On behalf of Barclays, I want to welcome everyone back to our Energy and Power Conference. This is the 31st year that we have this conference. Thank you very much for everyone joining it. Before I introduce our speaker that will kick off the conference this morning, I just want to, as a reminder, in support of the Harvey relief effort. Barclays, not only has donated money, but we also, in research, we decided to do our part, and so we have some fundraising efforts going on. In case anyone is interested, you can either donate it in some of the machines that we have set up, or you can buy the raffle tickets from any of the Barclays Energy and Power analysts. Thank you for the support. With that, with my extreme pleasure, our speaker that will kick off the conference this morning is Valero Energy.
We have Chairman and CEO, Joe Gorder. Joe, since he has become the CEO, I think the results speak for itself, have dramatically transformed the culture and the performance of the company. I think this is just the beginning and more to come. Without further delay, let me welcome Joe.
Thank you, Paul. I appreciate it very much, and thanks to all of you that have shown up so early and gotten up so early to be here to let us share a story. Let me go ahead and bounce you through here. This is our safe harbor statement, and I think you guys all know what it says, that management's expectations or predictions of the future and forward-looking statements are covered by the safe harbor provisions of the Securities Act of 1933 and 1934. With that, we will talk about who Valero is. Okay, I am not getting this to advance. There we go. Okay. What you have on this page is a description of really the three reporting segments that we have within Valero. We have the refining segment, which is the most significant. We have 15 refineries, 3.1 MM bpd of refining capacity.
We are in the fuels marketing business. We are the majority owner of an MLP, and also are the general partner of that MLP and have all the incentive distribution rights. Then we are a JV partner in a renewable diesel plant, the Diamond Green Diesel plant. On the MLP side, VLP, as it trades under, is a fee-based MLP, and it is a liquid-focused logistics asset MLP. It has been that since its inception. Then we have a renewable fuels business. This is an ethanol business. We have 11 ethanol plants with 91,000 bpd of production capacity, and these are excellent plants located up in the Corn Belt, up in the central U.S. Now, this is our geographic footprint. You can see the refinery icons.
We go from the West Coast all the way across U.S. Gulf Coast to Midcontinent, and then we have the refinery in Quebec and then one in Wales. You can see our wholesale marketing presence. It is very broad, and you can see our branded presence by the Valero icon that is in the different states. You can see our ethanol plants, as I mentioned, are located in the upper central Midwest, and our headquarters in San Antonio. While I am on this page, what I would like to do is just talk a little bit about the hurricane. If you see this map, what was interesting about Harvey is that Harvey came to shore probably 15-20 miles to the east of Corpus Christi. You can see where that is on this map. Then it proceeded to go inland.
It didn't reach San Antonio, but it came halfway up probably, and then it backed back out and then ran along the entire U.S. Gulf Coast all the way over to where it seemed to park over the Houston, Beaumont, Port Arthur areas. All in all, it touched five of Valero's refineries. Prior to Harvey showing up, we shut down Corpus Christi and Three Rivers. We continued to run the three plants over in the Houston area, so Houston, Texas City and Port Arthur. As Harvey moved to the east, we then reduced rates at Houston and at Texas City, and we continued to run Port Arthur, and then ultimately when the hurricane parked over and started dumping 50 inches of rain in Port Arthur, we shut down Port Arthur. Houston and Texas City ran at reduced rates throughout the hurricane.
Where are we today on all of this? Corpus Christi is back full bore. Three Rivers is still in the process of restarting. Houston and Texas City are operating. Houston is operating at slightly reduced rates. We have an issue with the cat, but it will be back shortly. Port Arthur is in the process of restarting part of the refinery. As the water receded, we were able to get in there and inspect all the electrical equipment, and it is in the process of coming back up.
What I would say is that an event like this points out the efficiency of the supply chain that we have in the energy sector. You see articles that are written that state that, how could this happen and why does it take so long to recover? The facts are this situation that we are dealing with is less than two weeks old.
Supply is back in the market. Refineries are running. The supply chain is functioning. We got great support from our partners on the crude supply side and from those taking streams that we produce and moving them out into the market. Think about this. You cannot run a refinery if you can't move the barrels that you produce out. You get into containment issues very quickly. I applaud everybody in this industry, and I appreciate everything that has been done in support of Valero's operations. Again, I think this map is a good way for you to visualize the effect that this had. Paul did ask me to mention, we haven't had a chance to go in and look on our forecast at the effect of this event yet.
But as I mentioned, we do have refineries running again, so any disruption is going to be short-lived. Okay. The macro environment. On the supply side, we continue to have plenty of crude oil and natural gas, although the OPEC cuts are being felt. We have seen the medium and heavy sour discounts on crude come in. On the production side, this is something that we have added. It is a point to be made, that global refining capacity is running near maximum utilization, and capacity expansions are lagging demand. So if you look at the environment from a longer-term perspective, clearly we are going to be well-positioned. Then from a demand side, we continue to have very high demand. It is driven by economic growth, which are supported by lower prices.
We have got structural shorts in the markets, then we have got regulatory changes like this IMO bunker spec, which is going to be very material to the industry. So the environment is generally good. The regulatory and geopolitical environment certainly creates some uncertainty. But we fully expect, on the regulatory side, that we are going to get reforms that are going to be beneficial to the business. Geopolitically, we just hope that things do not occur that would create major disruptions. All right, our strategy is a fairly straightforward and simple strategy, and it remains focused on really three major components. We want to maintain manufacturing excellence, and that is to be the best operator in the business. We are committed to maintaining a disciplined capital allocation program and delivering peer-leading returns to our stockholders. Then we are very focused on continuing to deliver earnings growth.
I will show you some slides here in a few minutes that would support our position on all these things, but we are continuing to invest in the business in a way that is going to drive earnings going forward. Now, this is something that we are very proud of. Our operating performance has just been excellent. If you take a look at the two graphs, the upper left and the upper right, you can see how we performed in a personnel safety and a process safety.
The organization continues to be focused on improving. 2016 was our best year in company history in these two categories, and we want to continue to improve every year. If you look at the bar graphs on the bottom, this is the result of the Solomon study, and we were able to update this since the last time you saw it for 2016's results.
You can see that we continue to perform very well. First and second quartile for our entire portfolio in all of these categories. So our performance has just been absolutely tremendous, and we are not satisfied with it. We are going to continue to drive improvement. Now, you saw where we are on a reliability from a reliability perspective, and management's focus and our investment approach is really targeted on continuing to produce high reliability and availability rates. What that then enables us to do is to continue to operate with very low operating costs. We are a very efficient operator, and you can see from the graph on the right where we stack up relative to the peer group in this. When you are in a commodity business, you have got to be the low-cost guy, but you have also got to be reliable.
I think what you can see here, I will speak more about in a minute, is the fact that the approach to investing capital that we have, a significant amount of our capital goes into maintaining and turning around our assets. That contributes to the availability and utilization rates, it also contributes to the low cash operating cost results that we are enjoying. This shows our CDU capacity and the feedstocks that we are able to run. Being on the Gulf Coast really provides access to low-cost natural gas and abundance of feedstock choices and great access to domestic and foreign product markets. We also have a very highly trained and skilled workforce, that is the reason that we focus on having U.S. Gulf Coast and Midcontinent assets. All of these things apply in this market, that really differentiates the competitive nature of different refineries.
Do they have access to low-cost natural gas and abundant crude supply and then product markets? If you look over at the chart on the right, this is something that is unique to our system. We are able to run a very wide variety of crude and feedstocks, which allows us to optimize the operation regardless of what the market happens to be giving us. We do have a wonderful portfolio. The geographic location is very helpful, but also the assets that we operate allow this to occur. This page talks about our opportunity to move products into different markets in the Gulf Coast. Locations that we operate in are very supportive of this. What you see here are actual destinations that our products move into.
Again, the asset location and the ability to move products into all these different areas really enables us to continue to optimize around the margin and take advantage of whatever arb happens to be open at the time. Then if you look over at the bar graph on the lower right, these are our historical volumes, you can see very clearly that we have the opportunity to continue to increase exports as economics would support. This is a new slide to the deck that many of you probably have not seen before, but about a month ago, we announced that we were making a significant push into Mexico. We have been supplying the Mexican market for over 10 years now with product movements. What we are able to do based on their reforms is take a more direct approach to marketing products there.
We partnered up with a publicly traded Mexican company, to build a terminalling facility in Veracruz. It is an 85,000 bpd facility. This is a material transaction to the Mexican market. We are going to be able to ultimately move 85,000 bpd into this market. We are going to rail the barrels into basically the Mexico City market and the Puebla markets. But the barrels that are supplied into Veracruz are going to be water-borne barrels that can come out of the Gulf, or they can come out of Quebec, or they could come out of Pembroke. We can supply it from many different sources, which again, allows us to optimize the supply into that market based on where the arbs happen to be at a given time.
So a significant transaction for the company, and I think you've heard us say before that our objective is to extend our supply chain, and by being able to do a project like this, we are extending the Valero supply chain in a more direct way. Now, you've seen this slide before on our capital management approach, and this is something that we're not going to compromise on. The overriding constraint, of course, is to maintain our investment grade rating and a very strong balance sheet, and then we're uncompromising on our commitment to sustaining our assets with CapEx for maintenance and turnarounds. And we're also uncompromising on our commitment to our dividend. We want it to be at the high end of the peer group.
We've been able to achieve that, and these are things that are priority focuses for us when we look at how we're going to use our cash flow. Then if you look at the discretionary components, again, we retain the competition among these other categories of growth CapEx, acquisition, and cash returns. And we are continuing to invest in the business, as we've talked about and as you'll see here in a moment. But we're continuing to invest in the business in high return projects with shorter cash flow cycles. They're going to drive earnings growth. Surplus cash flow that we have, free cash flow, we're not going to hoard it. We've told you that many times. We're going to use it, and we're going to distribute in the form of dividends and share repurchases.
Now, the next several slides demonstrate that we've walked our talk relative to this capital allocation framework. And here you can see that we have delivered sustainable dividend growth. There's been significant increases over the last several years. And if you take a look at the bar graph on the right, you can see where we are from a yield perspective, and it is a very healthy dividend yield. Our objective would be to continue to grow the dividend at a rate that we believe would be sustainable for the business that we're in. Then if you take a look at this, you can see where the cash returns have been. Our share count has continued to reduce. We're trying to drive higher EPS, and one of the ways that we can do that is by continuing to buy back shares.
And we achieved these results really in a margin environment that we would consider to be below mid-cycle. And we did this without depleting our cash. So we find ourselves with a capital allocation framework that's enabling us to deliver very solid dividend returns and continuing to return cash to the shareholders without compromising our cash position or the balance sheet. So it's a very strong position for us to be in. Then just to show you how we've allocated capital and our commitment to our discretionary and the non-discretionary components of it, you can see here what we've done. And you guys remember 2015 was an awesome year. Valero made over $9 a share. Last year, we made $3.72 a share. But you can see that the non-discretionary components of our capital didn't vary much year-over-year.
What we did is we adjusted appropriately on the discretionary components, and that was growth CapEx and share repurchases. If you look at the pie chart on the right, you can see that this year we're planning to spend $2.7 billion of capital. $1.6 billion of that is in sustaining CapEx. The $1.1 billion of growth CapEx is split about 50/50 between investments in our refining sector to increase our margin capture and to further optimize the system. The other half is around logistics assets that again, many are supportive of Valero's core business and also with a line of sight to third-party revenue growth. I think nominally you can expect that our capital is going to be in this $2.5 billion-$2.7 billion range for an extended period of time.
If it varied from that for one reason or another, we'd come out and make our case with you as to why it made sense to do that. We are focused on earnings growth. On the left here, we talk about some of the projects that we have underway. Projects in the execution phase, we've got the Diamond Pipeline, which will be on stream here at the end of the year. We've got the Wilmington Cogen plant, which we're making great progress on. We'll have that operating before the end of the year. The Diamond Green Diesel expansion is a mid 2018 project, and then the Houston Alkylation Unit is a first half of 2019 project. Of course, that will produce higher octane, which we're finding to be in much greater demand.
Other projects in the development phase, and we probably need to change this chart because the first point there is extending the supply chain into Central Texas and the U.S. Gulf Coast. Yesterday morning, we announced that we're, along with Magellan, doing a project that's going to take barrels from the Houston market over into the Austin market. That's a material project that ultimately will be one that we will put in VLP. We've got the reference here to extending the supply chain into Mexico and Latin America. I shared with you what we're doing on Mexico. We would like to do similar projects in other parts of Latin America because we believe those are good growth markets, and they're a natural home for products that are produced in the U.S. Gulf Coast.
If you look at the bar charts on the right, this illustrates the EBITDA that can be produced from projects that we've got under development at the targeted rates of return that we're projecting. You can see that we're going to be able to drive significant earnings growth with the capital investments that we're making today and that we would continue to make over the next five years. This is a very material outcome here, and that's why we feel good about not only are we returning cash to shareholders, but we are continuing to invest in good return projects that are going to drive EBITDA growth. I'll close with this. This page shows how we stack up, and you can see that on return on invested capital, we're the highest. If you look at refining EBITDA per barrel of throughput, we're at the very high end.
Net debt to EBITDA, we're the lowest. Our annual dividend yield puts us about at the median, and our P/E has us at the lowest. We believe really that we are undervalued, and we remain an excellent investment. We've got a proven track record now of excellent operating performance. We've clearly got a pathway to growth in our earnings stream based on the projects that we've already identified and with those that we have in the development pipeline. We've delivered very solid returns. We're seeing this multiple expansion, which is something that we have been attentive to, and there's more information on this in the appendix of the books that we've got to hand out. Anyway, we think Valero remains an excellent investment. With that, Paul, I'll stop, and we would be welcome to entertain questions if we still have time.
Sure. Thank you. I think we have time for several questions here, and then we'll move on to the breakout session if there's additional Q&A. There's a question. If there's any question there, please raise your hand. Yes.
Thanks. You talked about the IMO specifications earlier. Can you just talk about what Valero needs to do to be ready for that? Also within that, how you think it affects the market? Because there's a lot of talk about whether it's diesel, whether it's LNG, whether it's scrubbers need installing within that.
Yeah. No, very good. Gary, you want to talk about? She asked about IMO, what we need to do to be prepared for it. You might just talk about the general implications.
Yeah. The way we view the IMO bunker spec change is that overall, it will take a lot of the demand for 3.5% sulfur bunkers fuel off the market. A lot of that will be replaced with ultra-low sulfur diesel or 0.5% sulfur diesel. So you'll see a fairly significant demand increase in diesel. Then with the excess high sulfur fuel that's on the market, it will cause the heavy sour and medium sour discounts to widen as we approach that 2020 timeframe. So for us, we're very well positioned because we have all this coking capacity at our refinery, very complex refining capacity. We really don't make fuel oil, so there's not anything we need to do there. Then we're well prepared to be able to, with the new hydrocrackers we have online, to be able to produce incremental distillate barrel that the market will need.
Question on the VLP side. One of your competitors recently is going with the strategy of building organic projects at the parent and dropping at cost rather than a traditional drop-down multiple in support of their MLP. What's your view on this, and are you willing to do this for VLP down the line? Are there other forms of support that the parent can give?
Yeah. No, the key is doing these at fair value, right? The way that things are structured, you've got conflicts committee, so the MLP needs to be sure it's not paying too much for the asset and vice versa. It needs to be a fair price for Valero. But I would say on organic growth projects like that would be the plan is to effectively, and this will change with time as VLP gets larger and can finance its own projects where it can do them on its own. But in the near term, Valero will go ahead and develop the project, and then we'll drop them to VLP at the cost.
The way we look at the relationship, and this has been our historic way of looking at it, and it continues today, of looking at the relationship between the two is if Valero Energy has a project that they find would create value for it, and let's just say it's a logistics project. They would go ahead and build the business case for it and look at the economics associated with that project. Then we say, okay, if that's the case, if the answer there is yes, and if we drop it to VLP and give them a 12% rate of return, let's say, and they buy it from Valero, earning a 12% rate of return, and Valero pays that 12% rate of return effectively to VLP, is it still a good project for Valero Energy?
If the answer to that question is yes, then we generally have a go. The projects that we are talking about, the Diamond Pipeline, that is a project that Valero is developing and that will go to VLP. If you look at this Houston to Austin project, that is a project that Valero will develop that will go to VLP and so on. That generally is our approach to this, and I think the answer to your question is probably yes. Yes, ma'am.
Hi.
Hey. Sorry.
Yeah.
Clearly you are not a ma'am.
You mentioned that your view is that we are currently below mid-cycle refining margins. Can you just talk about that a little more? Where are we in the cycle for margins?
Yeah.
How do you get to mid-cycle, and what's the earnings power of the company at mid-cycle?
That's great questions. Do you want to?
Yeah. We view that gasoline cracks are slightly above mid-cycle, but that the diesel cracks have been fairly significantly below mid-cycle, and on an overall crack spread, a 2-1-1 or 5-3-2, you're a little below a mid-cycle type crack spread environment. Really, the driving force to getting above mid-cycle is this IMO bunker spec change. The IMO bunker spec change will cause distillate demand to increase, and with increasing distillate demand, you'll get diesel cracks that'll strengthen as we approach 2020. As you get to that 2020 date, that's what will really pull you up above mid-cycle margin environment.
The other thing, the only thing I'd add to what Gary said is we were in a period where the economy wasn't as robust as it could be. If you look at diesel demand in general, diesel demand is driven by economic activity. Gasoline, consumers consume gasoline. When things are good, they tend to consume more, and when they're tight, they tend to be more conservative. With the economic activity that we're seeing now, let's just talk about in the oil patch. A lot of diesel's consumed in the oil patch. When activity slowed materially, I think, Gary, it's fair to say we saw a decrease in our diesel demand in the markets where this is supplied. Now that we've got significant activity taking place again, you've got much stronger diesel demand. Demand for gasoline and diesel have been good.
But this has to happen for some period of time to push it back up, to push margins back up. But we were seeing margin improvement pre-hurricane, and obviously, you get a spike associated with the hurricane. Inventories were cleaning up. They were very high, and that was a hangover from the end of 2015, early 2016. As inventories adjust to getting and come back more to normal levels, I think we'll see the margins continue to improve.
There's a question at the back.
Do you have a preliminary estimate for when Port Arthur could return to normal operating rates?
Yeah. I think the guys are still in the process of doing assessments on part of the plant. Half the plant is back
Starting up.
starting up right now.
Yeah.
Okay? And the other, it's a matter of inspecting. Gary, you should speak to this, but it's a matter of inspecting all of the equipment that we have to be sure that we're functional.
Yeah. Overall, anytime you have water in a refinery, you have to really do loop checks on every instrument loop and every electrical loop. And so those are literally thousands of instrument checks that need to be done. Part of the refinery didn't take on a lot of water, and so we were able to get that up and running. But the water has receded, and it's a matter of the guys getting in and doing all these loop checks to find out if we have any electrical damage and then can bring up the rest of the refinery.
What we're talking about here isn't months, okay? We didn't have the type of physical damage as a result of this event that we had, like in Katrina and Rita, where power lines were blown down, and it was significant. The industry really did a good job of hardening itself over and as we live and learn, right? We continue to try to improve things, and the industry hardened itself materially since those events took place. We're probably 10 days, two weeks from Port Arthur being back fully functional, with part of it being up before that.
Yes. Hi. Just curious, your perspective on the Lyondell refinery sale process and just your opinion on what happened in that situation and why the refinery didn't move.
Well, I think it didn't move because they didn't like the prices that were offered for it. I'm not here to really speak about this, but in defense of the situation, that refinery was put on the market during a time period where we had very weak margins and they had pretty poor operating performance. So the valuations clearly weren't what their management was expecting to get, which I fully understand. Being the type of CEO that he is, Bob Patel decided that his team could improve that operation and try to create additional value with it, so they chose to keep it and to invest in it and to try to fix it. Will it come back to market one day? I would like to think so. I don't know.
I would like to think so because it shares a fence line with our Houston refinery, and it would be a great addition to Valero's portfolio. Yes, ma'am.
With VLO's footprint in Corpus and your partnership with one of the midstream companies that wants to bring a pipeline to Corpus already playing for the Diamond Project, would it make sense for the Valero family to participate in one of the Permian to Corpus pipelines with VLO as an anchor shipper and VLP having a stake in the project?
Yeah. Gary, you want to
Yeah, I think it could make sense. We talk about a lot of opportunities in that area because it's not just the Corpus area refineries, but we have a dock in Corpus that then you can load the crude and either take it to the Eastern Gulf or we've been exporting out of Corpus to feed our Quebec and our Pembroke refinery as well. So whether that's done with participation in a pipeline or entering into an agreement with a producer who has space to take delivered barrels, we're looking at all those options.
That's it.
Yeah. Can you talk about demand patterns at the retail level for both gasoline and distillate. It looks like we started, if I look at the EIA data, we started the year weak, then things have accelerated lately. If you could maybe quantify what sort of diesel demand you think you get from the oil and gas industry, how significant has the pickup and, just call it the rig count and activity been?
Right.
I don't know if you can quantify that.
No, I can't do the last, only because I don't have the data. Okay? I apologize for that. But on the first part of your question, Gary, you want to take a crack at that?
Yeah. Overall, I think, the way you described the market is exactly the way we've seen it. Gasoline demand was a little weaker at the beginning of the year. It looked like to us the weakness was primarily on the West Coast, and it was understandable because they had a lot of rain on the West Coast, which hurt gasoline demand. As we see demand today, gasoline demand is about flat year-over-year, and distillate demand throughout our system has been stronger year-over-year is what we've seen, and it is primarily where we see the improvement in demand is the regions where there is upstream activity. So in the Permian region, which our McKee refinery feeds, and in the Eagle Ford region in South Texas, we are seeing a lot more diesel demand than what we saw last year.
I think we have time for one more question before we move to the breakout session. If not, then we will proceed to the breakout session with Liberty one and two. Thank you.