All right. Good morning, we are up with our next presentation. It is my pleasure to introduce our next presenter, Joe Gorder, Chairman, President, and CEO of Valero Energy. We also on stage have Gary Simmons, Senior Vice President of Crude Supply. Joe took over, was announced as Valero CEO in May of 2014, took over around the end of the year. Stock has been one of the best performers really in all of energy since he took over. I think a lot of it has to do with the capital discipline that he has employed at the company since his time as CEO. With that, I am going to let Joe walk through a presentation for 20 or so minutes, then we will do Q&A.
Good. Thanks very much, Phil, and good morning, everybody. Okay, we will start with the legal requirements. Here is the safe harbor statement. I think you guys have all seen these before, so we will not spend any time on that. Let us go ahead and move into the presentation. I think many of you, based on those faces that I am seeing out there, know the company pretty well.
Valero is a premier independent refiner. We have 3 million bbl a day of refining capacity. We have 15 refineries. We have a very significant wholesale fuel marketing business. We have a sponsored MLP that we are the general partner of and the majority owner of. We are also the owner of a 50% interest in a renewable diesel plant that is at our St. Charles refinery, the Diamond Green Diesel plant. We have a new segment that we are showing now. We started reporting on this at the end of the first quarter, and that is our MLP.
The assets included in this reporting segment for us are those assets that are part of VLP's asset base. We have still got the significant portfolio of logistics assets at Valero Energy. Those assets are not reflected in this segment's reporting. They continue to be reported in the refining segment. The final segment of our business is our ethanol plants. Our ethanol business, we have 11 plants with 91,000 bbl a day of corn-based ethanol production capacity. They are very well located, and they have a very low operating cost. We have a very good portfolio of refining, logistics, and renewable assets. This slide just gives you an idea of our geographic diversity.
You can see the footprint here, and you can see that we have got the U.S. pretty well covered from a marketing perspective. You can see we have refining assets all the way from the West Coast to Wales. Significant presence in the U.S. Gulf Coast and the Mid-Continent. You can see the location of our ethanol plants. They are located in the upper Midwest, right in the middle of the Corn Belt, which creates significant advantages. Diamond Green Diesel, as I mentioned, is down on the U.S. Gulf Coast. We also are showing now Valero Energy Partners assets, and you can see those by the valve type icon. We have got a very diverse footprint, which provides us with significant competitive advantages.
The current macro environment, I would say is one that is characterized by a lot of uncertainty. From a regulatory and a geopolitical perspective, we've got a lot of things going on. You've got tax reform, you've got healthcare reform. You've got the RFS, which is getting a lot of attention. Then you've got the global developments. There's terrorism all over the planet right now. There's a lot of uncertainty in the market.
I f I were to take one thing away, our perspective would be that there's going to be regulatory reform here, and the regulatory reform is going to be more business friendly, and so we're encouraged by what might be coming out of the legislative and regulatory environment in D.C. From a supply perspective, there's still plenty of crude oil and natural gas, although the OPEC cuts are compressing the crude quality discounts, which I think we're all seeing, and we're certainly seeing it in our margins.
From a demand side, we still have GDP growth globally, and there is very healthy demand for products. Higher demand driven by the lower prices and the structural shorts continue to certainly support Gulf Coast refining and Gulf Coast margins. Our strategy is pretty simple, and it's really based on three things. First, maintaining manufacturing excellence, and I'll talk about these three things as we go forward. The second is disciplined capital allocation, and the third is a focus on earnings growth. F rom a safety and reliability perspective, you can see how we've done. We're very proud of these results. Our personnel safety continues to improve. Our tier one process safety performance continues to improve. In fact, 2016 was the best year in Valero history in these two categories.
Then if you look at the bar graphs on the bottom, you can see how we stack up relative to the peer group in the Solomon metrics. You all would expect me to tell you that we are the premier refiner in the business, and I would. T hese statistics would bear that out. We're going to get 2016 survey results here probably in the next month to two months, and so we'll be updating the deck to show how we've done. T he point I'd like to make on this is that we have had continuous improvement in our operations, and the only way to drive profitability in a margin business or to drive exceptional profitability in a margin business is through high rates of availability and utilization.
If you take a look at the graph here on the left, you can see how we've done, and our assets are very reliable, and we operate them very well. This is based on two things. One, management has a very intense focus on this, and the second is the approach we've taken to investing our cash flows. I'll show you more about how we've allocated our capital here in just a minute. T hese great results, availability and utilization, tie into the bar graph on the right, which shows that we have the lowest cash operating costs in the business, and we are a very efficient operator. We do have a portfolio that supports low operating costs. We're located significant refining capacity in the U.S. Gulf Coast and in the Mid-Continent.
The chart on the left shows our CDU capacity. The charts on the right show how flexible our system is in allowing us to optimize between different crudes and feedstocks based on what the environment happens to be giving us at that point in time. Being on the Gulf Coast provides access to low-cost natural gas, an abundant supply of feedstock choices, and great access to domestic and foreign product markets. In the Gulf Coast, we also have a very highly skilled and competent workforce, which certainly contributes to our results. Our portfolio provides some significant competitive advantages. This is a slide that you all have seen many times. We've had it in place for the last three years, and it's our approach to how we're going to use our cash.
The overriding constraint that we have is to maintain a strong balance sheet. The components of that are maintain the investment-grade rating, and then keep our debt to Cap low. That does several things. It takes the financial risk out of the model, and it also provides us with the flexibility to do things, to take advantage of opportunities when they present themselves. We've looked at our use of cash into two basic categories. The nondiscretionary category, which is our absolutely no compromise category, and then the discretionary category, which is a competitive category. On the no compromise, we've got our sustaining CapEx. I showed you how our availability and reliability has been. That's because we continue to invest in the asset base and keep it performing at a very high level. We're spending nominally $1.5 billion a year on this.
It's a little more some years, it's a little less some years, depending on the turnaround cycle. This is something that we're going to use as a first source of cash, along with dividends. Our dividends, from our perspective, are a commitment to our owners, and we are absolutely committed to defending that dividend with everything we have. Those two uses of cash are ones that we will not compromise on. If you take a look at the discretionary components, we've got growth CapEx, acquisitions, and cash returns. There is a healthy competition within our management team for the use of funds within these resources. We continue to invest in the business, and I'll show you more about the growth CapEx component here in a minute. Acquisitions, we have targets, but they tend to be opportunistic.
The cash returns are what we've used to balance the use of free cash flow over the last several years. We've told our owners, our investors, that our goal is not to hoard cash. We will maintain a healthy cash balance within the portfolio, but we're not going to hoard cash. To the extent that it's not committed to one of these other categories, we're going to go ahead and continue to repurchase our shares. We've set a 75% payout ratio target. We've exceeded it the last couple of years, and we'll just have to see how things shake out this year. Anyway, this capital allocation has guided management's decision-making now for the last several years, and it's delivering pretty solid results. Here you can see what our returns are, and the focus obviously is on the dividend.
You can see what we've done with the dividend per share over the last several years. If you take a look at the bar graph on the right, you can see how our dividend yield shakes up to the peer group. We tend to be on the higher end of that. If you take a look at the bar graph in the middle, you can see what our payout has been over the last 12 months, and we're at the top of the heap.
Keep in mind that we had this payout ratio, we achieved this payout ratio in a margin environment that we would deem to be below mid-cycle. When you think in terms of, is this capital allocation framework something that the team's committed to, and are they executing on it, I think you can see that the answer would be yes.
You can see that more clearly on this slide. If you take a look at the bar graphs on the right, we've broken it up. The two bottom segments of these bars are our nondiscretionary components, and the two top segments are those that are discretionary. We made over $9 a share in 2015. In 2016, we made $3.70 and change. You can see how we managed using our capital allocation framework within those two very different years. If you take a look on the right, you can see what our planned use for cash is for 2017. We've got a capital budget of $2.7 billion, of which $1.6 billion is allocated to maintaining the safety, the reliability, and to perform turnarounds. We have $1.1 billion committed to growth.
Speaking of growth, this is a little bit of detail on the high-return capital projects that we're focused on. We've told you for several years now, our plan is to spend nominally $1 billion a year on growth CapEx. What we've tried to do here is to give you a little more color on what those projects might deliver. The capital is really split about 50/50 between refining and logistics. If you take a look at some of the projects that we've got underway, we have the Houston Alkylation Unit, we've got the Valero Wilmington Cogeneration Plant, we've got the Diamond Pipeline Project, we've got the Diamond Green Diesel Expansion. All of these have passed the gated review process that we have in place, which calls for 25% rates of return for refining projects and 12% pre-tax rates of return for logistics projects.
What I want to do is explain briefly this graph on the right. You can see here, this is illustrative of the EBITDA that we expect to produce with the investment strategy that we have, which is $1 billion a year going forward for the next five years. The projects that we're executing today, we would anticipate, are going to deliver $300 million-$400 million of EBITDA. If you take a look at the return thresholds and $1 billion a year of CapEx going forward, you would expect in our refining segment, we're going to produce another $600 million-$700 million of EBITDA, and our logistics projects will produce $300 million of EBITDA. If you sum that up, it's $1.2 billion-$1.4 billion of incremental EBITDA.
The reason that we put this slide in the deck really is to help you all understand that we are very disciplined around our use of cash. We have taken the approach that we are not going to really talk about our capital project development process until we get to the point where we know we are going to execute on those projects. You all remember the methanol project that we talked about years ago.
We did not execute that. We got a little bit out in front of ourselves in talking about it, and then we ended up spending the next two years reconciling why we were not going to do a project. As a team, we said, "Let us just wait until we get far enough through the gated process that we know what a project is going to cost us. We have a better line of sight to the returns we are going to get, and then we will start talking about it."
That strategy is one that we still employ, but we need to share with you that we are not focused just entirely on return of cash to shareholders and acquisitions. We have a growth component to the company that is important for everybody to recognize. These next couple of slides speak in more detail to those growth projects. The Houston Alkylation Unit project is really a project that is driven by our focus on the fact that octane is going to be tight. The autos are going to require higher octanes to meet CAFE standards, and tier three is going to take octane out of the market. This is a very good project for us that has a $300 million capital cost.
The Valero Wilmington Cogeneration Plant fits into the category of improving our operations and lowering our operating costs, and it is going to improve the reliability and the cost structure around providing power to our California refinery. From a logistics perspective, we are looking at improving our lot in life on our ability to deliver crude into our Memphis refinery. This pipeline runs from Cushing to Memphis, and it will provide us a lot more flexibility around the crude that we are receiving in Memphis, and it will lower our cost to deliver crude into Memphis.
This is a project that you should expect is going to provide drop-down opportunities for VLP. Then we have got the renewable diesel project, the Diamond Green Diesel Expansion. We are taking this plant from 12,000 bbl a day to 18,000 bbl a day. Really, the capacity expansion is somewhat limited by the availability of feedstocks around this. We are doing this project with our partner, Darling Ingredients. Renewable diesel is liquid gold in an LCFS world, and the Quebec market has embraced LCFS also.
This product sells for a premium, and it is in short supply. This project has very solid rates of return also. The bottom line here on our capital is that we have got a very strong portfolio today that we are investing to continue to improve. We have used a map like this in the past, but it was much more general, and it just had the lines that showed conceptual product movements. We decided to go ahead and put on here a little bit more detail for you. John Locke's team painstakingly put in all these dots, which reflect markets that we have actually exported barrels into.
W e often get asked, "Well, is there sustainability in this export market going to Mexico or going into South America?" What we wanted to do was illustrate for you that the markets that we're exporting into are very broad. Gary can speak to this, and he will, I'm sure, during the one-on-ones, but we've continued to see very strong export demand. The bar chart on the right shows what our historical volumes have been. They have varied a bit, but at a fairly constant level, and they vary really based on the margin environment here at home. If we've got solid margins here and the arb's not open to move the barrels out, we keep them here. If there's a pull in the export market for incremental barrels, we'll move them into that market.
But we have the flexibility to do this today, and you can see based on our current capacity and our future capacity, that right now there is no constraint in our ability to move products out into the export market. The issue that we're always evaluating is how do we optimize the value of that barrel. When you look at what's been accomplished, you can see here that we've delivered solid earnings, free cash flow, and solid stockholder returns. What we've got here, this is a new slide in the deck. This shows you data from 2015 and 2016 averaged. The grid on the left reflects our peer-adjusted EPS and TSR, and then our free cash flow. The vertical axis is our average adjusted EPS over those two years. The horizontal axis is the total shareholder return we've delivered over those two years.
As I mentioned earlier, 2015 was a very strong year for refining margins. 2016 was a much more challenging year for refining margins. You can see how we performed relative to the peers. The size of the bubble reflects the free cash flow that our company was able to produce. That free cash flow is driven by excellent operations in the disciplined capital allocation. This is a strategy that we're going to continue to employ going forward. I think what we'd like to demonstrate to you is that there's a lot more ratable cash flow that can be thrown off by this company than anyone would give us credit for. We will continue to demonstrate that going forward.
Then if you take a look at the bar chart on the right, you can see what our average EBITDA has been per barrel of throughput, and it's the highest among the peer group over that two-year period. We do believe that Valero is an excellent investment. If you take a look at these metrics, our return on invested capital relative to peers is the highest. Our refining EBITDA per barrel of throughput is the highest. Our net debt to EBITDA is the lowest. Our dividend yield is above the median, and our price-to-earnings ratio is the lowest.
Now, that's the one that we scratch our heads on. Anyway, for these reasons and those listed below, we believe that we are very undervalued and that we are an excellent investment. Operations excellence, capital discipline, and earnings growth are going to continue to be the three primary components that drive our strategy, and we're going to continue to execute on that. With that, Phil, I'll conclude the comments, and we'll open it for questions.
Great. Thanks, Joe. Appreciate the overview and the new slides, certainly very helpful. I wanted to touch on perhaps the macro slide. You made a couple comments there that I thought were worth following up on. The first was the regulatory reform comment. You mentioned that you do expect to see a regulatory reform that presumably would be positive for Valero. Maybe if you could just comment on what you envision happening, and particularly, we have any day now, we should be getting the preliminary RVO for 2018. Any color you'd have there?
Okay. Yeah, the two things I think that would affect us the most are certainly the Renewable Fuel Standard conversations and the tax reform. The petition that we have with the EPA continues to be outstanding. They're reviewing comments, and quite honestly, I think they're trying to figure out what they're going to do with this. There's no question that the RFS isn't functioning the way that it was intended to function. We petitioned the EPA to move the point of obligation from the obligated party, which is the refiner, to the point of compliance, which is the blender. What that petition actually did was shine a bright light on the issues with the RFS and the way it's functioning today. To get to your answer, we're encouraged by what we're hearing.
We don't have any definite knowledge, Phil, of what's going to happen or the timing around when things might happen. I t is true that Congress is holding open hearings now on the RFS, which is very good. They had one several weeks ago. I believe they might have had one last week, and they've continued to schedule those going forward. It's getting a lot of attention.
The Industry Trade Association, the AFPM, along with independent refiners, continue to work the issue with the EPA. There's two components to this. We've got the regulatory component, which the EPA could deal with this issue. I think they are trying to figure out what they're going to do with it. Then you've got the legislative component. Several years ago, it might have been a year ago, Representative Flores introduced a bill to cap ethanol blending at 9.7%.
There have been subsequent conversations with him to help him understand the implications of that on the industry. I would fully anticipate that if we don't get some kind of regulatory reform, we are going to get some kind of legislation presented that's going to try to deal with this issue. It has a financial impact to Valero, but it's a life or death situation for a lot of refiners out there. It's a heavy burden to carry, and essentially, it's a transfer of wealth from the independent refiner that's got the obligation to comply to the large retail marketer who finds himself long this financial commodity called a RIN, which he doesn't need. They just have made a real market out of an accounting compliance tool. I think there's clear realization that shouldn't be the case, and I think it'll get dealt with.
Tax reform is another one. There are several issues flying around. I think if you ask me to handicap the BAT, I would say that the BAT is not going to happen. I do think they are going to look for ways to pay for the tax cuts, and categories that I think you should expect to be considered, and you probably read about, would be immediate expensing, interest deductibility, and LIFO.
We're having ongoing conversations with the regulators and the legislators on those topics as we go forward. I think generally, we've got more of a pro-business environment than we had. We're at least having conversations around these issues, which we did not have in the last administration. Being an optimist, which is what you have to be if you're in the refining business or energy, I guess, in general, I think that we're going to get some resolution.
Okay, great. The second comment you made was that you believe that the current earnings profile is below mid-cycle. While mid-cycle is always a difficult thing to define, especially in refining, one element that we've noticed is that the refinery utilization is pretty much flat out coming out of maintenance season, running 94%, 95% kind of week after week. I guess I'm wondering, as you think about where we are in the cycle, what will it take to see the mid-cycle potential become realized?
No, that's a great question. Gary, do you want to? Gary Simmons is, and I think most of you know him. Gary runs our commercial business, so he's responsible for everything from getting the crude into the refineries through the wholesale marketing part of the business. He's in this market day in and day out, and anyway, why don't you-
Yeah. I think for us, when we look at how do we return to a mid-cycle type case, I think we think with low prices, you'll continue to see good gasoline demand, and the gasoline cracks will remain strong, and really where most of the recovery will occur for refining margins will be on the distillate side. Certainly, the increased upstream activity in the U.S. has caused some increase in distillate demand. A lot of that will be driven by economic recovery throughout the globe, driving stronger distillate demand, and bring crack spreads back up.
We also look to this 2020 IMO bunker spec change. As the IMO bunker spec change goes into effect, that limits sulfur in the bunker fuel from the 3.5% weight percent down to 0.5% weight percent. A lot of marine equipment and ships will have to shift over and start burning diesel, which will cause a pretty good bump in diesel demand, which will drive the crack spreads up and help us get back to a mid-cycle type case and even above as you start to get to 2020.
Gary, how about on the crude differential side? Obviously, we've seen some tightening, particularly the comment made about OPEC cuts kind of compressing the crude quality discounts. Maybe you could just talk about what you're seeing there and how that might play out through the next nine months while OPEC cuts continue, but maybe even thereafter.
Yeah. I think certainly while the OPEC cuts remain intact, you'll see fairly narrow quality discounts on the crude. I think we've probably got them as tight as they'll go. I can certainly tell you in our system, starting with our June operating plan, we began to maximize light sweet crude. We're running record volumes of light sweet crude in our June operating plan, so it tells us that the pricing got in about as narrow as it could, and we actually started shoving some of the heavy barrels and some of the medium sour barrels back to the market. I think you'll see a little bit of improvement in the quality differentials as we move forward, but you won't have significant increase until the OPEC cuts wind down, which I'm not exactly sure when that'll occur.
What we read in the marketplace is probably the end of the first quarter of next year. I think when that happens, then you'll have to start seeing the medium sours fight for market share with some of the shale producers, and you'll see the discounts begin to widen at that point.
We also have Jeremy Tonet up here on the VLP side. Have him ask a question.
Joe, on the VLP side, being a sponsored MLP provides certain advantages, especially as VLP can touch Valero assets, and Valero can provide contractual support, especially for expansion opportunities. We saw Diamond was a great example of that. Just wondering if you would comment on how big you see that opportunity set could be for VLP over time, and how does that compare or compete against M&A opportunities in the market? Seems like there has been some elevated multiples recently. How do you think about allocating capital on the VLP side?
That is a good question, too. We have a significant portfolio of assets we can drop. It is about $1 billion of EBITDA. That provides a great line of sight to a VLP investor for where growth might come from going forward. We have got that in hand. Then the projects that we have talked about here. When you are spending $500 million a year on logistics growth projects, you are going to create a much more significant portfolio of droppable assets into VLP. A lot of these assets are tied into Valero's portfolio. The typical contract that we enter into between Valero and VLP is one that is long-term, so generally 10 years, with minimum volume commitments, which support the cash flow and the purchase price of those assets.
VLP has got a very ratable cash flow stream today, and our intention would be to try to maintain that as long as possible, which is going to be many years. We have slowed down our pace of drops a little bit a couple of years ago because the market was so miserable that when you were issuing equity at 10%+ discounts, it just was not attractive to us. Now that the markets are back, a couple key points for VLP.
There were two things that we needed to get done to make VLP somewhat more independent of Valero Energy, and one was to get the investment-grade rating, which we worked very hard to do, and the other was to get in place an ATM so that we had access to the equity markets on a ratable basis going forward because what we were finding was that a lot of the shorts were getting in VLP equity because we were so predictable on our timing for executing the drops. We would watch it, and the equity price would be here, and it would get beat down the closer and closer we got to an announced drop schedule. We decided we are not going to talk about it anymore. We are not going to forecast when we are going to do the drops.
We are going to continue to do drop-down transactions, but we will do them on a more random schedule, perhaps. Valero's willing to take the equity for VLP. W e're not going to push equity into the market at a significantly discounted rate. Anyway, that's the organic growth piece, which, Jeremy, is important because it allows us to control the growth going forward. The M&A side of the business is one that we've been very active in the process. We have not been very successful in the outcome. I would tell you that's not because we haven't been aggressive. That's because the bid-ask spread on so many of these assets is above what we think it should be. We have the ability to grow VLP with the drops at somewhat of a known rate.
But when you're paying a premium in the marketplace for some of these assets, it just doesn't make sense to do that. We were very active in a recent crude gathering system project that we liked because it would've allowed us to bring barrels into our Gulf Coast refineries. We were pretty aggressive, we thought, but we did not win the transaction. Anyway, we'll continue to do what we're doing. I don't think there's any concern about distribution growth in VLP. There is no shortage of opportunities. I think you can expect us to continue to try to drive growth there.
As you think about if 2017 ends up looking more like 2016 in terms of refining fundamentals, which the first half is kind of playing out that way. You talked about the $2.7 billion of spend. Maybe you could just talk about the committed capital there, the capital flexibility. In 2016, you pulled all the way back to $2.0 billion.
Yeah.
A lot more money went to buybacks in the process. Maybe just talk about how you balance CapEx versus buybacks and just generally your capital flexibility.
Sure. It's all return driven. We look at the respective benefits of doing either. The capital projects that I showed you, which are in the execution phase right now, they'll be done in another year and a half, and most of the committed capital is done. Phil, when we look at our allocation of capital, the reason we put some of these graphs in here is to show that even in a down market, we're producing significant free cash flow in this operation. Our strategy on capital projects tends to be a lot shorter cash flow cycle projects. We don't get ourselves strung out committing several billion dollars over a three-year period. It tends to be much shorter cash flow cycle. They tend to be higher return and quicker cash flow in.
As far as flexing that capital budget, I think everyone should assume that we're positioned to maintain the dividend, spend the $1.6 billion. Let's just say that's $2.7 billion or $2.8 billion of cash flow every year that we've got committed. If you layer on top of that another $1 billion of growth CapEx, that's well within our ability to handle. I'll just tell you, before we increase the dividend at the pace that we've increased it, we always run the models and stress test it, as you would expect us to. We never want to find ourselves in a position of cutting that dividend. There can be some movement within this capital, but I think for purposes of modeling, you need to think Valero's going to spend $2.5 billion a year going forward.
If things were really awful, could we cut back on the growth CapEx? Absolutely. We would not cut back on the maintenance and turnaround CapEx or the dividend. That's going to be the first two uses for cash within our portfolio.
Got it. We'll squeeze in one last one here. You talked about being active in the M&A process on the logistics side. How do you feel about refining or maybe other areas of interest?
Yeah, no, that is good. We participated in every refining transaction that was out there. W e are selective. We were involved in the Citgo process, we were involved in the LyondellBasell process, and the Citgo process obviously did not come to fruition, nor did LyondellBasell. Those guys were looking for valuations that exceeded, I guess, what the market thought that they should be paid for those assets. LyondellBasell's timing was very bad. They were coming out of a year of low margins and poor operations. I would not want to be a seller coming out of that situation. I can understand fully why Bob Patel did not want to sell at that point in time either. W e will continue to be active in that, but those are the two areas, Phil, honestly, that we are looking at.
I do not think you should expect us to do anything in the retail marketing side of the business. There is not a big petrochemical acquisition on the horizon. When we speak in terms of petchem, we are really talking about doing more with the streams that we are producing today. Benzene, propylene, things like that. It is building the infrastructure around it to allow us to high grade some of those products or continue to concentrate those products and sell them into the market to take the margin that we are giving to somebody else today. It is not like we are going to go build crackers and do multibillion-dollar projects. Anyway, I hope that answered you.
It does. Thanks so much. I think we are out of time, so thanks so much, Joe.
Thank you all.