Welcome to the Valero Energy Corporation Reports 2014 third quarter earnings results conference call. My name is Daniel, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. If you have a question, please press star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. Please note that this conference is being recorded. I will now turn the call over to Mr. John Locke. Mr. Locke, you may begin.
Thank you, Daniel. Good morning, and welcome to Valero Energy Corporation's third quarter 2014 earnings conference call. With me today are Joe Gorder, our CEO and President; Michael Ciskowski, our Executive Vice President and CFO; Lane Riggs, our Executive Vice President of Refining Operations; 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. Now, I would like to direct your attention to the forward-looking statements 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. Before we review the quarterly results, I'd like to highlight some of our strategic accomplishments in the last quarter. These actions align with our key strategies to reduce feedstock costs by improving access to North American crudes and to grow our logistics investments and Valero Energy Partners LP, our sponsored logistics partnership. In August, we secured shipping rights and the option to purchase a 50% interest in Plains All American's Diamond Pipeline.
When completed in late 2016, that 440-mile pipeline will connect our Memphis refinery to the crude oil hub at Cushing, Oklahoma. Regarding Valero Energy Partners LP, we completed our first drop for $154 million in cash at the beginning of the third quarter. We also continued advancing our capability to access and process advantage crudes during the quarter with the commissioning of our rail unloading facility at the Port Arthur refinery. With its startup in September, this is the third crude-by-rail facility we've completed in the past 13 months, with the other two completed facilities located at our St. Charles and Quebec City refineries. As mentioned in the release, we are also progressing on our other key investments as part of our strategy, including the completion of investments to receive advantage crude at our Quebec refinery on Enbridge's Line 9B pipeline reversal.
We also expect to complete the hydrocracker revamp at our Meraux refinery later this quarter. Looking out a little further, the two crude topping units at our Corpus Christi and Houston refineries are progressing as planned. Moving on to our quarterly results. As you saw in our earnings release, we had a strong quarter. We reported Q3 2014 earnings of $1.1 billion, or $2 per share. Q3 2014 operating income was $1.7 billion, or $1.1 billion higher than the third quarter of 2013. Most of the increase was in the refining segment, although the ethanol business also contributed. Refining throughput margin in the third quarter of 2014 was $11.81 per barrel, an increase of $4.05 per barrel versus the third quarter of 2013.
Wider discounts on sweet and sour crude oils versus Brent and stronger gasoline margins in most regions were slightly offset by weaker distillate margins versus Brent in most regions and higher natural gas costs. Also contributing to the higher throughput margin was our Quebec City refinery's higher year-over-year consumption of North American light crude in the third quarter. The refinery's feedstock diet consisted of 79% North American grades in the third quarter of 2014, which is up from 6% in the third quarter of 2013. In addition, we realized a reduction in crude costs in our Mid-Continent region when we completed our connection to a pipeline in Childress, Texas. This connection allowed us to receive an incremental 40,000 to 50,000 barrels per day of Midland-priced WTI crude oil, primarily for our McKee refinery.
Lastly, we continue to ramp up North American crude consumption in our Gulf Coast region by replacing an additional 100,000 barrels per day of foreign crude in the third quarter of 2014 versus the third quarter of 2013, with some of those volumes delivered to Port Arthur by our new rail unloading facility I mentioned earlier. Refining throughput volumes averaged 2.8 million barrels per day in the third quarter of 2014, which is an increase of 42,000 barrels per day versus the third quarter of 2013. Less turnaround activity and higher throughput capacity utilization led to the increase in volumes, which was supported by strong product exports and the increased availability of North American light crude on the Gulf Coast. We operated our refineries at 98% throughput capacity utilization for the quarter.
Refining cash operating expenses in the third quarter of 2014 were $3.81 per barrel, which is $0.07 per barrel higher than the third quarter of 2013, due mainly to higher energy costs. The ethanol segment generated record earnings of $198 million of operating income in the third quarter of 2014 versus $113 million of operating income in the third quarter of 2013. The increase in ethanol segment operating income was mainly due to a $0.27 per gallon increase in gross margin, driven by lower corn prices on an abundant corn harvest and higher production volumes from the startup of our Mount Vernon, Indiana plant. Ethanol production volumes averaged 3.6 million gallons per day in the third quarter of 2014. General and administrative expenses excluding corporate depreciation were $180 million in the third quarter of 2014.
Net interest expense was $98 million, and total depreciation and amortization expense was $430 million. The effective tax rate was 32.9%. With respect to our balance sheet at quarter end, total debt was $6.4 billion and cash and temporary cash investments were $4.2 billion, of which $231 million was held by Valero Energy Partners LP. Valero's debt to capitalization ratio net of cash was 10.5%, excluding cash held by Valero Energy Partners LP. Valero had approximately $5.6 billion and Valero Energy Partners had $300 million available liquidity in addition to cash. Cash flows in the third quarter included $622 million of capital expenditures, of which $123 million was for turnaround and catalysts. In the third quarter, we raised our dividend for the second time this year with a 10% increase.
We returned $489 million in cash to our stockholders, which included $145 million in dividend payments and $344 million in purchases of approximately 7 million shares of Valero common stock. Subsequent to the third quarter, we continued to return cash to stockholders by purchasing an additional 3 million shares of common stock for $138 million, which brings our total for 2014 to 18.4 million shares for $937 million. For 2014, we are lowering our guidance for capital expenditures, including turnarounds and catalysts by $100 million to approximately $2.9 billion. We expect stay-in-business capital to account for slightly less than 50% of total spending, with the remainder related to growth investments primarily for logistics and advantage crude oil processing capability. More than 50% of Valero's estimated growth investments in 2014 are for logistics, and we believe most of this will be eligible for drop-down into Valero Energy Partners LP.
For 2015 capital expenditures, including turnarounds and catalysts, we expect to spend approximately $2.8 billion consisting of approximately $1.8 billion for stay-in-business capital and $1.3 billion for growth investments. The majority of growth investments are allocated to logistics and increasing our capability to process advantage crude. For modeling our fourth quarter operations, we expect throughput volumes to fall within the following ranges: Gulf Coast at 1.55 million to 1.6 million barrels per day, Midcontinent at 450,000 to 470,000 barrels per day, West Coast at 260,000 to 280,000 barrels per day, and North Atlantic at 410,000 to 430,000 barrels per day. We expect refining cash operating expenses in the fourth quarter to be around $4 per barrel.
For our ethanol operations in the fourth quarter, we expect total production volumes of 3.7 million gallons per day and operating expenses should average $0.41 per gallon, which includes $0.04 per gallon for non-cash costs such as depreciation and amortization. We expect G&A expense excluding depreciation for the fourth quarter to be around $190 million and net interest expense should be about $95 million. Total depreciation and amortization expense in the fourth quarter should be approximately $425 million and our effective tax rate should be around 35%. I will turn the call over to Joe for a few remarks.
Well, thank you, John. As you may have seen, last week we announced that Bill Klesse has chosen to step down as Chairman of Valero Energy's Board of Directors at the end of this year. So on behalf of our Valero team, we just want to thank Bill for all he's done to make this company successful over his 45-year career, and we'd really like to wish Margie and Bill all the best going forward. John?
Thank you, Joe. Before I turn it over to Q&A, I just want to clarify on the 2015 stay-in-business capital, it should be $1.5 billion. I believe I said $1.8. Okay, Daniel, we have concluded our opening remarks. In a moment, we will open the call to questions. During this segment, we request that callers limit each turn to two questions, but callers may rejoin the queue with additional questions.
Okay, thank you. We will now begin the question and answer session. Once again, if you have a question, please press star then one on your touch tone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you're using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press star then one on your touch tone phone. Our very first question comes from Jeff Dietert from Simmons. Please go ahead.
Yeah, it's Jeff Dietert with Simmons. Good morning.
Morning, Jeff.
My question has to do with some of your crude feedstock cost, and specifically one with Saudi having raised their prices to the U.S. It appears that some of their crudes were not terribly competitive. We saw the crude imports for the total U.S. drop from 1.6 million barrels a day in April to less than 900,000 barrels a day in September, while Saudi was increasing prices during that period of time. Since then, they've had four consecutive months of price reductions. I was wondering if you could provide some color as to how attractive the Saudi crudes have been in the market through the spring and summer, and whether or not these recent reductions in prices make them more competitive now.
Hey, Jeff, this is Gary Simmons. You're exactly right. I mean, the Saudi barrels had gotten to where we felt like they were uncompetitive versus all alternatives. In the third quarter, our volumes from the total Middle East were down considerably where we've historically run. We're now seeing that they are making pricing moves to bring their barrels back, being competitive in the market. I would say with their recent announcement on their OSP, they're competitive or at least within $0.50 of ours.
Okay. Secondly, with the Brent pricing being weak and some of the West African prices being soft, have you seen those barrels price themselves back into either the East Coast market or the Gulf Coast market with some of the softness relative to LLS we've seen this fall?
Yeah, Jeff, the place that we pivot first is really our Quebec refinery. We definitely, as Brent got weak, we saw incentive to start buying some West African grades again and backing out some of the grades that we were taking from the U.S. Gulf Coast.
So both of those sound like increases in imports in a market where we've got pretty substantial domestic production growth. You think domestic prices have to soften to back those imports back out on the market?
Yeah. You could see that in the markets. Brent got weak about 3 or 4 weeks ago. We started to pivot as others did, and then we've had 3 straight weeks where crude oil inventories in the U.S. built. So it tells you then the differentials have to come back off to force those barrels back into the market.
Thanks for your comments.
Our following question comes from Paul Cheng from Barclays. Please go ahead.
Hey, guys. Good morning.
Morning, Paul.
I have one request and two questions. The request is that, since the sum of the part analysis may turn out to be an emerging investment theme in the sector, I know there's still a small number, but it will be helpful, I think, for your shareholder, if in your press release somewhere that you put down what is the GP cash flow and your total number of units in the LP and also that the total LP unit. I mean, even though those numbers can be found in your VLP disclosure, it's just helpful there to be in one document. In terms of the question, with the announcement from one of your competitor last week, in terms of their strategy and drop-down, they have done substantially accelerating.
Is there any clear or more transparent strategy or data that you can provide in terms of your VLP drop-down pace or the distribution growth for the next several years?
Yeah, no, Paul, that's a fair question. This is Joe. If we look at VLP, since the IPO, we've stated that we're going to grow our distributions between 20% and 25% a year. We're in target to be in the middle to the high end of that range. We just completed a drop and a distribution increase, and we're working on the next drop. VLP is less than a year old. We don't have a debt rating yet. We'll be in the process of getting that in the next year or so, and it's our intention to be investment-grade. When you consider the size and the pace of our drops to VLP, our original plan was to start with the logistics assets that would be more traditional. That's where we said that we've got the $800 million of EBITDA.
That is not a specific business unit that we have within Valero. It's assets that are used to support the rest of the operations, and so we haven't had P&Ls for them. That being said, we can go in and we can calculate what the EBITDA would be for those assets based on market rates. That's what we've done. What's come up here recently is this additional set of cases that would include, do you put fuel margins and process units into the MLP? So we're going to take a look at everything, and we're going to act accordingly. Obviously, it's never as simple as taking EBITDA, putting a multiple on it, and then saying that's what the value is. You got a lot of tax effects that need to be considered.
The other thing then is, with the use of proceeds, could they be used? I expect we're going to use them to do growth projects or to return the cash to the shareholders, depending on which option has the highest returns. But one of the questions we ask ourselves is if we do accelerate the drops, are we going to get a sum of the parts valuation increase? We haven't seen it yet.
Yeah, but at least based on what Tesoro and MPC reaction from the last several weeks, that seems like that has started catching on as a new theme.
Yeah, we see it too, Paul.
Yeah. Second question on the $2.8 billion next year budget, is that including anything in the methanol projects? If it is indeed going to go for FID, should we assume it's just an add-on or that you're going to balance it and adjusting it so that you still keep it at the $2.8?
Hi, Paul. It's Lane Riggs. That $150 million is in the 2015 CapEx with $2.8 billion. It's not approved yet. We're in the phase two development of the project, and we'll have another review and decide go or no go somewhere in the second quarter of 2015.
If you do go ahead, should we assume you still keep the 2.8 or that this is incremental? In other words, that you adjust your other projects so that you do not go beyond the 2.8.
It is in the 2.8.
Yeah, Paul, we have $150 million as a placeholder in that $2.8 million budget.
Oh, okay.
If we didn't proceed with the methanol plant, we wouldn't spend that $150 million, and we'd be at a $265 million.
I see. Got it. Thank you.
Our following question comes from Blake Fernandez from Howard Weil. Please go ahead.
Guys, good morning. Thanks. Congratulations on the rollover in CapEx into 2015. I guess this is a combination of a high-level question from Paul and maybe a tie on from Jeff as well with regard to the Saudi pricing. It looks like the logistics spending is decreasing, like 45% of the total down to about 30% of the growth total. I guess I'm just wondering with the Saudis changing their pricing, is there a chance where some of the infrastructure and North American crude investments that have been made, do we get to a point where some of that isn't quite as necessary? Do you still have the flexibility to shift back and forth to foreign versus domestic runs in your system?
Yeah, Blake, I would tell you, I think we've been very selective on what we've chosen to invest capital around logistics. We still think it makes sense, but as you talked about, we haven't done anything to lose our optionality that we can continue to import the foreign barrels. If Saudi makes more sense to run those barrels, we haven't lost any of our optionality to be able to do that.
Yeah, Blake, Gary makes a great point here. What we're dealing with are markets that are really volatile, and the opportunity today is the opportunity today, and it'll change tomorrow or the next day. The one thing that's certain is if you don't have the logistics in place to take advantage of the opportunity when it's there, it's gone. We feel very good about the projects that we've undertaken. The rail crude projects to move heavy sour crudes in are very good projects for us, as are the unloading facilities that we've got. Our commitments to pipelines, I think, are very solid for us going forward.
The fact that you've got the pressure on the crude price right now affecting the Saudis' willingness to move barrels back in, at the end of the day, is going to be good because we're going to see pressure on all of the barrels as they try to find a home in a refinery going forward. So we feel pretty good about what we've done and what we've got on the plate to do going forward.
Okay, thanks. The second question is on exports. We've seen record high utilization levels earlier this year, and you mentioned product exports in your press release. For one, can you give us a capacity number of what your current capacity is? Is that one of the main drivers that's been driving this higher utilization? Because when I look at my modeling, it seems like the earnings in 2012 were very comparable with where we're going to land this year. Basically, that insinuates there's not really that much more incentive from an economic standpoint to run. Is it simply a function of additional export capacity?
Yeah. What we did in the third quarter is we did 90,000 barrels a day of gasoline exports that primarily went to Mexico and Latin America. We did 227,000 barrels of straight distillate or 240,000 barrels of diesel when you include the kerosene. The distillate exports went to Latin America and Europe. We still have quite a bit of capacity left. On the gasoline side, we can probably do about 255,000 barrels a day, around 400,000 barrels a day of distillate export. We still have a lot of room to increase our exports. But for us, this is just an optimization that we do every day, Blake, and it's just a matter of where we can get the best net back for the barrels. When you look today, the domestic diesel market is very strong.
Some of our diesel exports have slowed down a bit as we send the barrels to the best net back market, which today is some of the domestic markets.
Okay. Thanks so much.
Our following question comes from Doug Leggate from Bank of America. Please go ahead.
Thanks. Good morning, everybody. Morning, Joe.
Hello, Doug.
By the way, Joe, congrats on you ascending to the chairmanship as well. It is nice to see you with all the titles.
Thank you.
You've seen what Tesoro has done here recently by talking about a full-service MLP. Obviously, there's a lot of different strategies seem to be going on within the space. I guess Phillips 66 is pursuing a similar kind of thing. I guess I'm curious as to looking outside of the refining backyard, so to speak, how do you view your MLP vehicle strategically in terms of maybe moving beyond just what we would associate as the normal course of business in refining?
I'll tell you, Doug, we do look at it as an entity that's there to support the core business operations of Valero Energy. We set it up with that intent. We set it up as a traditional logistics MLP that was going to primarily focus on transportation and terminaling assets. Obviously, the market's changing here a little bit, and people are making decisions to put a lot of third-party assets in some cases, and to put some of the fuels margin in the assets also. That's something that we'll take a look at going forward, but our view of it is a very attractive low cost of capital way to support Valero's core business.
Okay. I appreciate. I'll take some follow-ups offline because there's obviously multiple paths you can go down with that one. I guess my follow-up question is really to get your latest thinking on the fuels market generally, the gasoline market in particular. You still have your Aruba refinery kind of mothballed. It looks like Vencer Energy might have found a buyer, and obviously, the whole crude complex has come down. So I'm just kind of curious as to, what's your prognosis for the Atlantic Basin gasoline market, and should we expect the kind of resilience in cracks that we've seen in the last couple of years, or do you think there's an oversupply risk emerging on the margins? I'll leave it there. Thanks.
Thanks, Doug.
Yeah. I guess two separate questions. I do not know, Lane, do you want to address the Aruba one first?
Go ahead on the gasoline.
Yeah. Overall, I think we see gasoline demand in Atlantic Basin fairly flat. A lot of the question on the Atlantic Basin is really going to be what happens in Western Europe, and do you have rationalization occur in Western Europe? That will probably be the big driver on the overall supply-demand balances in the Atlantic Basin moving forward.
That assumes we do not have a crude export scenario, I am guessing.
Yes.
Okay. On the impact of Vencer, do you see that impacting your Gulf Coast markets particularly?
Hi, Doug. Look, I think that project is going to be a bit challenged. If they're producing gasoline, it's going to have to go somewhere, so we'll probably see it in the market. But I would stack up the competitive position of our Gulf Coast refineries against any refinery like that.
All right. We're going up with a similar view. Thanks a lot, Joe. Appreciate the time.
Thanks.
Our following question comes from Brad Heffern from RBC Capital Markets. Please go ahead.
Good morning, everyone.
Morning.
Coming back sort of to an earlier question, has there been any change as to the demand that you guys are seeing in export markets currently?
No. I would tell you from the third quarter to the fourth quarter, what I would expect is that our exports will probably be up a little bit. Most of that will be gasoline exports will increase into the fourth quarter. Distillate exports probably fairly flat, which is typical for us. Gasoline, typically, the exports are a little stronger in the fourth quarter and first quarter and fall off when we hit summer driving season here in the U.S.
Okay, got you. Then, you had a competitor last week talking about sort of a tight Maya market on the Gulf Coast. I was wondering if you guys have seen that and having difficulty getting sort of the heavier crudes in the door.
Our Maya volumes for the third quarter were right at our contract levels and up about 20,000 barrels a day, what we ran in the second quarter.
Okay, thank you.
Our following question comes from Ryan Todd from Deutsche Bank. Please go ahead.
Great. Thanks. Good morning, gentlemen. A couple questions, maybe one, if you could talk a little bit about capture rate across. Very strong capture rates that we saw across the portfolio this quarter, and I realize that falling crude prices probably increased the profitability at the bottom of the barrel. But outside of that, can you talk about maybe any other drivers of strong profitability and how sustainable maybe some of those might be on go-forward quarters?
Look. Ryan, this is Ashley Smith. Yes, we performed well. We had very limited turnaround activity in the quarter, so other quarters might not be as comparable when we had more turnaround activity. A lot of the capture rate is partially due to our investments. The hydrocrackers are running well. In fact, St. Charles hydrocracker is consistently running in excess of capacity. In addition, you saw some typical market stuff that is not in the indicator, such as VGO was relatively cheap in the quarter, and that paid us well, too.
Okay. So probably some odd and few non-recurring things, but maybe at least underline there some recurring things from your past investments, I guess, is that safe to say?
That is basically it. You are always going to have some movement into items that are not in the indicator. We also are seeing benefits from our previous investments, particularly in the hydrocrackers.
Okay, thanks. Then maybe one more on, and I apologize if I missed a little bit of the call. On crude flows from Corpus to Eastern Canada, I know you guys have moved some crude that has gone around there to the East Coast of Canada refining system. How much have you been moving, and how do you expect that to change in 2015?
Yeah. We moved 124,000 barrels a day of Gulf Coast crude to Quebec. That didn't all move through Corpus. Our project at Corpus will be online and fully functional first quarter, early first quarter. We'll start using our Corpus assets in the first quarter. But the volume we moved was largely over third-party logistics assets that we moved to Quebec.
Okay. If you just look at, when you look out to 2015 dynamics, both from the Line 9B eventual startup, and capacity, is that a number that you think you can grow substantially in 2015, or are there some limits there?
Well, when Line 9 starts up, we will run less barrels from the U.S. Gulf Coast than what we ran in the third quarter, and we'll supply more Quebec volume through Line 9.
Okay. Great. I'll leave it there. Thank you.
Our following question comes from Roger Read from Wells Fargo. Please go ahead.
Hi, good morning.
Hello, Roger.
Just to pick up a little bit more on sort of the CapEx for 2015, maybe for 2016 with the crude topping projects, in, I guess Corpus and in Houston, then maybe what the decision timeframe is on that. I am thinking also, crude softened up a little bit. We may see some slowdown eventually in U.S. production, if that has any impact on your thinking, then whether or not the recent developments on the crude export side, thinking of the DOE or EIA's report on gasoline prices being driven by Brent, not by domestic prices as sort of a shot across the bow for being in favor of exports, crude exports.
Hi, Roger. This is Lane. I will answer the questions about the crude units. They are approved, and they are under construction. We are building them. Right now, we are sort of forecasting they will be mechanically complete at the end of next year for oil in roughly the beginning of the first quarter of 2016, somewhere in that timeframe. In terms of the project basis economics, we assume that LLS is a parody of Brent, and that is not where we are today. So those are still good projects. They have returns around 30% in that pricing environment. So we still see those as good projects that are ultimately about backing out our intermediate purchases.
Again, we are long conversion capacity, so today we have to go to the market to buy intermediates largely from West Africa and the North Sea, and this just sort of changes our feedstock, the way we are going to feed our system. What was the second question?
Yeah, Roger, could you restate your second question?
Well, it was just more along the lines of, I was pointing out with the U.S. Energy Information Administration having come out with that report on gasoline, whether that had any impact on these projects overall. Originally these were going to be online in 2015, so I was just trying to figure out if you were, maybe the question is why are they now 2016 instead of 2015? Were you just delayed on construction, or were you looking at it internally and saying, "Well, if things change, maybe we do not want to go forward?
No, the projects were always sort of in the fourth quarter 2015, first quarter of 2016, and it is about mechanical completion versus oil in date. There has not been any delay with them. We are not hesitant about these projects, and we are going forward with them because they are not really about trying to produce more gasoline and more diesel. This is about trying to feed our system more economically, right, with domestic oil versus a foreign imported intermediate.
Okay. As you look at the fourth quarter here relative to the third quarter, in terms of what we have seen in crude differentials, how is it shaking up for you? I know we can look at the screens and make our guesses, but are you seeing anything significantly different, in terms of the Gulf Coast, let us call it the light heavies here?
No, not anything too significant. Overall, when you look at the LLS market, and Mars continues to price competitive with LLS, and I think the heavies continue to price competitively with Mars. As you move west in the Gulf, you start to see a bigger advantage to run some of the light sweep, but that is not too different from what we saw in the third quarter.
Okay. Thank you.
Our following question comes from Phil Gresh from JPMorgan. Please go ahead.
Hey, good morning.
Morning.
Morning, Phil.
Yes, a couple questions. So first one is just on the cash flow for the quarter and just what the working capital contribution might have been. I know there was a pretty sizable negative in the first quarter for working capital. Wasn't sure if that was a reversal of the big positive of the fourth quarter of last year. Just where we stand on working capital in general, and how to think about that in the fourth quarter.
Okay. Our change in cash for the quarter was an increase of $700 million, and of that amount, about $300 million of it was attributable to working capital. We had an increase in our payables receivable from that. That is primarily going to be a timing issue, most likely.
For the fourth quarter, any thoughts on whether there is additional contribution?
Towards the end of the year, as we manage around the LIFO inventory levels, there is the potential that we could have a reduction in our working capital.
Okay. Then just with respect to the cash flow generation profile in general, obviously very strong and Joe Gorder, your stock is cheaper on a free cash flow yield than most refiners. I am just wondering how you are thinking about impacting that valuation. You obviously talked about the MLP structure as an opportunity, but whether it is increasing buybacks or a meaningful step up in the dividend or something else you can do to change the game. I am just curious how you are thinking about things.
No, and Phil, that's a good question. When we look at the use of cash, we've got some very good projects. We're going to continue with the projects that we have underway. These have very strong returns, and they make us much more efficient. We realize that there's a balance between investment for growth and returning cash to shareholders. Now, I think our actions in the third quarter and through this year really reflect this realization. We've had two dividend increases, and we've had increased share repurchases while continuing with the growth projects that improve our overall business. To the extent that we have free cash flow going forward and to the extent that there aren't tremendous capital projects to use the cash for, I think you could see us continue on this path, and we'll be comfortable with returning it to shareholders.
Okay, thanks. I'll turn it over.
Our following question comes from Mohit Bhardwaj from Citigroup. Please go ahead.
Yeah, thanks for taking my question. Joe, if I could just follow up on your comments about the Atlantic Basin. If you look at where the crude prices are right now, and it seems like there is excess crude supply in the Atlantic Basin, what do you think it does for the refining business in the U.S., and how do you think production moves or these supply moves going forward?
Okay, yeah, let Gary Simmons give you a shot at that.
Very difficult to say. I think the key question there is what is the marginal cost of production in North America versus other regions in the globe? And of course, we're not an upstream company, so I don't really know how all that shakes out. I think the assumption you're making with the question is that as crude price falls, that the North American production falls with the flat price fall, and that may happen, but I really don't know enough to be able to comment on that.
Right. If you look at third quarter versus fourth quarter, one of the things that you said for the third quarter was that you were utilizing the front of the refining a lot more. So filling up the towers a little bit more and utilizing the downstream units a little less and where the VGO prices are and with the availability of light sweet crude. Do you think that's still the case in the fourth quarter?
Lane or
So I'll take a shot at this. This is Lane. Our signals in the third quarter were obviously max on everything, and to the extent that there was a signal to run as high a through rate as possible because that positive crude margins, and we had really good conversion unit margins because VGO prices were inexpensive. We still see those signals going forward in the fourth quarter. They are not as strong as they were in the third quarter, but we still have signals to run our system relatively full.
Right. And one final one for me, just on the Diamond Pipeline. Just to be clear, you guys have not exercised the 50% option on the pipeline yet. If you could also follow up on, if you look at some of your peers were talking about doing a study on Capline, and you were the main consumer as far as Memphis Refinery is concerned on Capline. Does Diamond Pipeline option also allow you to, sort of if there is a reversal for Capline, to participate in that?
Okay, Rich, do you want to?
Yeah, I'll take a crack at that. The Diamond Pipeline is progressing. It will be connected to the Capline. Today, Memphis is connected to the Capline pipeline. We would have dual supply source into the Memphis Refinery potentially and be able to take advantage of a reversal. But I think they are just undertaking a study as we speak, so it may be some time before that actually becomes reality.
As far as the option on the Diamond Pipeline?
I'm sorry. I missed that first part. On the option, we have not exercised the option. We have that option through early January of 2016 to make that decision.
Thank you for taking my questions.
Sure, Mohit.
Our following question comes from Evan Calio from Morgan Stanley. Please go ahead.
Hey, good afternoon, guys.
Morning, Evan.
Hey, Joe, can you walk us through the decision to reduce 2015 CapEx sequentially from 2014? I mean, is that a top-down decision to raise distributable cash or a function of higher hurdle rates or the project queue, and particularly as it relates to Midstream?
Just in total, it is down sequentially. Is that a desire to increase distributable cash flow or a function of how those projects shook out in the review process?
No, it is the latter.
Evan, we start with a list of projects, and if you look at it from the refining perspective, Lane has a process that he goes through. A tremendous rigorous review. I think the fact that he has this rigorous review shows up in the timing on the methanol project, right? This is a big project, and we want to be sure that we have the capital right. So he is going through this in a very methodical way, just to be sure we are on target. We put together a list of prospective projects, and we do this every year. What we are doing now is our list of projects that we talk about are those that we scrub to the point that we feel that there is a reasonable probability that we are going to do them.
The projects that we feel we can execute next year from either the refining side or the logistics side have been included in the budget. We feel we are fairly committed to that $2.65 million number. The $150 million for methanol is kind of a, "Let us see what we get." But it is a kind of bottom-up, what projects do we have to take a look at? Then we look at it from the top down and say, "These are the ones that we want to undertake based on their return thresholds." There is, though, a general view among this management team that we would like to try to return more cash to shareholders. So, having our capital at this level is something we are very comfortable with.
We believe it creates that proper value between the proper balance between continued investment to grow and optimize the business and rewarding the shareholder for his loyalty to us.
Mm. And just for clarification, I think in the opening, you stated that midstream is 50% of that growth CapEx, yet the release is 30%, which would be sequentially down. Which of the two is-
Well, no
midstream as a function of growth?
No, I think, if you look at 2014 versus 2015, we've got significant investment, for example, in the rail cars in 2014. That falls off.
We haven't intentionally tried to reduce the investments that we're making in the midstream side of the business. What we've got is probably timing issues here of developing the projects to the point where we're willing to put them into the capital budget. That's all we're dealing with.
Okay. So it's a +390, I guess, or it's $390 million, I presume, if it's that 30% figure. Is that right?
Hey, Evan, this is Ash.
Yep.
Yeah, you're correct. We're going from 2014, it was over 50% of-
Yep
both capital was in logistics, and it's because of the rail cars falling off. It's just going to be next year, a little over 30%. And you're right, it's right around $400 million in logistics.
Great. MLP able EBITDA exits up $70 million-ish kind of estimate. Is that reasonable?
It certainly keeps growing.
Right. Great. All right, good. I look forward to your analysis of a larger scope of droppable assets and good results, guys.
Thank you a lot.
Good. Thanks, Evan Calio.
Our following question comes from Ed Westlake from Credit Suisse. Please go ahead.
Hey. Pretty soon, we're just going to call these logistics conference calls as opposed to refining conference calls.
Yeah. We did notice that, Ed.
If they trade higher, we'll do it.
Yep. Well, the multiple arbitrage is pretty obvious, but let's carry on on that vein. Diamond Pipe, any sort of color on the EBITDA that that might contribute, if you go forward with that plan or overall investment level?
Well, I think we've talked about the cost being approximately $900 million. When you look at a proper multiple of around 10 times, that would get you $90 million, and 50% of that would back you into $45 million of EBITDA.
Great. Then, another strategic. Obviously, you must have seen the EPD Oiltanking acquisition, which was a somewhat elevated multiple, and obviously, assuming that there was going to be a lot of export growth to obviously drive throughputs and drive that multiple down. I look at your logistics and your refining system in Texas. I look at what Phillips 66 has done at Beaumont and the Bakken pipe project that's associated with that. I look at the Permian and the Eagle Ford and still growing, and I think there has to be something to be done. Am I off in terms of the landscape, or are there competitive barriers for you being able to compete as effectively?
There's competitive barriers to everything, right? But there's no reason that we can't compete effectively with this. As I mentioned earlier when we talked about the capital, we've included in the capital budget projects that we're highly confident we're going to do. The one exception is the methanol plant. I'm not saying we will or won't do it. We're just still in the process of looking at it. But we've got a lot of logistics projects right now that Rich Lashway and his team are in the process of developing. They're not far enough along to include in the capital budget, but they would be logistics-type assets that we would use to support the existing refining portfolio.
There's some of them that look like they're very good projects, but we're not going to get out in front of ourselves and share information on them until we get it pinned down.
Okay. I should ask a refining question.
The turnarounds obviously were pretty high as you connected up a lot of the hydrocrackers and did a lot of reliability work in 2012 and 2013, and obviously still in the second quarter. Obviously, it's easy to see how good your throughputs were in the third quarter. As you look out from here, do you feel that you have a more reliable refining system, or is there still more work that needs to be done to get the reliability to where you need it to be? Maybe a comment on general turnaround schedules into next year.
Hi, Ed. This is Lane. Our last really big reliability project we did was with Memphis in the second quarter, and that was replacing the reactor. The only thing that's coming now, we are in the process of starting up the Meraux hydrocracker, which is again, sort of reconfiguring that refiner. We don't really have anything quite like that going forward in our capital plans. Other than we're doing these crude units, those won't really impact our throughputs per se. Really from here going forward, we just have what I would say is our regimen of standard turnaround execution.
All things being equal, we should expect better overall utilization next year and perhaps the year after than the last three-year run rate.
Yeah. Our number one focus on everything we do, well, first is safety, but right behind that is really reliability. Our reliability spend is actually slowing because we're pretty confident that we have spent the right money on the right things to maintain a high reliability rate in our system.
Very clear. Thanks so much.
Our next question comes from Sam Margolin from Cowen and Company. Please go ahead.
Hey, good morning, everybody.
Hey, Sam.
A lot's been covered. I guess I'll stick to ethanol if refining questions are out of favor, too. But yeah, so the business has responded really well to lower corn prices. Obviously, results have been getting better and better. Just strategically, do you think it can tolerate any kind of stabilizing business component, a tolling agreement or something like that might make it eligible for a different structure? Or is this just normal volatility in the industry with a really good corn crop this year, in your mind?
Well, you want to speak to the market aspect of this?
Sure, Sam. This is Martin Parrish. On the market aspect, we like where we're positioned. Production's been high. As you can see, inventories have only built like 1 million barrels in total for the year. So, we feel really good where we're positioned. Exports are high. We think margins going forward are going to be good, and we like the business. As far as a tolling type deal, Sam, what are you thinking there? Is this a question about do we want to monetize the business or?
Yeah, I suppose so. It's been a pretty steady stream of better and better results in the segment. I was just wondering if this factors into it at all now that maybe you see earnings getting more reliable or visible in the segment.
Well, we'd like to believe they'd stay at these levels forever. But I think 2012 it was, wasn't it? Would remind us that there can be a lot of volatility in this business, too. We've looked at the ethanol plant portfolio, and it trades. If you look at comps, there just aren't a whole bunch of them, first of all, and they tend to trade at the same multiple that the refining assets trade at. So there's really not a big significant incentive for Valero to go out and monetize these and try to create additional value. At the same time, I would say that we're very pleased with the operation of the business. Martin has done a fine job leading it. He's got a very strong team.
The cash flow that's being produced by these assets is tremendous, and we do like having it as part of our core business. We do believe long term that ethanol is going to be fundamentally part of the fuel mix, and so having this business as part of our portfolio makes sense.
Okay. Then just touching on that as a follow-up, the RFS, we seem to be a little bit behind schedule on an update here. It seems like your thesis has played out based on refining margins that RINs are kind of being passed through. Do you see that as giving momentum to, I don't know, maybe a mandate reduction or any kind of movement at all? If you can get any updates, that'd be great.
I do not know if we have a lot of insight here. I think we feel like it is going to be after the elections here before we get the new RVO, and it is so late in the year at this stage that we do not think that it will be substantially different from where we were last year.
Okay, great.
It is pretty interesting that we are here in November, and we do not know what the 2014 obligation number is yet, but-
Interesting is one word for it, yeah, I guess.
Thank you, Paul.
Okay. Well, thanks a lot, guys. Have a good one.
Okay, you too.
Our following question comes from Paul Sankey from Wolfe Research. Please go ahead.
Hi. Good morning, everyone.
Good morning, Paul.
You covered a lot of ground here with getting to the point of the ethanol MLP. I won't ask a follow-up on that one. Could we just sort of bring it all together a bit here, Joe? What concerns me is I think we were hoping for quite a significant step down in CapEx next year. What I'm listening to is that you're competing in a mature market, but you're still spending on these numbers about double your maintenance or stay in business CapEx, with the remainder being obviously growth CapEx. Can't we get to a place where you are much more aggressive about cash return to shareholders as the kind of predominant aim? I heard good stuff about you potentially not doing the methanol project, but at the same time, there seems to be a potential for logistics spend to step up.
As I say, to me, this is a CapEx number which is flat next year with this year, whereas we were hoping for something that was quite a bit lower. Thanks.
Okay, Paul, I know this has been your perspective. When we look at the capital, okay, you got $1.4 billion, $1.5 billion that we need to spend on the assets to maintain them, the way we want to maintain them. We've got the crude unit projects, which have 25-plus % rates of return, and they're not putting any more juice in the market per se. They're optimization projects. We've got the opportunity to drop at higher multiples logistics assets. We're going to continue to invest in those. If you extract the methanol plant, the $150 million placeholder from the 2.8, we're at 2.65. That is well below the $3 billion that we forecasted this year. And we don't arbitrarily select projects to undertake, without looking at the alternative use for the cash.
If we're deciding to do a capital project, I think we're very comfortable making our day in court and sharing what the returns are going to look like on this and why it's a better alternative to us than repurchasing shares, for example. So, I do think that this management team has reduced the capital spend. I think if we look at it going forward with the rigor we have in the process and the thresholds we're setting for acceptance of projects, we're going to see this continue to be at this level. It may continue to decline. But I don't want to not do projects that improve the operation of the business and have good returns when they're available to us.
Yeah, I understand that. I guess the concern is really what you're saying is that you have to see European refineries shut down in order to make room for some of this stuff. And that's just a concern we have, that there's too much capital going into the business overall that's dependent on the competitive environment moving in your favor.
Okay.
Paul, keep in mind, our projects are designed principally to reduce feedstock costs. If we have cheaper crude, we're going to shut down. I mean, that's going to force excess capacity in Europe to shut down. So we will become more competitive.
Great. Just the final part of this is, what do you think a competitive return to shareholders is? You have a couple of percent yield. Could you just talk a little bit more about that, John? I will leave it there. Thanks.
I am sorry, Paul, real quick, though, are you talking about at VLP or are you talking about at Valero Energy?
Well, just, yeah. For example, if I own a Valero share, what do you think of as being a good return to the shareholder in terms of you saying that you are respectful of cash return to shareholders?
From a cash perspective or just total?
Yeah, total is fine. People obviously prefer a regular dividend, but I understand that the volatility of the business makes that a tough commitment.
Yeah. Okay. I think what we would say is we have a cost of capital. We got a cost of capital out there, which dictates our assessment of where we are on projects, and then you've got a return on capital employed that we're hoping to have be in this. We haven't set the target per se, but 10% range, 12% range. A piece of that is certainly going to be the dividend, the share repurchase aspect of it. But we recognize that we've got a need to exceed cost of capital on our projects and on our business.
Understood. Thank you very much, John.
The question comes from Allen Good from Morningstar. Please go ahead.
Good morning, everyone. I'll be brief since we're getting here late. Suncor CEO made some comments last week about shipping Canadian heavy to Europe and down the U.S. Atlantic Coast and even to the Gulf Coast. Do you see that as a viable alternative long term to get greater heavy Canadian, heavy volumes to the Gulf Coast? Could that even be potentially a source of opportunity for Pembroke at some point?
Yeah. For us, I think, we feel like there's better options to get Canadian heavy to the U.S. Gulf Coast than taking it to the East Coast and around. But absent of any of those opportunities moving forward, we definitely see that it's an option to get additional heavy supply to the Gulf. We also see that there is an opportunity to move the Canadian barrels to Pembroke as well.
Great. Thanks. Can you just give us an update on the projects you have either underway or on the planned stages to increase competitiveness of California and get some discount crude out there? Just your latest thoughts on your assets out there as well.
Yeah. You have-
Hey, Allen, this is William. We are still working on the Benicia Rail Project. Our comment period on EIR is over. The city is answering all the questions, and we sort of expect that to be finished in December. We think permits will get issued in the first quarter. That's really the In terms of the strategic capital that we have spending on the West Coast, that's pretty much it. Everything else, we're being very careful in our spend on the West Coast because we have obviously great opportunities in our Gulf Coast and our MidCon and our Northeastern assets. We're very careful. We run a very tight ship out there, and that's how we're managing the West Coast.
From a strategic perspective, we think it's great to have good assets with strong management teams out there that provide us the option to take advantage of the strong margin environments that you can have from time to time out there.
Great. Thanks. I appreciate it.
Okay. We have no further questions at this time yet. Sorry.
No, that's okay. I was just going to say, we appreciate everyone calling in and listening to the call today. If you have additional questions or didn't get a chance to ask your question, please contact our investor relations department. Thank you.
Okay. Thank you to my speakers, and thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.