Good morning. Our next presentation is Valero Energy. We are very happy to have CEO and Chairman, Joe Gorder. Joe has been the CEO since 2012, and since then has inserted a renewed sense of capital discipline, and we can see the phenomenal performance of the stock and also their free cash flow subsequently. We are very happy for Joe to be here to share with us his insight. Thank you.
Well, thank you, Paul, and good morning, everybody. It's a pleasure to be here with you. I just might point out up here on the front, on the far left there, we have John Locke. John is our Vice President of Investor Relations. In the middle is Lane Riggs, and Lane is the Executive Vice President. He's responsible for all refining and engineering for the company. We'll get through this presentation, and then we'll entertain any questions you might have, and I'll count on the two guys to help me share the right answer with you. Let me begin. We've got to show, of course, the safe harbor statement.
Essentially here what we have is, this says that management's expectations or predictions of the future are forward-looking statements intended to be covered by the safe harbor provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. With that behind us, let me move into who we are. Valero Energy is the world's largest independent refiner. We have 15 refineries and 3 million barrels per day of highly complex refining capacity. 70% of that is in the Gulf Coast, which we'll talk about more later, is advantaged. We have a significant wholesale fuels marketing business. We market products both branded and unbranded. Branded through 7,500 outlets, and it works out to about 800,000 b p d of volume through that wholesale marketing business.
We have a master limited partnership for which Valero Energy serves as owns the general partner and all the IDRs and a significant ownership position of the common units. We also have a significant inventory of logistics assets that I think we'll talk about here shortly, are available to drop into VLP. We also have a very significant renewable fuels business. We have 11 corn ethanol plants that produce 85,000 b p d of ethanol, and then we have a renewable diesel plant that we partnered with a company called Darling on, and it produces 11,000 b p d of renewable diesel. That's the company in a nutshell. This gives you an idea of our geographic footprint. If you take a look at the teal colored states, those are where we have a wholesale marketing presence.
If you look at the states with a logo, that's where we have a branded wholesale presence. You can see the refinery icons and our refinery footprint stretches from the West Coast all the way down through the U.S. Gulf Coast up into the Mid-Continent. Then if you look to the upper right, you can see that we have a refinery in Quebec City. Then to the far right, you can see that we have a refinery in Wales. So we've got a very good geographic footprint from a refining perspective. The ethanol plants are located in the Upper Midwest, which is significant in the fact that they're very close to the source of feedstock.
Of course, one of the big expenses in running any facility is getting the feeds in and being close to the source of supply, the corn in this case, is very beneficial to us. Our headquarters is located in San Antonio. Then the Diamond Green Diesel renewable plant is located on the side of our St. Charles refinery near New Orleans. Now, the point I'll make on this chart is that we do have a significant refining presence in the Mid-Continent and in the U.S. Gulf Coast, and those are advantaged locations in today's market. From a macro perspective, the fundamentals are largely the same as they have been in the past. There's plenty of crude and natural gas in the world from a supply perspective.
Although domestic production has declined some, globally, crude continues to be in length, and I think you can see that if you take a look at the market structure. Imports are certainly offsetting any declines that we've had in domestic crude. Then the second point under supply speaks to the logistics build-out, which has been significant. So the barrels that historically have been bottlenecked in the Mid-Continent of the United States now have free ability to flow to wherever they can garner the best price, and many of those barrels are flowing to the U.S. Gulf Coast. So we're in a period of supply abundance, both from a crude and a natural gas perspective. From a demand perspective, forecasted GDP growth is going to continue to support demand growth, as is lower product prices.
I think we've all seen domestically, gasoline demand through the bulk of the year has been somewhere around 10 million barrels per day, which is significant. Diesel demand's reasonable, and so lower prices are certainly supportive of that. Then from our perspective, specifically having a significant presence in the U.S. Gulf Coast, the product shortages that are being experienced in Latin America, Europe, Africa, and Eastern Canada are certainly supportive of our business, and I'll show you more about that in just a minute. But basically, from a macro perspective, the market hasn't changed significantly from Valero's point of view. Now, this is something that we're very proud of. You can see here that we've got data points that are specific to the company. On the upper left, you've got our personnel safety statistics. Then on the right, upper right, you've got our Tier 1 process safety statistics.
We have a relentless focus on both of these safety categories. That has really led to excellent performance. 2015 was our best year ever, and Lane and his team continue to work very hard on this, and hopefully we will see continued improvement as we go forward. If you look at the bar charts on the bottom, this speaks to our performance relative to the industry benchmarks which the peers participate in. You can see here how on all of these metrics, our performance has continued to be very good. This is the summary of the metrics for our entire portfolio. It is very difficult to have an entire portfolio perform in first quartiles in all these categories, but many of our refineries operate in the first quartiles here.
Basically, if you summarize these bar charts on the bottom, it tells you that Valero has the best operating company in the business. Okay. Advantage locations in the U.S. Gulf Coast. I spoke about this just briefly, but you can see from the bar graphs on the right that we have a significant presence in the Gulf from a CDU capacity perspective, by far the largest in the peer group. Over 55% of our capacity is there. When you think about this, being on the water is material because it provides access to the low-cost natural gas. There is abundance of feedstock choices available to us, which provides great optionality, which I will speak about in a minute. It also provides access to domestic and foreign product markets, which I will show you a graph on in just a second.
We have a very good footprint from our perspective. The flexibility in the feedstock selection can be seen really on this graph. You take a look at the bars on the right, on the left, excuse me, and it shows our feedstock ranges in the Gulf Coast. Here you can see the ranges that we can run of each type of feed. Heavy sours ranging from 23%-34%, and so on. It is important to note here that these vary based on the economics at the time. Every day, we are running the LP models to determine what the most cost-effective crude slate is, and the team is buying feedstocks in a way that allows us to continually optimize here. That is a significant advantage. Frankly, it is what makes Valero hard to model from a guy like Paul Cheng's perspective.
If this was a lot simpler, if we were purely a Mid-Con refinery or we were running WTI, it would be a lot easier to do. The fact that we have the ability to continually vary the feedstock selection allows us, again, to optimize, and it makes it difficult for modeling. If you take a look at the chart on the right, this shows where we are from a cash operating perspective, and you can see that we have the lowest cash operating costs in the peer group. That tells you that we are the most efficient refiner in the marketplace, and it goes back to what I showed you a moment ago on those industry stats, which I believe, again, supports the position that we have the best refining operations in the business.
Now, this speaks to our ability to access product markets from the U.S. Gulf Coast. The red lines are the distillate, the black lines are the gasoline. This basically shows that we have efficient access to many markets and allows us to move barrels into the highest net back markets. If you look at the bars on the right, you can see what our historical export volumes have been. The capacity increases that you see are available to us in the bar on the far right are really projects that we have identified at our St. Charles, Port Arthur, and Houston refineries. You can see exports have continued to increase. So far this year, I guess it is through June, we have done 262,000 bbl a day on average of distillates and 130,000 bbl a day of gasoline. We have the ability to do more.
The reason we have not done more is because the net backs have been better to keep products here at home in many cases, so we have not exported additional volume. But we do have that as an outlet for us. All right, this is a capital allocation framework really that we introduced about mid-2014, and it is something that really guides a lot of our decision-making on the use of cash. It starts with the fundamental premise that we are going to maintain a strong balance sheet. This includes maintaining the investment grade rating and keeping the flexibility within our system by maintaining a low debt-to-cap ratio. Those are the overall constraints that we operate under. If you take a look at our use of cash, we view it from a non-discretionary perspective and a discretionary perspective.
The non-discretionary components include the sustaining CapEx, which works out to be $1.5 billion - $1.6 billion a year generally, and that is what we need to spend on maintaining the portfolio and on doing turnarounds to continue to support those high level of operations that I showed you we enjoyed on the slide earlier. The dividend is the other component here. That is something that we have made a commitment to our shareholders, to our owners about, and we intend to do everything that we can to defend that dividend. Right now, there is absolutely no risk of the dividend being an issue, and our objective would be to continue to look at the dividend going forward for growth. But those are two things that we have committed to and that we will not sacrifice in any regard.
If you look at the discretionary uses of cash, we have got three components there. We have got the growth CapEx, we have got acquisitions, and cash returns. What I would tell you about this is that there is competition for the use of cash between these three categories. We want to continue to grow the business, so we are trying to balance the investment that we make in the business with the repurchase of shares, and then the acquisition opportunities that are available to us. If we can develop capital projects that have high rates of return, we will make our case with you that those are projects that we should do. If not, we are not going to sit on a bunch of cash, and we will continue to buy back shares. We have committed to a 75% payout ratio this year of net income.
So far, we're ahead of pace to achieve that, and as cash continues to be freed up and we're not using it for projects, we're going to go ahead and return it. Balancing growth and the return of cash via the dividends and the repurchases is something that this management team's been focused on, and you can count on the fact that it's going to continue. If we take a look specifically at our capital investments, we are focused on maintaining the assets, as I mentioned, and then really enhancing our margins and growing our logistics business. If you look at the pie chart on the left there, you can see that we've got $1.6 billion approximately attributed to safety and reliability capital. The margin improvement in cost reduction capital is really tied to asset optimization within the refining sector and the logistics business.
You can see that that strategic CapEx is really split about 50/50 between those two categories. This is something that we expect is probably going to continue for some period of time. We get asked oftentimes, how much latitude do we have in the growth CapEx component of this? There is a fair amount. The projects that we've embarked on in recent years have been shorter cash flow cycle projects, smaller in their nature with higher rates of return. Adjusting the pace of spend and the startup of new projects is something that we have more control over than when we used to do more lengthy, long cash flow cycle projects in the past. This $2.5 billion-$2.6 billion capital number is something that we're very comfortable with and fits well into the cash flow scenarios that we're forecasting.
If we look specifically at what we're doing from an asset optimization perspective, you guys have heard about these projects now for some time. We completed the two crude units, one at Corpus Christi and one at Houston, which increased our capacities by 160,000 b p d. Essentially, those projects we viewed as optimization projects that allowed us to back out more expensive purchase feedstocks and displace it with crude. Both projects were executed flawlessly. They are on time, on budget, and they started up without a hitch, and they're running very well today. We're very proud of the fact that we had great project execution there. If you go over to the product side, we had the hydrocracker expansions at Port Arthur and at St. Charles, which are both complete. They'll increase our distillate production by 23,000 b p d.
In January of this year, our board approved a new alkylation unit at our Houston refinery, which will allow us to deal with some of the octane shortages that will result from Tier 3 implementation down the road. Of course, alkylate's a good high-value blend stock. That's a project that we believe is going to look very good. Projects under development are really intended for margin enhancement to increase our ability to produce higher valued projects, and then to provide additional feedstock flexibility. Historically, we would have talked about these projects, and I think many of you that have heard us talk before realize now that we're being very disciplined as we go through the gated capital review process. When we're comfortable that we're going to actually execute on a project, we'll provide a lot more detail on it.
We don't want to get out over our skis, and so we take a little bit more conservative approach to talking about these projects. Suffice it to say that we've got a lot of very attractive, interesting projects that are currently under development. We have a MLP, Valero Energy Partners. I mentioned earlier that Valero owns the entire 2% GP interest, all the IDRs, and we own about 67% of the outstanding common units. The assets that are in VLP today are highly integrated with Valero's refineries, and we have targeted a 25% annual distribution growth through 2017, and we've been very upfront about that. Those objectives are going to continue to be in place, and the 2017 target remains intact. If you look at what we've accomplished in the LP since the IPO, we've had a 72% increase in the cash distributions.
We've dropped $1.5 billion of assets from Valero Energy to VLP. We've accessed the public equity market successfully. Where the equity markets have been somewhat unattractive to us, we've gone ahead and used the sponsor to provide the support to finance the drop-down transactions to continue to drive the growth in VLP. It appears to us that the capital markets for the MLPs are improving significantly. Valero support going forward will still be there, but it's something that we continue to look at to see what the most optimal way to finance subsequent drops is. Anyway, the LP is an operation that continues to function very well, and we are doing exactly what we said we're going to do with it.
Just to show that we have line of sight to growth within VLP, we put this chart in, and it basically speaks to the fact that we've got $1 billion of MLP-able EBITDA, and it's broken up into these categories. Again, to achieve continued growth in VLP is something that we're not worried about. We can either do it through drop-down transactions, or we can do it through third-party transactions. Drops that we would execute would be similar to the drops that we've done in the past, which would be agreements with the sponsor that would be fee-based, provide fee-based revenue streams with minimum volume commitments and significant term. So we're not changing the nature of VLP. We also have a renewable fuels business, which I spoke about earlier.
Again, we have 11 corn-based ethanol plants that produce 85,000 bbl a day of ethanol, and we've got our Diamond Green Diesel plant, which produces renewable diesel. Both of those operations are advantaged in that the location of the ethanol plants creates an advantage. We have the same technology in most of those ethanol plants, so they're cookie cutters. So being able to apply Valero's good operating processes to it is something that we've been able to do to continue to optimize those operations. Again, it's a very good operation. The renewable diesel plant is something that we're looking at expanding. As you know, as we continue to have regulations in place that are going to drive more bio-blendings, being invested in that makes sense, and the expansion project is something that's going through our gated project review process now.
Now, the outlook for renewables is positive from where we sit today. The ethanol prices have been affected, and the ethanol margins have been affected by the low crude prices, so they've gone down hand-in-hand with that. It hasn't been as robust as it's been in the past. But as we continue to see increased demand and as the export markets for U.S.-produced ethanol continues to increase, we feel very good about that business going forward. And then renewable diesel margins continue to be pretty good. Of course, they're supported by the mandate that we have in place and then the credits that are in place. The renewables business is a pretty solid part of our portfolio. I'll conclude with this, that based on what I've shared with you, we believe Valero is an excellent investment.
If you take a look at these bar charts, you can see where we are from a return on invested capital perspective. We're very near the top of the peer group. You can see where we are on an EBITDA per barrel. We are very near the top of the peer group. Net debt to EBITDA, we are the lowest in the peer group, and then the dividend yield is well above the median within the peer group. So when you combine these four factors with the things that are listed down below, we do believe that Valero is significantly undervalued and is a great investment. Paul, that's all the prepared comments that we had. With that, we're good to take questions.
Thank you, Joe. We will take several questions here before we move to the breakout session. Any questions? There's a question over there.
Hi.
Good morning.
Could you highlight what your appetite might be for third-party acquisitions utilizing your MLP currency, and whether you would consider an acceleration of your MLP asset base akin to what Marathon did with MarkWest?
We don't have any intention of doing the type of transaction today that Marathon did with MarkWest, which would change the nature of our LP materially. Would we look at using the currency to do transactions? Absolutely. In a perfect world, we would find assets that dovetailed into Valero Energy's refineries and that we could provide the same type of financial commitment to that we do the drop-down transactions. The growth of the LP really has been something that we've looked at from Valero's perspective as if Valero can benefit from a particular project, whether it be organic or a drop, okay? Or let's just look at organic projects. If Valero can benefit from an organic growth project and it's something that they would do on their own, then we take a look at that project. We run it through part of the project development cycle.
Then we look, if we dropped it to VLP, what would be the benefit to Valero Energy if we paid VLP a 12% rate of return on that project? If we get a yes from a Valero perspective on the initial project, that creates value. If Valero Energy can pay a 12% return to VLP on a project and still create value for itself, then it's a project that's a slam dunk to us, and we go forward. The market for third-party assets has perked up a bit from an MLP perspective. We're starting to see more opportunities out there.
We thought really we have seen more in the last six to 12 months, but I think as we look at a period where you might have a more extended period of pressure on commodity prices and crude prices, I think the assets are starting to rattle free. And then it is just a matter of finding ones that are accretive. We intend to grow it. We will grow it with the drops. We will also look at third-party transactions to grow VLP. It is a quiet group this morning.
Yeah. Joe, maybe I can ask you an industry question. If we are looking at, in the past, I think management have estimated that LLS will ultimately trade roughly break even to Brent. Even though the oil production in the U.S. has been in decline, we are still quite plentiful. One may argue that we may not need the import of the light oil that much, but in the meantime that we see LLS actually trading at a premium, and certain times at $1-$2. So how the dynamic has been working? Is it a surprise to you?
Yeah. Okay. Hey, Lane. Okay, so Lane Riggs, before he ran refining, he ran crude supply. Far be it from me to usurp the guy who knows this. Do you want to take a crack at this?
Yeah. In terms of our strategic outlook, we have always made sure in terms for investment reasons, we always look to make sure that LLS and Brent were at parity because even before the oil export ban, there was always that potential that could happen. So from a strategic or project narrative, we always made sure that we could test our economics versus that. In terms of LLS selling at a discount, today on paper, actually LLS is a little bit below what we would call ICE Brent, but you have a dated structure which is a little bit below. So they are pretty close to parity these days. Interestingly enough, we are exporting WTI to our Pembroke refinery. That is the first time that has happened, and we have sort of a rational view of the market versus maybe some other people.
It's the first time that that's actually worked, and it's very close. But it does tell you, at least today, the domestic market's a little bit long versus the dated related physical cargo market. Our short-term outlook is that it'll go back and forth, and you'll have windows one way or the other. There's not structural link domestically versus a foreign alternative. There's just overall length. Over time, I wouldn't disagree. If you have a view that flat price goes back up, the oil, there is sufficient build out of all the midstream from Cushing, everything else.
Oil will flow to the Gulf Coast, and then it's just a matter of whether world wants the oil, and that'll be a function of the flat price, right? When the world wants domestic oil prices will go up, there'll be more U.S. production, and then it'll flow out. To make it work, LLS will have to be at a discount to dated by some amount, depending on world freight.
Thank you. There's a question over here.
Thanks. Just was curious about your view on sort of more the global market now with the Chinese teapot refineries ramping up exports, and Middle East capacity is increasing and so on. How do you see the role for the U.S. refineries, and particularly Valero?
Okay. No, that's a good question. The products that we produce are fungible, right? They can move anywhere on the planet, and I'm telling you the obvious there. But when we look at our situation, we look at how do we maintain our position as the most competitive operator in the business. We have significant internal focus, and being the lowest cash operating cost in the business is a material advantage to us over other people. When you look at the competitive nature of refining capacity, the components that go into it are, of course, your ability to operate well, safely, reliably, and in a cost-efficient way. When you look at advantages for refiners, you look at do you have a feedstock advantage? Do you have a natural gas advantage? Do we have plenty of feeds that we can get in?
Do we have access to fuels and feedstocks in the form of natural gas that we can use that are very cost effective? Then how's the labor pool function and so on. If you look at U.S. Gulf Coast refining, there are very few places, perhaps in the Middle East, but very few places that have the same type of advantages that we have in the U.S. Gulf Coast. The Chinese, frankly, we don't see them moving barrels into the markets that we're moving barrels in. When you think in terms of our exports, we're moving barrels to South America, into Latin America, so I would include Mexico in this, and then to Western Europe, okay? Our refineries are far more competitive than anything that you have in any of those markets. Frankly, those are the natural markets for Valero to move the barrels into.
We're not seeing it. Just as a point of reference, you probably remember back when the Reliance refineries in India started up, right? We were hearing that they were just going to beat the brains in of the U.S. refiners. Well, it hasn't happened, has it? Every quarter, I ask our guys to produce for me a financial analysis that compares a U.S. Gulf Coast produced barrel moved up the Colonial Pipeline into the New York Harbor versus a Reliance produced barrel put on a ship and moved into the New York Harbor. We look at the relative cost structures and the margins of those two barrels moving into that same market. Consistently, there is a significant advantage for the U.S. Gulf Coast produced barrel. Will they put barrels into the marketplace? They will.
If you're worried about the ability for the refining industry to absorb barrels being moved into the market, you've always got to look at who is the marginal producer. You're not going to find him in the U.S. Gulf Coast. You're going to find him in the Mediterranean. You're going to find him in Western Europe. Those are the guys that don't have the advantages that I mentioned to you before. Cheap natural gas, abundance of supply of crudes, and labor costs are much higher, and so on. Those are the guys that are marginal guys. Those are the guys that are going to have to cut first, and that are going to get squeezed. I feel very good about our position. Again, our focus is on running our operation, and we do that very well.
There's a question over here.
Good morning.
Morning. When it comes to product exports right now, do you mind just offering some commentary on Lat Am ARBs and what you're seeing there? And then same thing for distillate going to Europe, how you're seeing things there.
Lane, you—
Well, in the near term, our exports have been down a little bit just because the ARBs haven't been quite as open, so we haven't been putting as much into Europe. But we're still, I don't know, what's our last reported number? Like 240,000-ish barrels.
Yes, 260,000 bbl.
260,000 bbl of diesel and like 130,000 bbl or 140,000 bbl of gasoline. As Joe alluded to in his comments, we're always putting barrels either into Latin America or Europe. The ARB hasn't been as open here of late, but we're still obviously exporting. I'll just leave it at that.
Maybe just a quick follow-up?
Go ahead. Yell at us. We can hear you.
Yeah, just a quick follow-up. There's been some commentary that the cost of RINs is leading people to actually export product at negative ARBs. How do you think about that commentary?
Well, there's no doubt we factor in the cost of the RIN to the export. So in a way, the RIN subsidizes exports out of the United States. So the RIN goes up, your marginal As a net buyer of RINs, we include it in our alternatives, right? So we can either put it on Colonial, or as long as we have margin to run, then we can put it in the world. As that RIN price goes up, it's in our cost, and it pushes more barrels out to the world as the RIN price goes up.
Yeah. But it affects every product movement that you're looking at, right? Whether it be the exports or moving the barrels domestically. I mean, the approach that Lane described works in either case.
Well, great. Given the time, we will move to the breakout session for additional Q&A. The breakout room is Liberty 1. Thank you.
Hey, Paul is saying there isn't going to be a breakout session. We have two minutes left.
Yep.
You want to—?
Yes. Is there any final? Yeah, that's a—
Hello? I just want to ask about the California gasoline market and how you see it currently. Is it in balance, short, long? Just a bit of color from your perspective.
Yeah.
Our view is, the West Coast was obviously hurt more by the Great Recession than some of the rest of the United States, and it has recovered here in this lower flat price. I would say at the trough of the recession, the West Coast was probably long a couple of refineries, so a refinery could go down out there, and it would not matter. The West Coast is not particularly geared to export well, so it is hard to clear. Last year, one refinery was down for an extended period of time, and it left the market pretty tight, and not only did it prop the West Coast up, it propped the Gulf Coast up and really somewhat the world. It just sort of tells you, and it would get acute if there was a second refinery that went down.
I guess Valero's view is the West Coast is roughly balanced. There is always some refinery that is always going to have operating problems, so it is hard to see what that would look like. We are definitely in a, the West Coast is more at import balance than it has been since probably 2007. I am not prepared to say that it is net short. It is net short, assuming always some small or medium-sized reliability event on the West Coast.
Thank you, everyone.