opportunity. I think you kind of alluded to it in the last comments there.
But maybe what we should think about that way in terms of cash as opposed potentially, I think as Manav laid out, just buying back all your equity.
That's a little tongue in
cheek there for you as well, of course.
Well, that's a different discussion. But I think I'm being recorded here, Roger, so I'm not going to answer that one.
Yes. No, I'm setting you up.
But just really on the acquisition front, what do you see out there?
Well, first of all, on the premium, there's a combination of acquisition and organic growth. You see that we set aside around $80,000,000 for premium, if you will, premium logistics assets. We are developing our plan here. And as the plan matures, we'll come to the market with that. I want to emphasize that on the logistics side, still the market is under pressure.
As we know, MLPs are out of favor. And we will need to have a hard look on that. Now we don't want and I want to be clear, we do not want to buy something just for the sake of buying something because we have the money. And we try to be disciplined in the past, but we do want to look at it. So that's a balance.
Obviously, we won't surprise you with an acquisition that is 12 times or 14 times or 16 times. That's not who we are. So we just need to remember that this is a combination of organic projects, acquisitions with the right pricing and returning cash to shareholders aggressively.
Okay. And then retail was an area where you originally started the company, you sold off that particular retail operation, but it was a result of years of investment improving the operation and getting a premium valuation. As you look at the Eilan retail, you've had it almost a year now to really kind of look at it. What is the path there? I mean is that one of the places we should presume some of this CapEx or I say this CapEx cash flow could go maybe a higher CapEx?
Are there opportunities there? Or is it more of a it's good enough and leave it alone as is?
Well, let me tell you, yesterday, well, in the last 3 days, I was in Big Spring and Midland. We were in Big Spring and Midland, just spent 3 days over there. And the area is just booming. On the retail side, as you see, we have record results on the retail side. I actually think that we will achieve record results every quarter now for the next few quarters just because the market is so strong in the areas that we're in.
However, the stores that are in the area, including our stores, are sometimes dated stores that need some help and also building some, if you remember, megastota like we did with Merco years ago. So that's an area that we are looking at. We are not talking about here 100 of 1,000,000 of dollars. It's probably in the magnitude of, call it, same stores or 8 stores to start with. So I wouldn't read much into it in the great scheme of producing the amount of cash flow that we are producing.
Okay. And then maybe just the last way to think about that. You've got the one convertible debt piece that's going to go away here at the end of the quarter. What else would you do balance sheet wise as you look forward? I know it's not like a lot of the debt necessarily has any prepayment value, but I was just curious as you're balancing acquisition share repo stronger balance sheet and for a crude different environment that while very favorable for the near term won't be here forever in terms of cash flow generation.
Just how do you look at the overall picture there?
Well, thanks for again for asking about the convertible. That's an opportunity I neglected to mention that earlier. We will settle the convertible with cash the $150,000,000 with cash by the end of September. So that's $150,000,000 obviously won't impact net debt. But in our mind, something that has the potential to be semi equity obviously will go away with cash.
So that's going without saying. The other thing that we need to look at and that creates a lot of noise is the J. A. R. E.
ON facility. One of the facilities expired, the West Coast facility that alone had expired 2 months ago. Obviously, we didn't renew it and we moved on with our life. The same thing or there are 2 expirations coming in 2020 for El Dorado and then the remaining of the system early 2021. We're looking at it very carefully.
At this point, as Kevin, Artie and I talk about that, our intent is to sell that within our means and more traditional facilities. So that's the next step in that area.
Okay. Thank you.
The next question comes from the line of Prashant Rao from Citi. You may ask your question.
Good morning. Thanks for taking the question. I wanted to circle back on the capital allocation and sort of the balance sheet cash expectations and what you guys are seeing out there in the market. Specifically, I think there's in terms of IMO 2020, I'm surprised nobody brought up the question yet on the call. But I understand that you guys have a lighter crude slate and the story is very Permian focused and that's been the narrative and that's what's been working.
But is there some way that maybe you could take advantage of expectation in widening out light heavy differentials? Is that something that you're exploring from a use of cash perspective in terms of investments? Or how should we be thinking about that? Because as the Midland discount sort of tightens back up and transportation problems get abate, at least in the intermediate term, that might become the next leg of a longer term cash flow story. So wanted to get your latest thoughts on that.
Absolutely. First of all, just to remind everybody, and I know that you remember that, both El Dorado and Big Spring can go between light, typical WTI that we see now and medium sour, the WTS or Mars like. So if this count opens up, then the 2 refiners can do it pretty easy. That's their configuration. That's in that on that side.
I do want to emphasize that obviously, we're benefiting from Midland right now, but we are taking few steps around the logistics and around other areas to allow ourselves to capture more when IMO shows up. I want to be and maybe I was too conservative when I thought that Midland cannot be minus 17 and now we're at minus 17 all of a sudden. I'm going to be a little more conservative here on the IMO. I'm not sure we will see the benefit that everybody expects as I think more and more people taking the steps. But again, that's we need to wait to see if it comes or not.
Okay. Thought question then on the synergies target. Just wanted to ask where the if there's anything in particular where the upside came from versus your expectations in the rate you guys have been beating the announced target seems like Q on Q for several quarters now, but in this quarter in particular, anything to call out? And then going forward, what else is maybe there is dry powder in your back pocket that maybe we're not counting?
Yes. I actually think that we have it in front of us. I think we're filing the presentation today as we are seeing investors in the next 2 days pretty much across the board. And I think we're seeing you guys next week. So on the commercial side, the new estimate is between $33,000,000 to $40,000,000 On the operation side, it's pretty much the same, around $23,000,000 to $25,000,000 Cost of capital, what we reported earlier, dollars 35,000,000 and corporate, a little more between $36,000,000 $39,000,000
Okay. Fantastic. And just one last one, I'm going to take another stab at what Manav was asking earlier. I think previously you guys have called out sort of a sensitivity on every incremental dollar on the Midland discount as to what that means in terms of EBITDA. Few months ago, those around, if I remember correctly, every $1 being $75,000,000 in annualized EBITDA.
Would you be willing to call out a specific sensitivity number or is there things a little too dynamic right now?
No, that's exactly the number. It's the same $75,000,000 now that's the reason we basically gave you what the essentially it can move a few pennies here, a few pennies there because of inventory end of the quarter. But essentially, we gave you Midland that you can model it for the Q3, dollars 10.80 So if you take that $10.80 times 75,000,000 barrels divided by 4, that's the impact on the quarter of Midland. If you want to understand the incremental, it's $7.80 times 75,000,000 barrels divided by 4. That's on top of what you saw in the second quarter.
Okay. That's what we thought. I just wanted to make sure we get that exclusively confirmed. Thank you very much. I'll turn it over.
Thank you, guys.
The next question comes from the line of Mr. Phil Gresh from JPMorgan. Sir, you may ask your question.
Yes. Hi, good morning. I guess I'll just follow-up right there. Just to clarify on the backwardation component of that color that you gave in the prepared remarks, that just be a modest partial offset quarter over quarter of I think you said $1.30?
That is correct. That's exactly Phil. We wanted to give you a full disclosure. As we see more backwardation in the market versus contango, like any other refinery, what the way we buy it, we will suffer from about $0.30 setback versus you last quarter was contango roughly $0.20 or $0.15 I think that's probably the model for everybody else. That's how everybody buys crude.
But just wanted to be clear on that.
Yes. No, that's helpful. And then for Kevin, just on the cash flow color that you provided on the working capital, how much would you expect to reverse of what's happened in the first half in the back half? And secondarily, we don't have the Q yet, but obviously the Q1 had a pretty big headwind on the deferred tax piece. So just wanted to clarify how you're thinking about cash taxes relative to the book tax rate on a full year basis.
Is there some reversal that happens there as well?
Yes. So as of right now, we're expecting the full working capital headwind to come to fully revert back by year end. So we would expect from here on out essentially 0 net working capital changes. And then on the cash tax piece, we're estimating about $40,000,000 cash taxes paid in the second half of the year for full year.
$40,000,000 is for the full year?
Yes. In Q3, that will hit. Okay.
Got it. And then as we think about this capital allocation piece, Uzi, you mentioned the convert pay down. You mentioned you're looking at some M and A opportunities, but obviously everyone's highlighting here that your cash flow generation probably still would exceed all of these things. So is the are the M and A opportunities you're looking at kind of modest in size? And is there any reason that you couldn't extinguish this buyback in the next 2 to 3 quarters anyway even if you are looking at these other things given your positioning?
We agree. When we say nobody should expect us to write a check of all of a sudden $1,500,000,000 or $2,000,000,000 or something that won't have unless there's a well, I shouldn't say nobody should expect that. Unless there's an opportunity, but as it stands right now, I don't see that opportunity knocking on our door. We were very conservative in the past and we will continue to be conservative maintaining our balance sheet. However, let's be clear, the numbers are pretty big here for upcoming quarters of the free cash flow.
So there's no reason to believe that we won't look at it very carefully. Last quarter, we increased the dividend. Before that, we did the special buyback. So there are other means to do it outside just going out to the market and buy day in, day out, which if we see opportunities like that to create value, the shares today at $51 if you remember, we bought from Malone a big chunk from Malone, Israel, I'm going by memory, in the mid-30s. So just bear with us on, hey, we want to return cash.
We're committed to that. We just want to do it in a smart way.
Okay. Thanks a lot.
Thank you, Phil.
The next question comes from the line of Mr. Paul Cheng from Barclays. Sir, you may ask your question.
Hey, guys. Good morning.
Mr. Cheng, welcome back. We missed you.
Thank you. Thank you. You see, the utilization rate actually the last several quarters has been very good. Do you think that is sustainable or that you're being lucky and don't really have a lot of downtime that what have you done maybe somewhat differently to achieve that?
That's a great question. Like as Kevin said earlier, we expect similar situation in the bearing something unusual happening. We expect the same thing in the Q3. I think Fred and the team did a great job improving reliability. We took care of the bed actors.
Obviously, in couple of years ago, 3 years ago, we had the growth project. But as we completed them, our attention got back to reliability. And as we control the quality of the crude bear in bear through our gathering and checking system, there's no reason to believe that we won't continue performing the way we perform. We do have a turnaround coming for El Dorado in the Q1 of 2019, But until then, we expect to run pretty smoothly.
And how big is the turnaround for El Dorado in Q1 2019?
In terms of dollars or in terms of I'll give you
both. In tank.
Downturn, probably between 35 40 days oil to oil. It's a major turnaround. And in terms of cost, we always budgeted $50,000,000 I would say, call it $50,000,000 to $60,000,000 that's the number for the turn on.
What unit is going to be down?
I'm sorry?
Which units will be down?
The entire refinery will be down.
The entire? Yes. Okay. And usually, you're talking about one of the reason why you've been able to run better is that you see more and more oil, you get there yourself. So what is the percent of oil that now you pause and gather by yourself or your control?
I would say that we gather between West Texas and other places, probably a little more than twothree of our own oil.
Yes, Danny. So I presume that majority of that you are not getting, is it now is in Coral Spring or they are still spread
Some of it obviously, Big Spring is the easiest place to do. So Big Spring is most of it. We do get some, actually a good portion in Tyler and in El Dorado. And now we start to do the same thing at Croats.
And what is your target for the next, say, 12 to 18 months? Do you think you can get to 80%, 90% or that's too aggressive?
No, no, no, we can. We absolutely can.
Okay. So that's and maybe that a couple of questions for Kelvin. Kelvin, earlier that when you say $38,500,000 of the inventory timing effect, is that solely related to J. Aron? Or that's also including on the Trademont impact?
No, that has nothing to do with J. Aron. That is simply the inventory timing effect between when we purchase Midland Crude and when it actually shows up in our P and L. So there's just a physical lag between when we purchase crude, it goes into inventory and it gets processed through the system. And then there's also a FIFO effect on top of that.
So if you recall that we've got we account for inventory with the FIFO method at every refinery except for Tyler. So you see an additional delay between purchased crude and kind of the realized impact in the P and L due to that effect.
But the FIFO effect essentially is because of Jay Aaron, right? Because you are under LIFO for your company.
Yes, that's exactly right. So we account for
I'm trying to separate out between the 38.5 what is related to FIFO, which is related to J. Aron and what is the other? Do you have the breakdown?
We didn't break it down that way, but it's a combination of both the FIFO and just the physical lag in the way we process crude through our inventory system.
Yes, because the number that I have some difficulty to fully reconcile earlier that according to Yuxi, on the spot, the Midland discount is over $8 and that on the treatment basis over $5 and your actual realized is $3 So the difference between the spot and what you realized is over $5 and you process over 2 91 day. So that should be 90,000,000 We talked about everything. So I'm trying to understand what the 38.5 really mean.
Paul, I don't know where we got the $8 There's no I don't think that there's $8
On the spot I mean spot price on Yes, but remember you Cushing is 8 over 8.
You're right. But we buy it. Always, we buy it 1 month ahead of time.
No, I understand. I understand that. That's why I'm trying to understand what is that $38,500,000
Okay. The $38,500,000 is that we buy 1 month ahead of time, okay? So if you look at it, not the spot, but the FADAS you just mentioned, it's FADAS that we bought 1 month ahead of that. Then we are actually processing the crude 1 month after we actually bought it. So the $5 that we bought, we actually now it takes another month to process it.
So if you want to calculate back on the envelope, even though we did give you the number of $10.80 what you need to do is to do the not the spot, but the forward month average, but you need to start 1 month earlier. So for the month of for the Q3, what you need to do is to take June as it was traded in May, July as it was traded in June and August as it was traded in July, do the average and you will get very close to the number I just told you.
Yes. I think that so that means that, that number is basically the difference between the treatment defense and what you realize. Is that fair to characterize like that?
Exactly. Now obviously, that will come back in the future because the system doesn't change. So if tomorrow morning, Midland will go from 17 to 15, you all of a sudden see a benefit to that of $2
And Kevin, I missed when you're talking about the hedging that what do you have any realized hedging gain or loss in the quarter?
We have a little bit of hedging gain and loss. However, I want to that's a good point for me to say that we do look at hedging of the Midland differential a little bit. We did so far, I would call it a little less than 10% of the production. It's pretty much it fluctuates obviously. We're talking about 18 months from now.
So we are around the money. We don't we're going to once it starts because we did forward, we will start providing you with information. But we do look at hedging a little bit of the Midland forward curve.
Right. Then how about in the second quarter we saw, did we have any realized hedging gain or loss?
Hold on for a second. Let us look at this.
Follow us on our tables at the back of the release.
Yes. So if you look at Page 19 of the release, Paul, dollars 9,900,000 of unrealized hedging loss in the quarter.
Right. I'm talking about realized. I saw the unrealized. I'm curious that do you have any realized hedging gain or loss?
Why don't we we don't have any problem, why don't we look at that number and give it to you. Is that okay?
Yes, that's fine. Final just curious that you see when people are asking about the cash return, some of your competitor that they will have a very explicit way. So say, I want to further cycle be 30% of the cash flow or 40%. Is that a policy or strategy that you will adopt or that you think you need more flexibility so this is not for you?
That's a great question, Paul, and I'm going to answer it very directly. Some of our peers that are doing great job creating value for shareholders are much bigger companies than us. And they are not based on growth or acquisition and we feel that the value we create to our shareholders is by a combination of growth as well as returning cash. So we want while we want to retain cash and be aggressive when we have access cash flow like now, we still want to maintain a dry powder, if you will, to make sure that we can be nimble and to continue to grow our company, like we did with the Alon acquisition or before that the El Dorado acquisition.
Thank you.
Our next question comes from the line of Mr. Paul Sankey from Mizuho Securities. Sir, you may ask your
question.
Mr. Sankey, you may ask your question. The next question comes from the line of Mr. Neil Mehta from Goldman Sachs. Sir, you may ask your question.
Hey, good morning, guys.
Hey, Neil. Good morning.
Good morning. So first question I had, given how big your gathering business has become, you guys are on the spear tip of what's happening in terms of Permian oil production. Given what you've seen in terms of the differentials, have you seen any slowdown in terms of activity from your producing customers or suppliers?
Actually the opposite. The way the system works and I'm getting here a little technical, but I'll do it anyhow. At the beginning of every month, we get projection of production from producers and we do business with many, many of them. So once we get that production plan, that's how we plan our purchases. And every month, you by the end of the month, it comes whatever it comes because they won't slow down or speed, but they'll just go with the flow.
Well, in the Q1, what we saw the Q1, what we saw because of the if you remember the freeze in West Texas, huge slowdown. Well, now we are in the middle of the summer and it's just booming. And every month, what we see from producers is that they call us and say, okay, I was wrong, take a little more can you take a little more oil? And then obviously once they do that, then you see toward the end of the month, the differentials are tanking and that leads to the weakening of the following month. So absolutely no slowdown.
Okay. That's helpful. And in terms of Brent WTI, we spent a lot of time talking about WTI Midland, you guys are also levered to the Brent WTI differential. Cushing is really great. Basically, the effective tank bottoms here at this point.
I mean, how do you that playing out from here, Uzi, the spread between Brent WTI, one would think that we'll start to see Cushing inventories build back up and just curious on your latest thoughts there?
Well, you're asking a great question, Neil. I want to emphasize one thing before I answer just Brent TI is that we look at Midland Brent, which is obviously in excess of around $20 right now. And if Midland continues to do what it does, then Brent cannot go back to $15 in our mind. However, I do think that there's an opportunity. We do think that there's an opportunity for Brent TI to widen a little bit in the Q4 and in the Q1 despite Midland being in such a discount.
So if you will, I would add probably $1 or $2 to the current discount between Brent and TI.
The last question I have is on Crops. Historically, this has been a problematic asset for Alain. This quarter, you beat us on operating expenses to the downside and it looks like it ran pretty well on realized decent margins. Could you just talk about where Krotz is in terms of the turnaround? Is this a sustainable type of run rate that you can drive performance from the asset?
And what type of crudes you're able to bring into the facility because that's historically I think been the area of the greatest problem, which is just getting discounted crudes into crops?
And Neil, I'm going to say, probably I told you a year ago that either we fix crops or we'll do something with it. And we put a lot of effort, energy and sweat into this thing, bringing crude to the refinery and then also increasing netback. Obviously, we have space on Colonial now. Rins are cheaper. So Crocs is enjoying that as well because of the synergies, we combine the space between the two companies.
And let me just remind you that Crocs has actually positive yield, not negative yield. So when prices of crude go to $70 or $65 all of a sudden, Crocs shows improvement. We still have ways to go. I want to be clear. 1st of all, reliability, we are working on it.
We still have a little tweaking even though we do have a great refinery manager over there. The second thing is the Alky. The Alky is a big project. We need to complete it and we need to commission the unit. Sometimes early or in the first part of next year that will bring another probably in today's market more than what we said 35 to 40, we'll stick to 35 or 40, but of EBITDA.
And then we need to get ready to for IMO and maybe the opportunities around that and blending of different things as Crod has that opportunity as well. So I wouldn't be surprised if court will continue to perform well for us.
The next question comes from the line of Mr. Doug Leggate from Bank of America. Sir, you may ask your question.
Hey, guys. Thanks for taking the question. This is Clay on for Doug. So on the E and P side, there's been a few deals announced where producers are trading longer term margins for nearer term flow assurance. Wondering if there is any opportunities for DK to participate here where a deal could potentially prolong the wider spreads for a duration?
Well, if you do something like that, you do it away from the market. We do have several deals that we do cash deals and not paper deals, but we haven't done anything behind 2019. So if you ask about long term behind 2019, we have not done it.
Okay, got it. And just want to expand on one of Paul's earlier questions. Can you just expand a little bit on the $3,000,000 differential in the quarter? I understand the accounting and the impact on the reporting of the spread capture there, But it looked like it could have been higher. So my question was, was the buying of the crude perhaps weighted towards the front end of the quarter where the spreads were a bit tighter?
And are there any issues that we should be watching out for when we're modeling out for 3Q?
I'll be very, very strong. We buy our crude ratably. Obviously, we play with it a little bit, nothing that you pay attention to. We try to beat the spread just a little. 2nd, we do not and I was asked that question many times in the past, I'll be very strong.
Whatever you see on the screen, this is what we get. Not even $0.01 less. As a matter of fact, sometimes because of the gathering a little more, but let's just leave it to that. 3rd, I don't know how you Clay, you got to that it's weaker than what you expected. It's very simple.
If you take, as I said, the formula is very simple because we have inventory for 1 month and we buy 1 month ahead of time. So if you take May and you look at what June was traded in May and then you take what July was traded in June and then you take what August was traded in July. You do the average of the 3, you will get to the around there's little noise, but around the 10.80 that we provide you. If you do the same exercise for the 2nd quarter, you take what April was traded I'm sorry, what March was traded in February, what April was traded in March, what May was traded in April, do the average of the $3, you will get it to the $3 roughly.
Thanks for the breakdown there. And last question, just on the refinery turnaround in 2019, if spreads are as wide as we think they're going to be, would you consider pushing that out to the following year?
No, and I'll tell you why. It's very simple. If you remember, we have a system of 207,000 barrels a day. The refinery will be down 75 1,000 barrels. We will play around with crude to have as much advantage crude going or cheaper crude going through the system.
So while it is going to be down, we will try and in the past we were successful for the most part moving that cheap crude to the system somewhere else.
Thanks for the answers guys.
Thanks, Lee. Thanks.
The next question comes from the line of Mr. Silvio Micheletto from Mizuho. Sir, you may ask your question.
Hello. Can you hear me?
Oh, Mr. Zenki, welcome back.
Finally, these fancy items, Izzy.
I'm so excited.
Yes, I'm sorry about the early announcements. We're trying to get used to the new phones here at Mizuho. Uzi, there's only one question I can possibly ask you, which is, have you considered taking Delek private?
As you probably know many times, yes. However, first, we want to continue to grow. So if there's an opportunity for us to buy something cheaper than us, then we probably shouldn't do that. However, as we look at the screen, we know that we are pretty cheap right now compared to our peers. So I wouldn't say this is something that was considered CSP lately, but if the opportunity comes, we will be nimble to do so.
Yes. It feels like you've got a lot of good opportunities in the Permian. I guess these are gathering type. What is the nature of the opportunities there just industrially?
This is pretty much what we're looking at from organic standpoint. We did a lot of work. People want to deal with the refiner directly and people want there will be opportunities in the premium. Don't be surprised if there will be some announcement over the last few quarters.
You've been a bit coy on the buyback, but I get the feeling it's not because of the scale of the or rather it's not because there's huge acquisitions out there. It's just that you're being somewhat circumspect. Can you remind us, you tend to have a view of the intrinsic value of Delek. Can you talk a little bit more about buyback just to give us more to think about? Thanks.
Well, honestly, the buyback is now a key component. We were on the light side this quarter as we were looking at different options. But if and there's no reason that it won't mature because we see the cash flow coming in. As it comes in, there's no reason to believe that we won't be more aggressive. I do want to leave, as I said in the past, Paul, and we know each other for many, many years, that I we want to leave some dry powder an opportunity arises.
Yes, that's understood. Uzi, I noticed it's past 11, so I'll jump look forward to seeing you.
Thanks.
The next question comes from the line of Mr. Matthew Blair from Tudor, Peter, and Holt.
So Plains mentioned last night they may expand the Red River pipeline by 100,000 barrels a day. It seems like additional WTI barrels into Longview would be a positive for DK. Could you just talk about this opportunity here? And would you consider being a shipper on the expanded line?
Well, I won't be going specifically on specific lines here. I'm not going to be professional, but we do, as you know, have a big hub in Longview. You're absolutely correct. So opportunities to bring more barrels to the hub and then by definition lowering the cost of the hub makes sense. I'll leave it to that, Matt.
Okay. And then two questions on hedging. So one on this Midland timing impact, shouldn't you have inventory hedges in place that would really account for this gap between when you purchase the crude and when it and when you actually run it? And then 2, you mentioned this approximate 10% mid cush basis hedge. Was that a negative in 2Q for you?
I'll answer the second question first. No, the answer is no. There was no very little if I'm going by memory, very little. No, the answer is no. Not negative and not positive.
On the inventory, we can, but being a bigger company, it doesn't make sense to spend money on something that doesn't mean much besides accounting because the cash will come anyhow. Why to spend money on inventory or hedging something that is completely paper? The moment if next month the differential will go from 17% to 15%, all of a sudden there will be positive impact and not negative. So why to do that? It creates some noise, which we probably need to work on it from an accounting standpoint.
But spending money on something that is accounting, I don't know, I'm not sure that's something that we should do.
And the $38,500,000 timing impact, so that cash benefit showed up in your CFO in 2Q, right?
Right.
Okay. Okay. Thank you very much.
Thank you.
This concludes our question and answer session. I would now like to turn the call over to the presenters for their closing. Presenters?
Thank you, Don. I'd like to thank everybody for their great interest in us this morning. Thank you for the support, both analysts and investors. I'd like to thank my colleagues here around the table with the great support that they give me and give the company. I'd like to thank the executives and the Board of Directors, But mostly, I'd like to thank each one of the employees of our company that makes this company so great.
Thank you. We'll talk to you in the future. Bye.
This concludes today's conference call. Thank you for your participation. You may now disconnect.