Good afternoon. Our next presentation is Valero Energy. We are very happy to have the CEO and Chairman, Joe Gorder, to be with us. Since becoming the CEO in 2012, Joe really has transformed the company, and to some degree, the industry, to be more capital-disciplined and investor-friendly. Certainly, the market has taken note, and we have seen great performance. I am sure that Joe is going to tell us all the exciting things happening with the company. Without further delay, let me welcome Joe.
Thank you, Paul. Paul, thanks for allowing us to attend the conference again. You guys put on a great conference, and we always appreciate having the opportunity to join you and to tell the story. Let me begin with the safe harbor statement, and I think you all know what that means. It means that Valero has a strong legal team that can craft something that no one will read. All right. Okay. Who are we? We are, in my opinion, the world's premier liquids fuel manufacturer and marketer. We have 15 refineries with over 3 million bbl a day of refining capacity. We distribute our fuels through the wholesale branded system that we have and also sell bulk.
We have an MLP, which is VLP, and we have a 50% ownership interest in a renewable diesel plant that we just completed expansion from 12,000- 17,000 bbl a day of production capacity. We have 10,000 employees and a market cap of $50 billion. Our MLP that I mentioned is a fee-based master limited partnership. We have 1 million bbl a day of pipeline throughput and 3.5 million bbl a day of terminalling throughput. It is a liquid-focused MLP, so we have not changed course at all since we IPO'd it back in 2013, the end of 2013. 100% of its revenues are fee-based. Then we have our ethanol business, and we have 11 very high-quality ethanol plants that produce approximately 95,000 bbl a day of ethanol.
These plants, as I will show you here in a second, are very competitive based on their geographic location and the quality of their operations. This slide just gives you an idea of our geographic footprint. The teal-colored states are those that we have a marketing presence in. Those with the V logo are where we have a branded marketing presence. You can see the refinery icons. We stretch from the West Coast of the U.S. down through the mid-continent, heavy exposure in the U.S. Gulf Coast. Then if you look to the upper right, you can see that we have got a refinery in Quebec City. Then if you go further to the east, we have a refinery in Wales. Our ethanol plants are also shown on this chart. I mentioned their location.
You can see we have a concentration of them in the upper Midwest, so it's right in the middle of the Corn Belt, and that provides a significant advantage to these plants from a feedstock cost perspective. The pipeline-looking icon is the VLP assets, Valero Energy Partners assets, and they're also shown. Anyway, we've got the country covered, and then we cover the Atlantic Basin really with product movements out of the Gulf Coast, out of Canada, and out of Wales. Now, if we step back for a second from Valero, and we talk about the macro environment, the fundamentals still look really good. I think as you all know, there's an abundance of crude supply and natural gas that are available to us. Even with the OPEC cuts, the North American production is offsetting those cuts at this point in time.
The logistics around crude and feedstock movements have improved materially, which have allowed all of us refiners access to an abundant supply of different types of crude. Then on the product demand side, world economies remain strong. Gasoline, of course, is largely consumer-driven, and as long as people are employed and they feel good about their situations, they consume gasoline. Diesel is more of a fuel based on economic activity. With the economies percolating along, things look good there. The lower prices are also helping on the product demand side. It sure makes it easier for people to consume. Then if you look at some of the markets that we supply, for example, Latin America, Eastern Canada, Europe, and Africa, these markets are in short supply a lot of times of the year.
It provides a natural pull for products produced in the U.S. Gulf Coast to move into those markets. Then we'll talk about it more in a minute, but the bunker fuel market's going to change with IMO, and that's going to have a significant impact, positive impact on the industry. Then finally, global petrochemical demand continues to be strong. From a regulatory environment, we've had some nice tailwinds. Certainly, the tax reform has been helpful to our business and most others. The RFS conversations, that's the Renewable Fuel Standard, continue to progress, and we're still looking for that win-win solution. Then IMO, which I mentioned, is going to be a big deal going forward. Okay. We have a very simple strategy that our team is committed to for creating value for all of you, and that is based on really three points.
One is maintaining our manufacturing excellence. We want to operate safely, reliably, and environmentally friendly, and we do all three of those things consistently. We're going to continue to be disciplined in our capital allocation. We want to provide very significant returns to you, both in the form of dividends and share repurchases, and we'll cover that more in a minute. Then finally, earnings growth. We're not just caretakers of these assets. We want to continue to try to grow the earnings capability of this company, and we've got many significant capital projects that we're working on right now that are going to help do that. Anyway, that's the basic strategy for the company. Very simple and straightforward. Now, safety and reliability is really important, and we're focused on this all the time, and we work very hard at it. Frankly, we're very proud of these results.
If you look at the graph in the upper left on personnel safety, you can see that we are well below the industry average, and we continue to operate at a very high level here. Keeping our people safe is something that is critically important to us. If you look over to the right, you see the Tier 1 process safety events. Those have come down to a very low number also, and we continue to work on that. The bar charts along the bottom are based on the Solomon industry benchmarks. We listed two data points for you, 2008 and 2016. The key point here is that we have continued to improve our operations on each of these significant metrics over that time period. That leads me to conclude that we are, in fact, the best refiner in the business.
We operate the business very well, and it is what we do. I might just add that the bullet point on the bottom, that our injury and process safety event rates in 2017 were the lowest in company history. Lane and his team will continue to try to drive those lower yet. This doesn't come without a lot of work and a lot of investment, and we have continued to invest in the plants to increase their reliability. That is what has led to these results. Lane can discuss more of that when we have an opportunity to either do your Q&A here or in some of the one-off meetings that we are going to have. We focus very hard in increasing reliability to enable us to capture higher margin.
If you take a look at the two graphs, this change in mechanical availability that you see here in the bar graph on the upper right, you can see what we have done since 2008. We are in the upper second quartile for our entire portfolio. We have many that are first quartile, but when you average it across the entire portfolio, we are just right below the first quartile breakpoint. This contributes to achieving this lowest cash operating cost per barrel among the peers that you see in this bottom graph. This is really hard to achieve, and it takes a lot of work. Squeezing pennies out of this business is very difficult to do, but it is something we are focused on and will continue to try to do going forward.
Frankly, being the lowest cash operating cost operator in a commodity business is very significant. It basically says you are able to capture more margin than anybody else in any operating environment. We do have an advantage portfolio because the bulk of our assets are located in the U.S. Gulf Coast and then also in the Mid-Continent. You can see from the chart on the left, this is our crude capacity, both in the Gulf Coast and the Mid-Continent. You can see that we are the largest. That allows us tremendous flexibility in the crudes that we can run because we can bring them in by pipe or on the water. The ranges of crudes and feedstocks that we run is seen in the chart on the right.
You can see the swings that we have in our ability to run heavy sour and medium sours and so on. Having the opportunity to continually optimize the crude and the feedstock slates that we process are critical to our profitability. Lane's team is running the LP models on a consistent basis, always looking for what slate we should be running and what products we should be producing. The great news is that our system has the flexibility to allow for that optimization. IMO 2020. I heard before I came in here that Gary Heminger did the keynote address, and he spoke a lot about IMO 2020. I am sure that he told you it was a big deal. I would agree with Gary completely. The change to the lower sulfur bunker fuels is going to be a huge deal for this industry.
It is going to shift a lot of the heavy fuels into different uses, and it is going to make them very cheap. If we think about what this does for us really, a reduction in the sulfur content is going to increase the demand for distillate, and it is thereby going to increase the cracks for distillate. It is going to strengthen the gasoline cracks, and it is going to increase the discounts on all of the sour crudes that we are currently processing. That is very significant to us. Now, we have been somewhat reluctant to throw out what the absolute number advantage is for us under an IMO 2020 environment, but it is very significant. It will be billions of dollars in incremental EBITDA. Then if you take a look at the chart on the right here, this just shows where our distillate yields are among the peer group.
If you are trying to pick winners and losers from IMO, our ability to run multiple different types of crudes in the system to process the really nastiest heavy sour crudes and feeds that are out there and to convert it into distillates is a very significant advantage of our portfolio. Now, our portfolio also facilitates the global optimization of product exports. What we have listed here for you on these maps are the actual destinations for our products. You can see that Valero, through its system, is moving products really all over the globe. We move products to higher netback markets. We are not moving products just to move products. We move products when we can earn a higher margin on those than we could if we just sold them into a pipeline or into a local market here in the U.S.
These destinations that we are moving barrels into are paying more, and they are pulling the product in, number one due to growth, and number two, to supply challenges that they have got within their own system. For example, Mexico has not been able to run their assets at very high utilization rates over the past several years, makes them significantly short of gasoline and diesel fuel. The natural market for that market to be served is out of the U.S. Gulf Coast. We have been very aggressive at doing that, also looking to South America. Then you can see the movements over into Western Europe. That is primarily diesel fuel that we move that direction. We move gasoline fuel out of Wales into Canada and into the East Coast of the U.S.
And there have been times when we've had blowouts of the cracks on the West Coast of the U.S., where we've moved barrels out of Pembroke all the way over to California. Our system provides a lot of flexibility to move barrels to the highest netback markets. If you say, "Well, are you tapped out on your ability to do that?" The bar graph at the bottom shows that we still have significant capacity if the market demands it to move barrels into alternative markets. We have invested to grow our wholesale business and our supply business abroad also. This is all done, again, with margin optimization in mind. We have focused on Latin America. As I mentioned, it is a natural market for U.S. Gulf Coast product.
Mexico and the West Coast of South America is where we focused thus far. We've got significant activity taking place down in Mexico, where we've invested in a terminalling facility at Veracruz, and we're going to move barrels inland from there. We're also moving barrels across the border in Texas. If you leave North America and you move to South America, we've acquired a couple of terminals in Peru. We've got the physical assets, but we also bought a marketing business that goes along with those assets. Our objective here is to extend our supply chain because we move our barrels, and we're going to continue to move our barrels.
But having a stake in the ground where we essentially have a short in a market that we can move those barrels into is something that we've desired to have for some time. That's why we're investing abroad like this. For those of you that have attended one of our presentations before, you've seen this chart many times. We have been constant over the last several years with our focus on being disciplined with our capital management. I always tell you the overriding constraint that we have, and since Donna's sitting up here in the front I'll say it again, that maintaining a strong balance sheet and our investment grade rating is one of the key things that we focus on. We're going to operate within the constraints that that would require.
If you look at our use of cash flow, we've really broken it up into two buckets. We've got our nondiscretionary component, which is made up of sustaining CapEx and dividends. We are absolutely uncompromising in our commitment to maintain our assets, to keep them safe and reliably operating. We're also uncompromising in our commitment to maintain our dividend. If you look at the discretionary components within this framework, we've really got growth CapEx, acquisitions, and cash returns. Cash returns that we're talking about here really are the share buybacks. Growth CapEx is something that we've invested $1 billion a year the last several years, and I think that nominally you can expect that we're going to keep investing $1 billion or so a year in growth CapEx.
Acquisitions, as always, are opportunistic, and if we find a deal we like that benefits the portfolio, we wouldn't hesitate to pull the trigger on a deal. Cash returns. The share repurchases that we look at are basically the flywheel for our use of cash. We have made a commitment that we're not going to accumulate tons of cash on the balance sheet. Over the last several years, we've been able to continue to buy back our shares fairly aggressively, and we expect to be able to continue to do that in the future. We get asked a lot about in an IMO world where your EBITDA increases materially and beyond after your capital projects come on stream, what are you going to do with all the cash? What I constantly do is refer people back to this chart.
I think the best proxy for what people are going to do in the future is what they've done in the past, and we remain committed to this framework. The 40%-50% payout ratio target we've got here is something we're committed to. To the extent that our free cash flow significantly exceeds that, I think you can expect that we're going to be looking at how to return that to shareholders and what form to do that in. Here's what we've done over the last several years. Paul mentioned that we were a shareholder-friendly company, and I would agree with him on that. We have significantly reduced our share count over the last many years, and we've significantly increased our dividend over the last several years.
If you take a look at the bar chart on the right, it shows where our dividend yield is relative to the refiner peer range. We have committed to paying a dividend at the high end of that range, and we are there, and we fully expect that we're going to try to keep it there going forward. Okay. Discipline, that's a word that we use a lot. Our discipline in capital allocation is shown here. We have been fairly flat in our growth CapEx and our maintenance CapEx over the last several years. I think Lane and I would tell you that we look at $2.5 billion- $2.7 billion a year that we're going to spend on maintenance CapEx and growth CapEx.
The dividend component of this has continued to increase, and to the extent that we've had significant free cash flow, we have bought back more shares. That's something I think you can expect to continue in the future. If you look at the pie chart on the right, that just shows you what our expectation is for 2018. We're looking at sustaining CapEx of $1.7 billion and growth CapEx of $1 billion. If you ask me what I thought it might be going forward into 2019, I would tell you it's going to be in this same general range. Cash returns is great, and that's something we're highly focused on, but we aren't just caretakers in this business. We're continuing to invest in high return projects. $1 billion a year is basically split about 50/50 between logistics projects and refining projects.
A couple of the capital projects that we have been talking about over the last year are now on stream. The Diamond Pipeline, the Wilmington Cogen, are both operating well. We have got in here that we have produced about $150 million of incremental EBITDA since the middle of last year with those projects, and they are very good projects. Diamond Pipeline is benefiting us significantly right now. The Diamond Green Diesel expansion was just completed. It is running now. So I guess we got it done in August, Lane?
Yes.
It is functioning very well. So that is going to start contributing to this. If you look at the projects in execution here, we have got a couple of alkylation units, which we believe are going to enable us to produce higher value blend stocks and gasoline at a much cheaper cost. We have got the Central Texas Pipeline and Terminal System, which is going to provide us greater access into the general Austin market. We got the Pasadena terminal that we are doing with Magellan that is going to allow us to export products more efficiently. Then we got a cogen unit that we are working on at Pembroke right now, which will lower their electricity costs, and improve their infrastructure supply of steam and electricity going forward. Then other projects that we have in development, you can see some of them listed here.
They are all intended to either reduce our operating expenses, provide us access to new markets, but all are focused on increasing the margin capture that we have. Then if you look at the bar charts on the right, this really illustrates for you what we expect the EBITDA contribution to be from these projects. We have listed it here by projects in execution, and then the projects that are in development in refining, and in logistics and other. Then you can see what the total looks like it is going to be. This assumes we continue to invest $1 billion a year of capital at the return thresholds that we have set for ourselves. Frankly, we are seeing that a lot of our projects now are exceeding those return thresholds.
But if we did it at those levels, this is what you should expect Valero to do over the next five years. Okay. I mentioned earlier that we have a master limited partnership, VLP, that is publicly traded. We have consistently executed on the commitments that we made to the market at the time of the IPO at the end of 2013. If you look at the bar graph in the bottom left there, you can see that we have had consistent increases in the distribution per unit for the LP. Then if you look at the bar graph on the right, we have also had consistent increase in the distributable cash flow for VLP. I will just say that VLP is very strong financially. We are going to deliver on the 20% growth rate that we committed to this year. So it is a fine operation.
Then let me talk about our ethanol business. We have a great portfolio of assets. These assets are very well run. They are very low cost operations. They consistently run above nameplate capacity. We have 11 plants producing 95,000 bbl a day of ethanol. Although the margins have been low in this business, we fully expect that ethanol is going to be part of the motor fuel component in the U.S. for a long period of time, and these margins will improve with time. If you look at the chart on the right, this is where a lot of this ethanol is going. The U.S. market is fully supplied, so exports of ethanol continue to increase. You can see of the 116,000 bbl a day of exports that are leaving the U.S., Valero was responsible for 28,000 of that or 24%.
So our ability to continue to operate at high levels will continue based on our ability to export the barrels, which we have successfully been able to do. Based on everything I just shared, we believe that Valero is a compelling investment. We have a great portfolio. We have a very disciplined growth strategy. We have a great management team. We are delivering solid returns. If you look at these bar charts across the top, you are going to look at them and say, "Well, gee whiz, that looks pretty good." But when you consider that it is of the entire S&P constituents, it is even more impressive. This is how we stack up relative to the other S&P companies. The one thing that we have shown over the last four years is that we have been able to consistently outperform.
For the reasons that I just mentioned, our portfolio, our people, and so on, I think that we are going to be able to consistently outperform going into the future. The last thing I will leave you with is that you guys should all leave here and buy Valero. If you get up and go, I am okay. All right? But thanks for your time. Paul, I guess we are free to take questions now.
Yes. Thank you, Joe. We will take several question here because management actually not going to have a breakout session. Any questions? There is a question in the middle.
Do you plan to make any capital investments in response to IMO 2020? Are you aware of any refiners that are intending to make any, or is this just wait and see what happens and basically figure that you are going to just benefit from the chaos?
Well, Lane, why don't you go ahead and take a crack?
Am I on? Can you guys hear me? Okay, here we go. So in the base, Valero is already very well positioned for IMO 2020, so we are not, I am going to say, spending a lot of money in this space. We are going to make sure that our logistics are intact to be able to blend the right fuel oils that we need to meet it. For example, you want to make sure that our slurries that are out there can meet the specs and get them in the right tank. Then we will probably do some minor debottlenecking in a couple of our cokers. But I really do not expect our spend in this area directly tied to IMO to exceed anything around $50 million. So that is sort of where we are. With respect to the industry, you know as much as I do. I will say that.
Yeah. The one thing to think about, and you described it as chaos. I think it will be tight. You would expect distillate margins to increase, and then of course, people are going to try to maximize distillate, and so you would see the gasoline market tighten up, too. We always figure out a way to do this. But Lane, if somebody were to decide today that they wanted to invest in a big way to deal with IMO, what is the timeline?
Well, if they were just starting today, they are probably four to five years away. I presume that anybody that took up this, they would at least started thinking about this a year ago. So if it is a big investment, a coker, a big resid, hydrotreater, or a hydrocracker, they are probably still at least three years away from that coming on the ground. I think everybody just sort of as an industry has sort of cautiously approached IMO 2020 from a capital perspective.
Yeah. I think one of the big questions for us really was going to be the degree of compliance. Based on what we are seeing, I think we saw news blurbs today that China is even starting to implement this sooner using 0.5% sulfur weight. So if they comply, we will get good compliance, I am sure, in Europe and in the U.S. So I think the compliance rates are going to be something that is perhaps higher than we even anticipated. Yes, sir. Oh, sorry. We have a mic behind you, ma'am.
We have a microphone. Sorry.
Yes. Hi. I apologize if you addressed this earlier in your presentation. I came in a bit late. Can you address your current thoughts on VLP and its future or how you plan to how you want to think about it? The transcript in the 2Q call was-
Choppy?
Yeah, just basically, we don't want to take more paper.
Right.
That type of thing. So obviously, we've seen people basically buy in things or make adjustments or whatever. Can you address that?
No, yeah, I sure should. As we all know, the whole market for MLPs have changed. When we went out and we IPO'd it, we did a sponsored MLP, and we did it with the intent of growing it by drop-down assets. The way you do that is by issuing equity to public markets. Those public markets aren't there to buy that equity anymore. It looks like the bloom's off the rose for sponsored MLPs from what we can tell. We also have IDRs in place, which were in place at the time that we IPO'd it. So, the plan that we executed when we entered into the IPO, what we said we were going to do, we've done. Now we are working diligently to come up with the best solution for us.
It is a little bit interesting that we find ourselves, most of us that did sponsored MLPs did it with the intention of providing yourself with another source of capital, and it just has not worked out that way, and that is just the way it goes. I would expect that between now and the end of the year, we are going to have a very clear plan as to what we are going to do. I think the growth rates that you have seen over the past are not going to be growth rates for the future. Everybody was 20%, 25%, 30%. You are just not going to see that because the market is not paying for that anymore.
If you will stand by and be patient with us, we will get word out here as we go through the end of the third quarter and early fourth quarter, and then I think we will give you some very clear direction. Yes, ma'am.
When we talk about the implementation-
Do I know you, sir?
Yes, sir. Obviously, people are aware of what happens to diesel, and we can debate what happens to gasoline, but it seems that the more permanent structure creates a sulfur penalty in the heavy crudes. Can you just spend a second on what you think happens to light heavy spread? What are the new build economics for the industry to respond to that light heavy spread? What does it cost for a flowing barrel of greenfield complex refining capacity in the rest of the world? Thank you.
You bet.
Well, Ham, I am glad you were looking at Lane.
Yeah, I will weigh on the last part of that. I think most people, as everyone understands, is today bunker is 3.5 weight percent, and a big part of that is the heaviest part that comes off a vacuum tower, out of the heaviest crude. These are the Mayas and many of the South American crude grades. But it is not only that, it is really the AG grades. All of them, their VTBs are much higher in sulfur than that, so they have to find a place, right? So far, coker economics have been great for a few years now, which means that there is still molecules there. There are parts of the barrel that do not really have a home, and it has been getting burned in power plants and scrubbers and ships.
As IMO is implemented and you go from three and a half weight percent to half a weight percent, there's a part of the barrel that doesn't currently have a home. As your mind works through all that, the first thing that'll happen is that part of the barrel will get distressed because it doesn't have anywhere to go. Refiners, what they'll do is they'll re-optimize, and since cokers have already been economic and all these resid destruction units have been economic for a while, that means the only response can be to get lighter, right? You start shifting your purchases to a lower and lower sulfur grade crudes, which they also happen to be lighter. Consequently, medium sour, heavy sour crudes get distressed.
You're going to see the medium and heavy differentials start separating even more so until this home for this sort of distressed 3.5 plus weight percent material can figure out where it's going to go. In terms of, I'll just say a coker today, a 50,000 bbl a day coker would cost somewhere north of $1 billion, $1.5 billion. That would just be for the coker. If your refinery doesn't have diesel hydrotreating and hydrocracking and all the other associated units to upgrade it, because when I coker resid, none of those products that come out of a coker, actually, I can't do anything with them. They require further processing to get into transportation fuel. I mean, you're talking about a lot of money for somebody to do a grassroots thing.
Now, the industry, I'm sure, will go through a series of debottlenecking to try to tweak around this. But the economics in this space have been fairly compelling for a while. Obviously, this will be a big light, and we'll see, and I'm sure everybody has a certain amount of capital they're spending. But if you're trying to do something really big, expensive to try to solve this problem.
Plus or minus what we've been at. Do we go to 15? Do we go to 17?
What I would say is, in your mind, you have to develop a model for ultimately where does that really heavy stuff go, and I don't know that we have a historical perspective on this yet, right? We could all think through how that's going to work. I guess my answer to that is they're going to be wider. Assuming all this goes through, they're going to be wider as a percent of crude than they ever have been in history because we've never been in a situation where we're going to be this long, medium and heavy sour resid.
Yeah. Thank you, everyone. Unfortunately, the time is up, so we will end the session here. Thank you.