Welcome to the Valero Energy Corporation Reports 2016 4th Quarter Earnings Results Conference Call. My name is Vanessa, and I will be your operator for today's call. At this time, all participants are in a listen only mode. Later, we will conduct a question and answer session. Please note that this conference is being recorded.
I will now turn the call over to Mr. John Locke, Vice President, Investor Relations. Sir, you may begin.
Good morning, and welcome to Valero Energy Corporation's Q4 2016 earnings conference call. With me today are Joe Gorder, our Chairman, President and Chief Executive Officer Mike Cyszkowski, our Executive Vice President and CFO Lane Riggs, our Executive Vice President of Refining Operations and Engineering Jay Browning, our Executive Vice President and General Counsel and several other members of Valero's senior management team. If you have not received the earnings release and would like a copy, you can find 1 on our website atvalero.com. Also attached to the earnings release are tables that provide additional financial information on our business segments. If you have any questions after reviewing these tables, please feel free to contact our Investor Relations team after the call.
I would like to direct your attention to the forward looking statement disclaimer contained in the press release. In summary, it says that statements in the press release and on this conference call that state the company's or management's expectations or predictions of the future are forward looking statements intended to be covered by the Safe Harbor provisions under federal securities laws. There are many factors that could cause actual results to differ from our expectations, including those we've described in our filings with the SEC. Now I'll turn the call over to Joe for a few opening remarks.
Thanks, John, and good morning, everyone. The 4th quarter and the full year 2016 were good for Valero as we achieved our best performance ever in the areas of personnel and process safety, plant reliability and environmental stewardship. We're very proud of our team's exceptional execution, which we believe is imperative in our business and critical during a low margin environment like we saw for most of the year. In the Q4, we continued to see good domestic demand supported by low prices and solid export volumes due primarily to demand strength in Latin America. While we saw seasonal declines in available margin in some regions, margins in the Gulf Coast region remained healthy and distillate margins in all regions were bolstered by a return to more normal weather patterns in North America and Europe.
We also saw attractive heavy sour discounts relative to Brent. A persistent headwind again this quarter was the exorbitant price of RINs. We spent $217,000,000 in the 4th quarter to meet our biofuel blending obligations. At this level, this is a significant issue for us, so we continue to work it aggressively with regulators. Our efforts are focused on moving the point of obligation because we believe this will level the playing field among refiners and retailers, but more importantly, it will improve the penetration of renewable fuels, lower RIN speculation and reduce RIN fraud.
However, based on current rules, we expect costs in 2017 to be similar to the $750,000,000 amount we incurred last year. Given the significance of this cost to our company, this issue continues to have our full attention. Turning to our refining segment, we initiated turnarounds at our Port Arthur and Ardmore refineries in the Q3. Both events carried over into and were completed in the Q4. Our employees and contractors worked hard to safely complete these events.
We believe distinctive operating performance is highly correlated to capturing more of the margin available in the market. In our ethanol business, we also ran very well and saw strong margins in the 4th quarter due to high gasoline demand in the U. S, strong pull from export markets and low corn prices. Also in the Q4, we invested over $600,000,000 to sustain and grow our business. Construction continued on our $450,000,000 Diamond Pipeline project, which we believe is on track for completion at the end of this year.
And we continue to work on our $300,000,000 Houston alkylation unit, which we expect to be mechanically complete in the first half of twenty nineteen. We also have additional growth investment opportunities under development around octane enhancement, cogeneration and feedstock flexibility. And finally, regarding cash return to stockholders, we delivered a payout ratio of 142 percent of our 2016 adjusted net income, which was 78% higher than our payout ratio for 2015 and well above our target for 2016. Further demonstrating our belief in Valero's earnings power, last week, our Board of Directors approved a 17% increase in the regular quarterly dividend to $0.70 per share or $2.80 annually. So John, with that, I'll hand the call back over to you.
Thank you, Joe. For the Q4, net income attributable to Valero stockholders was $367,000,000 or $0.81 per share compared to $298,000,000 or $0.62 per share in the Q4 of 2015. Q4 2015 adjusted net income attributable to Valero stockholders was $862,000,000 or $1.79 per share. For 2016, net income attributable to Valero stockholders was $2,300,000,000 or $4.94 per share compared to $4,000,000,000 or $7.99 per share in 2015. 2016 adjusted net income attributable to Valero stockholders was $1,700,000,000 or $3.72 per share compared to $4,600,000,000 or $9.24 per share for 2015.
Please refer to the reconciliations of actual to adjusted amounts as shown on Page 3 of the financial tables that accompany our release. Operating income for the Refining segment in the Q4 of 2016 was $715,000,000 compared to 876,000,000 dollars for the Q4 of 2015. Adjusted operating income for the Q4 of 2015 was 1,500,000,000 dollars The decline from the 2015 adjusted amount was primarily due to narrower discounts for most sweet and sour crude oils relative to Brent, weaker gasoline margins in some regions and higher RINs prices. Refining throughput volumes averaged 2,900,000 barrels per day, which was in line with the Q4 of 2015. Our refineries operated at 95% throughput capacity utilization in the Q4 of 2016 with major turnarounds at the Port Arthur and Ardmore refineries completed early in the quarter.
Refining cash operating expenses of $3.83 per barrel or $0.36 per barrel higher than the Q4 of 2015, primarily due to favorable property tax settlements and adjustments in 2015 and higher energy cost in 2016. The ethanol segment generated $126,000,000 of operating income in the Q4 of 2016 compared to a loss of $13,000,000 in the Q4 of 2015. Adjusted operating income for the Q4 of 2015 was 37,000,000 dollars The increase from the 2015 adjusted amount was due primarily to lower corn prices and higher ethanol prices. For the Q4 of 2016, general and administrative expenses excluding corporate depreciation were $208,000,000 and net interest expense was $112,000,000 Net interest expense was lower than guidance due to prepayment penalties associated with the early redemption of the 2017 notes being reflected in other income. Depreciation and amortization expense was $468,000,000 and the effective tax rate was 21% in the Q4 of 2016.
The effective tax rate was lower than expected due primarily to stronger than projected relative earnings contribution from our international operations that have lower statutory rates and other items as referenced in the release. With respect to our balance sheet at quarter end, total debt was $8,000,000,000 and cash and temporary cash investments were $4,800,000,000 of which $71,000,000 was held by VLP. Valero's debt to capitalization ratio, net of $2,000,000,000 in cash, was 23%. We had 5.6 $1,000,000,000 of available liquidity, excluding cash, of which $720,000,000 was available for only VLP. We generated $998,000,000 of cash from operating activities in the 4th quarter.
With regard to investing activities, we made $628,000,000 of capital investments, of which $244,000,000 was for turnarounds and catalysts. For 2016, we invested $2,000,000,000 which was slightly lower than guidance due to lower turnaround cost and the timing of some growth spending. And of this total, dollars 1,400,000,000 was for sustaining and $600,000,000 was for growth. Moving to financing activities. We returned $440,000,000 in cash to our stockholders in the 4th quarter, which included $271,000,000 in dividend payments and $169,000,000 for the purchase of 2,700,000 shares of Valero common stock.
For 2016, we purchased 23,300,000 shares for $1,300,000,000 and had approximately 2,500,000,000 dollars of authorization remaining. For 2017, we maintain our guidance of $2,700,000,000 for capital investments, including turnarounds, catalysts and joint venture investments. This consists of approximately $1,600,000,000 for sustaining and $1,100,000,000 for growth. For modeling our Q1 operations, we expect throughput volumes to fall within the following ranges: U. S.
Gulf Coast at 1,630,000 to 1,680,000 barrels per day U. S. Mid Continent at 415,000 to 435,000 barrels per day U. S. West Coast at 195,000 to 215,000 barrels per day, which reflects a major turnaround at the Venetia Refinery and North Atlantic at 440,000 to 460,000 barrels per day.
We expect refining cash operating expenses in the Q1 to be approximately $4.15 per barrel, which reflects projected increased natural gas prices. Our ethanol segment is expected to produce a total of 3 point 8,000,000 gallons per day in the Q1. Operating expenses should average $0.39 per gallon, which includes $0.05 per gallon for noncash costs such as depreciation and amortization. We expect G and A expenses, excluding corporate depreciation for the Q1, to be around $175,000,000 and net interest expense should be about $115,000,000 Total depreciation and amortization expense should be approximately $485,000,000 and our effective tax rate is expected to be around 30%. That concludes our opening remarks.
Before we open the call to questions, we again respectfully request that callers adhere to our protocol of limiting each turn in the Q and A to 2 questions each. This will help us ensure other callers have time to ask their questions.
And thank you. We will now begin the question and answer session. And we have our first question from Brad Heffern with RBC Capital Markets.
Good morning, everyone. Morning, Brad.
Hey, Joe. So I was wondering, obviously, a big topic of conversation has been the border adjustment tax in the space. So can you go through your thoughts on how that's going to affect feedstock costs, your ability to pass it on and maybe the likelihood that you see of that actually making it through?
Yes, you bet. We'll give you a point of view. What I'd like to do is let Jason Fraser answer that question. Jason has recently taken the position as the individual responsible for our public policy and strategic planning group. So we brought him back from London to take on this job.
And it's interesting, we put the 2 functions together, strategic planning and public policy, because in our view, you really can't bifurcate the 2 anymore. They're going to be very intertwined. So Jason, you want to go ahead and share your point of view?
Sure. Yes, I'll give you a heads up on where we are with the house tax blueprint. And we read all of you all's reports. As you know, there are greatly differing opinions on the blueprints, including the border tax border adjustment tax aspect, how it affects our industry in Valero. We're performing our own analysis as well as working through scenarios with AFPM, our trade association.
We're also engaged with the legislative process. We're at the very early stages. No legislative text has been released by the Ways and Means Committee yet. So we're not sure exactly what's going to be in it. But we're going to continue to work this issue.
Regarding the likelihood of passage, you guys know that any kind of major legislative change like this is difficult to pass. If there isn't bipartisan support, the Republicans may have to use a budget reconciliation process. We also have a new administration, which adds another variable. So it's really hard to handicap at this stage how it's likely to turn out.
Okay. Thanks for that. And then Joe or maybe Gary or Lane, the South Coast AQMD in California has talked about potentially banning the use of hydrofluoric acid. I was curious if you know what the impact would potentially be on Wilmington and maybe the chance of that
going through as well?
So Brad, it's Lane. So yes, we're engaged in the process and there's obviously a conversation around it. And I can't really share much more than that than it does impact our operations because we do have an HF unit there as long as the operator there in Torrance. And there are technologies out there. Obviously, the most straightforward one is the sulfuric acid, but there's also one of the other technology providers in the space has another solution and but we're certainly working with them in terms of how long it might take to if they choose to go down that path and how long what the phase in or at least the requirement would be, but we're very involved.
Okay. I'll leave it there. Thanks guys.
And thank you. Our next question comes from Phil Gresh with JPMorgan.
Hey, good morning.
Hi, Phil. I just wanted
to start with the return of capital. Obviously, the year ended up north of 140%. You're guiding to 75%, which is consistent with the guidance you've always said. But there's obviously a big delta between those two numbers. So I guess I'm wondering how you're thinking about that target relative to what you accomplished in 2016 and And just taking note of the fact that 4Q did step down a bit from the rest of the year on the buybacks.
Okay. Yes, Phil, this is Mike. We continue to spend our discretionary cash according to our capital allocation framework. When we look at how much we're going to buy back in a particular quarter, we do look at the net income, but we also consider cash flow. And so for the quarter or for 2016, we did pay out 142% of net income, and that equated to 51% of cash flow.
Okay. So you're suggesting we should consider cash flow as a metric as well?
Well, not suggesting that as our overall guidance, but in a lower margin environment, where net income is hit with our depreciation, we do take that into consideration when we're returning to our shareholders.
Phil, and we've talked about this before, we set the 75% target because it's easy to see And cash flow can move around, obviously, and Mike's right. Looking at net income in a low margin environment, we set an expectation, and we consider it to be kind of the floor. It's our commitment to our shareholders. To the extent we can do more, and it's the best use for the cash, we'll go ahead and continue to buy back shares. I think the move we made with the dividend this quarter clearly reflects our comfort level and our board's comfort level with the earnings capability of the company in a down market.
And so obviously, if you look at a $2.80 dividend, it's going to continue to be a more significant component of the 75% payout ratio. We're very comfortable with that. But we will continue to buy back shares and the guys will do it the way they've done in the past, some to some extent ratably and to some extent opportunistically.
Sure. Okay. That makes sense. And if I could maybe just push a little bit more on Brad's question, more from the angle if something were to happen, maybe just talk through your system, the amount of crude you import, the amount of product you export, you gave some numbers on product exports, but maybe just what changes you think you would potentially make if this were indeed implemented?
Yes. I mean, it's and I'll let Gary and Jason and Lane can we can all speak to this. But obviously, you're going to optimize your crude slate. The big question around this whole border adjustment is how are the markets going to react to it. And frankly, we've read every one of the sell side reports on this and then consulting reports, as Jason mentioned, And it's got a lot of moving parts.
Some people look at it on a static basis. Some have looked at it when you take into consideration the markets adjusting and some have taken into consideration the currency adjustment also. So right now, there's a skeleton out there that they're trying to put flesh on and we don't know exactly what it's going to look like. But I think it's fair to say that we're going to continue to optimize our operation. And if you recall, Gary, I don't remember how long ago, but we were running over 1,000,000 barrels a day of light sweet crude.
And there's been times we've run 600,000 or 700,000 barrels a day of light sweet crude. So Phil, we've got the flexibility in the system. Gary, you want to talk at all about the markets and
Yes. So if you look really over the last several years, our strategic objectives have been around flexibility and developing export markets. And so we believe that puts us in a really good position to be able to handle whatever the border tax may throw our way.
Okay, got it.
Thank you.
And thank you. Our next question comes from Neil Mehta with Goldman Sachs. Good morning, guys.
Hi, Neil.
Joe, I want to start off on the product markets here. We've seen a couple of weeks of gasoline inventory builds. I wanted to get your sense of what you think is going on there. Is there an issue with underlying gasoline demand? And how do you see it playing out from here?
Yes, it's a great question, Neil. Gary, you want to share your thoughts?
Yes, Neil. I guess, to me, when you look at the DOE numbers, it's always difficult this early in the year to tell a lot from the numbers. But certainly, when you look at gasoline demand, we're trending below last year's level. Last week, staff showed gasoline demand really at the lower end of the 5 year range. The part to me though, when you look at implied demand, which includes the exports, implied demand is actually tracking above last year's level, which is a little confusing.
It's certainly confusing to us when we look at our operations because what we've seen in our operations in the Gulf is we've had a number of weather impacts in the Gulf, primarily fog, which has hindered our ability to really load ships, which hinders our ability to do the export. So at least in our mind, the exports in the DOEs are probably overstated, which would in turn tell you that domestic demand is understated. And so I think you'll see a revision in the stats where exports will be lowered and the domestic demand raise, but we'll have to see how that plays out. Really, when you look regionally, we don't see any indication to believe that domestic demand is down. You have a few locations.
We had high levels of rain on the West Coast, which hindered our demand there. You had some instances in the upper Midwest with some ice storms, but none of that's abnormal. So I don't think we see anything that tells us demand this year is going to be dramatically different than what we saw last year.
And then so Gary, what do you make of the inventory build? Is that just a function of fog and having some issues getting the product out? Or the refining industry running too hard in response to strong cracks to end the year last year?
Yes. So I would say PADD 3 definitely is a result of fog and weather clears and you'll start to see the PADD 3 market clear. Obviously, the concern is the PADD 1 market. And our hope certainly was with less carry in the market, you would see a less of an incentive to put barrels into New York Harbor and store them for summer. And really, we've been on a similar trajectory as what we were last year.
I think the only thing that we see that's different in the market, we don't have a lot of line of sight to the barrels people are putting into tanks, but it does look to us like a lot more of the inventory this year is a winter grade gasoline, which if that's true, you should see play out is before RVP transition, people will have to liquidate those barrels and the market will get a little soft, but then you should see inventory cleanup before you get to gasoline season. To your comment, I do think part of this is obviously the utilization rates are just too high and we're producing more diesel and gasoline than the market can absorb. When you look at the Northwest Europe cracks, it looks like this week we've gone below a level where we generally start to see some run cuts in Northwest Europe. I also believe regionally, the Rocky Mountain region, the upper Midwest Chicago market, those markets are long and you'll see some run cuts there. So you combine that with turnaround activity, and I think you'll start to see inventories come back in.
That's great. And my follow-up here is for Cisco. Cisco, there are a lot of puts and takes in the quarter. Do you mind walking through the tax rate, which was a little bit lower, the interest expense guidance, which was a little bit different and some funkiness in other income?
Okay. Yes, Neil, I can do that. Okay. 1st on our tax rate, for the quarter, we were 21% versus our guidance of 31%. We had a couple of things going on there.
First, we had higher income than previously projected with most of this being in Canada and the UK, which has the lower statutory tax rate. So that was worth about 3% on the tax rate. Next, on a few of our tax audits, the statute of limitations expired. Therefore, we reversed reserves associated with these audits. And those reversals, along with a few other small adjustments, was about 7% on our tax rate.
Okay. We had a few items that we did. We chose not to identify them as special items for this earnings call, but I will walk through those. First, and you talked about 1 already, the debt prepayment penalty. We inadvertently on our last call included that penalty and interest expense.
It actually flowed through other income. That was a charge of about $42,000,000 Offsetting that, however, was kind of a unique item. It's the Canadian commercial paper recovery. Back in 2009, we wrote off that investment. Part of the deal, we exchanged our commercial paper for some notes.
And in the Q4, we received payment on those notes and that was about $50,000,000 So those 2 kind of offset each other in other income. And then lastly, we had in the 4th quarter a LIFO charge. We had a decrement and we had a LIFO charge of about 55,000,000 So we chose not to identify any of these four items as a special, but I did want to go over that. So in summary, we had 2 expense items, the debt prepayment and the LIFO charge. We had 1 income item, commercial paper recovery.
And then we had the lower tax rate. So when you net those 4 items together, that was $0.02 per share on our earnings.
That's great. Thanks a lot.
You bet.
And thank you. Thank you. Our next question comes from Doug Leggate with Bank of America Merrill Lynch.
Thanks. Good morning, everybody. Joe, one of the other, I guess, policy moving parts that has emerged in the last week or so is Keystone. And of course, OPEC, the newswire that suggests it's heavy barrels that are getting cut. So I'm just wondering what can you share with us about the dynamics of what you're seeing on the Gulf Coast specifically as it relates to how you expect the heavy differential or discount to evolve over the next uncertain period, I guess, that we have?
You bet.
Doug, this is Gary. What we've seen is we've certainly seen some impact of the OPEC cuts. Our crude allocations have been cut a little bit, primarily from Saudi Arabia and Kuwait. But we've seen minimal impact to our system from the cuts. We continue to see good availability of grades from Latin America, Canada and U.
S. Sources to replace the volumes that have been lost from OPEC. Thus far, the impact from the cuts has really been offset by lower refinery demand due to refinery turnarounds. So probably the April, May before the full impact of any cuts are seen. Directionally, we really didn't see the medium sour discounts react at all to the OPEC cuts when the cuts were announced.
You saw an increase in flat price, but the discounts really didn't change. Here over the last week, the medium sour discounts have come in a little bit, but we've actually seen heavy sour discounts move wider. PMI adjusted their K factor to make Maya a little more the discount a little wider. And I think they had to do that to compete with the Canadians. So we've seen heavy discounts actually move wider.
We always look at 3% fuel oil as kind of a leading indicator of where the discounts are going. And 3% fuel oil has actually moved from 85% of Brent last week to 82% of Brent. You see fuel inventories at Singapore that are above the 5 year high. The arb to ship fuel to Singapore is closed. So that would kind of indicate that the discounts will actually move wider.
Okay. Just on the Keystone issue, I guess I don't want to push the point too much because I realize how much uncertainty there is. But I seem to recall in the past that you guys had maybe I've got this wrong, we're talking about becoming an anchor shipper with an option to even acquire an interest on it. Have I got that wrong? Or is that back on the table?
Well, so we are our shipper, we're still a strong supporter of Keystone. We don't have the ability to actually be an owner in the line. So we're working with Trans Canada as they try to better understand the executive order and drum up customer support. Our belief is that the direct connection from the Western Canadian production to the U. S.
Gulf Coast is a good thing because we have the most efficient capacity to really process those growing areas of production. Our intent, again, would be to process those barrels in our system, not to export the barrels.
Okay. I appreciate that. If I could squeeze in the last one, because that was kind of
a follow-up, I guess. But,
Joel, your dividend and buyback policy, I realize you addressed it earlier, but I just want to ask you a question about that very quickly. It's become the MO, I guess, of your tenure as CEO, the return to shareholders. What are you thinking now in terms of the dividend yield? Because you're now sitting with, if not the highest, pretty close to the highest yield in the sector. Is that kind of a do you have a target in mind?
Do you have an idea of how that dividend growth can evolve relative to buybacks? Just what are you thinking in terms of the overall balance of 1 versus the other? And I'll leave it there. Thanks.
Yes. Thanks, Doug. The yield obviously is a function of the stock price and we can't control the stock price. What we can control is how we reward the shareholders of the company and how confident we feel about our ability to produce cash flows, free cash flows within the company. That we try to manage, right?
And we do it through the capital allocation framework that Mike mentioned earlier. The dividend and our maintenance CapEx is nondiscretionary in our minds, and it will continue to be. So making commitments to our shareholder returns through the dividend is something that we don't take lightly and we model extensively. The buybacks and the growth projects, organic capital projects and acquisitions are areas that we consider to be competing for the use of free cash flow. And we look at the timing on our project development activities.
We look at the return on our projects that Lane and his team are developing and Rich and Martin have, and we compare it to the value of buying back shares. And so we make the decisions accordingly to provide the highest returns for the shareholders. We I would tell you, I wouldn't I'd be lying to you if I told you that we look at the absolute yield and say that is what determines our decision around the dividend policy. It's more how do we feel about the cash flows that we can produce within the system.
I appreciate the answer, Joe. And I guess we'll see you in a couple of weeks. Thanks.
All
right, Doug. Thanks.
Thank you. Our next question comes from Ed Westlake with Credit Suisse.
Hi. Thanks for taking the call. It's Johannes here. I have to pinch hit today unfortunately for you all, but fortunate for me. Thank you for taking the call.
Glad you're here.
The first question, I guess, has to do with the other big policy that's not border adjustment taxes that, is being pushed aside for the moment, but still probably very important to you all and that's RINs. You mentioned it earlier up in the call. And what sort of progress are you seeing in terms of trying to move the point of obligation or engaging with the EPA as there's been a transition? I know that Scott Pruitt is not in his seat yet, but nonetheless, if you've got any sort of color on that. And then would you expect the RIN market to move before any sort of policy change once there is some sort of clarity on which direction it's going?
Or are you modeling out for 2017 the higher RIN expense because you don't think the market is going to move?
Okay. Fair enough. Jason, you want to take a crack at our RIN?
Sure. Yes, I can talk about the
point of obligation effort and then maybe somebody else can speak to the RIN price. Okay. Yes, the comment deadline on our petition to change the point of obligation is February 22. So that period is still open and there's still comments being generated. We firmly believe that once all the evidence is reviewed, the EPA is going to agree to change the point of obligation.
Regarding the introduction of the process of Attorney General Pruitt as EPA administrator, which has been some discussion about that as whether that will change the dynamic. In his confirmation hearing, he said he would administer the RFS in accordance with Congress's statutory objectives. He would make his decision based on the evidence in their administrative record. And it all sounds great to us. That's all we would ever ask for.
So we think that after hearing all the arguments and reviewing the facts and what's in the record and consulting with his staff that they're going agree that it should be moved. So we don't really see anything changed due to this changeover of administrators.
And then on the actual RIN price and the trading price?
Yes. So our view is certainly you would see a reaction in the market if this gets done and you'd see rents come off. We've seen some market reaction already. It's difficult for us to model because of all the uncertainty around this.
But yes, I guess, Gary, we started the year like $0.95 per RIN and now it's like at 0.50 dollars So we've made the point all along that this is a market that we believe is ripe for manipulation. And the fact that you've had this movement in it, it sure isn't based on fundamentals.
Sounds good. So hopefully there will be some movement. Okay. The other question I have, I guess, has to do with California margin weakness. Clearly, the margin environment in California has come off quite a bit over the last 6 months.
Do you see an underlying reason for that? What the big driver is? Is there a difference in the way the market is clearing? Is it just that torrents has come back online? Is there some sort of dynamic, whether it be weather or something else in terms of EMT that you would like to cite?
Kind of just curious as to what's going on out there from your eyes on an operational basis.
Well, I certainly think Torrance coming back online has impacted the market. Here in the Prom market, as I mentioned, we saw some weaker demand with rain on the West Coast. But overall, L. A. Is moving to summer grade spec today, which you pull butane out of the pool, which directionally tightens it.
And then next month, the Bay will go to summer grade tightens it. And then next month, the bay will go to summer grade gasoline. So all those things should directionally help demand and bring supply and demand back into balance.
Okay. So you don't see any sort of a grinding issue there? No. Okay, perfect. Thank you very much for taking the call.
And thank you. Our next question comes from Paul Cheng with Barclays.
Hey, guys. Good morning.
Good morning, Paul.
I have to apologize. First, I joined Lei. So you have my question, you already adjust, just let me know I will take it offline. Two questions if I may. First, if I looking at the contango curve, the current structure seems to suggest that you want to build inventory because that May June margin was very high for gasoline.
On the other hand, the stock is high right now. So just curious that internally for Valerio, how you guys contemplate on those diverging forces? And when you plan your 1, how you go through the process?
Yes. So Paul, for us, most of our tankage is more operational in nature. And so we don't do a lot of storage plays to take advantage of the market structure. We do some of it, especially on the crude side, but it's more related to buying opportunistic barrels that we believe had wide discounts and then you can also take advantage of the market structure. But overall, we don't do a lot of that.
But I mean with the inventory physical asset availability is there or that you don't physical asset availability is there or that you don't really do that? You were just because of the game theory that if you slow down other people, it's going to take up the snack anyway. So you're just going to max out your production even end up that you may build inventory yourself?
Yes. I think to me the key on the inventory build is that what we're seeing out in the market is a lot of winter grade gasoline. And so our view is that those barrels are going to have to clear before we have RVP transition. And as those barrels clear, it will bring the market down and you will see economic run cuts and lower utilization while those barrels clear before you actually get into summer driving season.
Yes. But Gary, you're not suggesting that it's Valero that's going to make the run cuts.
No, that's right.
I mean, Paul, we're the lowest cash operating cost guys in the business, and we don't have any strong interest in balancing the market Looking
at the margin capture rate, system wide, it's Looking at the margin capture rate, system wide in the Q4 is about 56%, 57%, which is 6% lower than the 3rd quarter and 21% lower from the year ago level. And if you're looking at your last 5 year average, it's about 65%, 66% and this year is about 60%. Just curious that is that just because of the rising oil price or what is there anything that you can see structurally whether it's in your system or that in the market new condition to make you believe this year, the 60% margin capture rate is what the future may look like or that this is really more of an one off certain items impacting that?
Yes, Paul, this is Gary. I'll take it. Mike started the call with some comments that we took a LIFO charge in the Q4 of 2016. Really that LIFO charge explains the Q3 to Q4 variance that you talked about. It also explains a portion of the Q4 2015 versus Q4 2016 results.
In addition to that, we had a couple other items. There's really nothing operational that I see, but the other big things that affect the year over year results. In 2015, the blenders tax credit was enacted in December of 2015. And so all of the credit was booked in the Q4 of 2015, 2015, whereas in 2016, that blenders tax credit was kind of spread out through the year. So that had an impact on the capture rates.
And the other big thing that we're looking at in terms of the capture rates is just the cost of the RINs. So in the Q4 of 2015, RINs were around $0.49 whereas the Q4 of 2016, they were $0.96 And so that delta in the cost of RINs also impacts our capture rates.
Gary, I mean, you certainly explained for the quarter. And for the year, RIN topic is part of the explanation. But for the full year of 60%, capture rate also seems quite low compared to the last several years what you have been able to achieve.
Yes. We can dive into it more with John, I would suggest. But those are really the big items that we see. We don't really see anything operational, Paul.
Okay. Thank you.
And our next question comes from Roger Read with Wells Fargo.
Yes. Hey, thanks. Good morning, guys. Good morning, Roger. I'll leave some of the policy to the side for now.
But I guess specific question for you. Exports have been a huge part of on the product side, 2016 it looks like a good start to 2017. Pemex is out saying they intend to run a lot better in 2017 than 2016. That's their forecast. I mean, we'll see what turns out to be true.
But could you characterize maybe the incremental growth in exports for you as to where that's gone? And if Pemex were to run better in 2017, is that a risk we need to be concerned about? Or are there enough other growth areas internationally?
Yes. Roger, it's hard to tell. As Lane can tell you, it takes a long time to improve refinery mechanical availability. So we'll see what happens there. But I think one of the things that we're looking at, we export to Mexico and to South America.
And certainly, when you look at a lot of the consultant views where Brazil has had negative demand growth over the last couple of years, we're forecasting some decent demand growth in Brazil. So even if we were to lose some volume into Mexico, I think it could be absorbed in other locations in South America.
Okay. And then second question, M and A, I know with some of the policy uncertainty, maybe sellers don't want to sell and buyers want to be a little questionable. But I was wondering Joe as you kind of think about the longer plan here Lyondell pulled their unit off the market but maybe some of the other opportunities that exist out there right now?
Yes. Mike, you want to speak to this?
Well, yes, Lyondell did pull their refinery back for now. Other than a few things on the West Coast, there are no opportunities really for the refining space presently.
Well, that was brief. And I heard that Lane was a miracle worker. So maybe we could get him to work for Pemex that will fix him.
No, we don't want to do that.
But Roger, you're right. I mean, but Mike what Mike said is exactly right. And it was characterized earlier. The Lyondell Refinery is a nice opportunity, but they chose not to sell it. And we're just not seeing a lot of refining assets that are for sale that would add any value to Valero's portfolio.
So from an acquisition perspective, what do you focus on? You focus on the opportunities in logistics and other areas where you can improve the earnings capability of the company by improving your logistics, your feeds in, your products out and then potentially upgrading your stream. So we're not in a position. We don't believe we're in a position where we've got to go do a deal to balance out our portfolio. We look at this a little differently and that we continue to seek ways to try to improve the quality of the portfolio we've got in place.
Okay, great. Thank you.
In order to get to every question, we please ask that you limit yourself to one question moving forward and we thank you for your understanding in this matter. And our next question comes from Chi Chiao with Tudor, Pickering, Holt.
Thanks. Good morning. Mike, do you have the cash balance held by the company's international subsidiaries as of year end 2016? We've noticed that balance has been steadily growing over the last couple of years. And I was just wondering if you could also talk about whether, one, that cash is available for use for domestic CapEx and capital returns to shareholders 2, what are their are there any repatriation inefficiencies in the current tax structure?
And then 3rd, how does some of the tax policy changes proposed under the new administration impact the repatriation of that cash going forward?
Okay. Roughly at the end of the year, we had about $2,000,000,000 of cash that was in the UK and in Canada. So
presently
Okay. Our current structure that we have today would allow us to move most of the cash back to the U. S. Without incurring a significant tax penalty. We haven't needed to do that presently given where our U.
S. Cash balance is as well.
Do you feel any
That was an incredibly clever way to ask 3 questions.
It's all related, right?
Yes, we thought it was. That was good.
Well, do you feel the need, any urgency to get that cash back given the potential changes in the repatriation policies going forward here?
The need to get it back, I don't think we have a sense of need to get it back. Would it be nice to have access to it and Jason and the team are looking at the repatriation implications of the border tax adjustment. You always want to have your cash totally accessible to you. So it'd be great to get it back. But I would tell you that this let's just assume that we're able to bring it back and bring it back in good shape.
The question is then what do you do with it? Do you reinvest it in the business? I don't see us changing our approach to capital if we had the cash back, okay? I mean, I don't think Lane is going to say, gee whiz, now I can do a whole bunch more because we're not holding back on things that we're doing today. So it'd be wonderful to have access to it without paying any tax on it.
That's not likely, but I don't think it changes anything we're doing, Chi.
Okay, great. I'll leave it there. Thanks, Joe. Appreciate it.
And thank you. Our next question comes from Spiro Dounis with UBS Securities.
Hey, good morning, Thanks for squeezing us in here. Just wanted to follow-up on the RFS without getting into what does it look like and then when does it change, just thinking about, I guess, an environment where the point of obligation has actually moved away from the refiners. Just curious in terms of reaction or just change in behavior on your part, maybe the refining industry in general, what are some of the things you think happens, I guess, on day 1 without the point of obligation? I think one thing we think about maybe is that exports actually go down because of course that's a good way to avoid the RIN. Just curious if you're thinking about anything else in terms of changes in product mix?
Gary, you want to?
Yes, I don't know that to some degree, the export market has over time recognized the RIN. So I don't really know that it really changes the dynamics of the export market that much if the point of obligation moves.
Yes. I mean, we've all adjusted to this. The really the frustrating thing from our perspective is the negative effect it has by shifting the value of doing business from us to the guy who's capturing the RIN. And so obviously, it would be beneficial to Valero if the point of obligation moved, which would reduce our burden. And frankly, we believe it would take a lot of the speculation and the manipulation opportunities out of that RIN market and it should lower the price of RINs.
Now the RBOs will have a factor on that and so on, but from a refiner, from an independent refiner's perspective, it will be positive.
Our next question is from Jeff Dietrich with Simmons.
Good morning.
Hi, Jeff.
I'm sitting here in Houston looking out my back window and the fog has cleared in the Houston Ship Channel. So hopefully that's good news.
That is good news. Yes. Do you see our ships loading, Jeff?
They're going out one right after another. I had a question on your pace of MLP drops and there are a few things going on, one of your peers accelerating. There's also the potential for lower corporate and individual tax rates under a Trump administration, potential for higher interest rates. How do these things impact your thinking on MLP valuations and the attractiveness of drop downs.
Okay. Rich, you want to? Yes.
I'll take a crack at the our peers accelerating. So we've been pretty consistent in the execution of our strategy from the IPO that we're going to take a very measured pace. We believe that that's more of a prudent to our prudent to have a measured pace on our drop downs. Valero has exceeded their targeted total payout ratio for the past 2 years. VLP doesn't really need to do any acquisitions or drop downs to meet our distribution growth.
There's not a need for the cash as we've kind of talked about the cash balance at Valero. So we are just going to stick to our measured approach of growing, focusing on growing the distributions. We've been clear that we're growing distributions in 2017 at 25% and at least 20% in 2018. So it's really the focus is on the distribution growth at the LP and we've got the coverage to achieve this and without doing any drops.
And then Jeff, the tail on that was the tax interest rate changes? I mean the lower
corporate tax rate, if that's what gets put in place, obviously would make the corporation a little more attractive. However, the MLP will still have the tax advantage structure versus
the corporation. And interest rates, I mean, it just it provides an investor a different option, right? But you still have the benefits of everything that you have today with an MLP ownership position.
Thank you. Our next question is from Ryan Todd with Deutsche Bank.
Hey, thanks. You may have touched on parts of this over the course of the call, and I apologize that I missed some of it. But can you talk through what you see as some of the similarities and differences as we look at the macro environment versus last year at this time? And margins are a little bit better, but we've seen some pretty significant inventory builds over the last 4 weeks again. I mean, what are some of the lingering challenges that are maybe similar to last year?
And what's different this year that gives you confidence that we won't just repeat the 2016 environment again?
Yes, this is Gary. I think the similarities, we continue to see the industry running at high utilization rates And so the production of gasoline and distillate is exceeding demand in the marketplace, which isn't good causing inventories to build. The difference we see is it looks like on the gasoline side, a lot of what's being put into inventory is winter grade. So again, our view is this will have to clear before RVP transition could bring inventories down before gasoline season starts, which would make this year a little different than what we saw last year and should lead to better gasoline cracks. On the distillate side, not too much different.
I think the things that we're seeing on the distillate side is slightly better demand. So year over year, we've had a little colder weather here in the U. S. And also in Northwest Europe, which aids distillate demand. And then as we see some resurgence in the upstream, the drilling activity, it also leads to a little better incremental diesel demand.
So those are kind of the key factors we're looking at the market.
And Ryan, we don't know enough yet about the infrastructure projects that are being talked about at the federal level right now, what the implication to those are. But anytime you get projects like that taking place, they tend to drive distillate demand. Of course, it would drive gasoline demand also. But then there's the other things, petrochemical feeds, asphalt, things like that. So we're actually encouraged by the outlook and by the focus on the infrastructure within the U.
S. So we'll just see how it all plays out.
So I guess at a high level, it's safe to say, is your view on 'seventeen that it's still a little bit better than 2016, but we'll wait and see.
Yes, I think definitely we see the gasoline market being similar to 2016, but a slightly better diesel market than 2016.
Okay. Thank you.
Thank you. Our next question comes from Blake Fernandez with Howard Weil.
I'm not sure I'm as good as Chi, but I'm going
to do my best to
get at least 2 in for 1 here. Questions on pipelines, I know you talked about Keystone, but I'm curious for 1, do you have a sense of what the current transport cost is in the market and where that might go to once the pipes in the ground? And then secondly on DAPL, can you think of any direct or maybe indirect positive impacts that may have, whether it's just additional crude, light sweet on the Gulf Coast? Thanks.
Yes. We that's some of the things that we're working with TransCanada on. So we don't really have guidance of where the Keystone XL tariff is going to be, and that's certainly something that we're working with them on. In terms of DAPL, yes, I think you kind of hit on it. It definitely will be bringing more light sweet to the Gulf Coast, which should be good for us.
Good deal. Thank you.
Thank you. Our next question comes from Faisal Khan with Citigroup.
Hi, good morning. It's Faisal for Citi. Thanks for squeezing me in here. Just going back to XL for a second and back to, I think, Doug's question. Have you guys talked to them about taking an equity interest in the pipeline?
I mean, now that you have the sort of MLP up and running, it might make sense for them to have an equity partner with their anchor shipper?
You should Fazil, you should never ask us that question when you got a guy who is responsible for the MLP in the room. But to answer your question, honestly, no. We haven't talked about an equity stake in Keystone.
Only because it might make sense for them to syndicate out some
of that risk, given how large the pipeline is. But I'm not sure if that's made
That may be true, buddy, but that doesn't mean that we'd be the guy.
As always the
price. That's right.
All right. Thanks guys.
You bet.
And thank you. Our next question comes from Craig Shere with Tuohy Brothers.
Good morning. Thanks for squeezing me in.
Sure, Craig.
Quick follow-up on Phil and Doug's questions about capital deployment and buyback questions. It seems that the buybacks were kind of turbocharged a little bit in 2016 when shares were more in the mid-fifty area versus in the $60 plus area. As you think about flexing buyback metrics from earnings to cash flow in a low margin environment, How does the share price itself factor into your analysis?
Mike, you want to?
Well, I mean, we don't have specific seasonal targets for our buybacks. It's on an annual basis, it's at least 75% of net income. And our program does consist of both somewhat ratable purchases, but also opportunistic purchases too. So we just evaluate when we want to accelerate that depending on the stock price.
Is it fair to say that the mid-fifty dollars area is a kind of a turbocharge area for you?
We couldn't answer that question. But and I think Mike answered it properly. It's we sure don't want to signal our timing on our buying, but we look at what we view to be the earnings capability of this company. And if the returns on the buyback buy back shares. And we've said for years that we're not going to then we're going to buy back shares.
And we said for years that we're not going to hoard cash. So to the extent that we produce free cash flow, we'll continue to look at the buybacks.
Fair enough. Thank you.
And thank you. Our next question comes from Paul Sankey with Wolfe Research.
Hi, guys. Good morning. Forgive me if this has been off. How long
have you been?
On the Exxon call. Let's be honest. Now they made me wait till the end. But I mean, it's further to an earlier comment about the Houston Ship Canal. The good news for you from New York is that it's snowing very heavily here.
So there should be a bit more gas oil demand, I guess. Guys, I'm sorry if you've asked this answered this already, but what's the latest view on the border adjusted tax? And what are you doing? I guess you have to at some level plan for the potential for that to happen. What would you do if it did occur?
So I guess the question is, what's your understanding of the likelihood that it happens? And what would be your response to
it if it did? Thanks. Okay. Yes, Jason did talk to that earlier. You just want to give them the likelihood and then we can talk Gary or we can talk about the other component of that question.
Yes. We really at this stage, we hadn't put a handicap on the likelihood yet. It's so early. We don't even have any draft of legislative text floating around the committee. So we don't feel it's proper for us to try to guesstimate that now.
Yes.
And then Gary, on the as far as Paul, it comes down to how are the markets going to react to this, right? And we've read all of the reports and we've read the consultants report, something is going to be really good for refining, something that may not be as good for refining. And we talked earlier about the fact that we can adjust the crude slate. But Gary, the markets are going to react.
Yes. So everything we've been doing is to increase feedstock flexibility and also be able to grow these export markets and both those things should align well with this and we can optimize the system around the border tax.
Yes, I guess the punch line kind of goes back to 2010 to 2014 when we were trying to maximize product use of U. S. Light sweets. Where did you end up on all that? How much more could you use at the end of the process?
And do you have any numbers to illustrate the flexibility?
Yes. So if you look in our IR presentation, I think it's Slide 9, it does a pretty good job of going through how we can swing our system between individual grades. We got to where we were processing over 1,000,000 barrels a day of domestic light sweet crude. I guess that was pretty tougher, so it wasn't. It was pretty tougher.
So we've added some additional capacity since that time as well.
Yes. And the interesting thing was that I guess, at Port Arthur, you were able to increase overall run rates, throughput rates because we were running the lighter slate. So Paul, we'll be able to flex the system to deal with it. I guess the question is how to how do the global crude markets respond to the duty? Do they price to continue to push their barrels into the market?
Or do they find a different home? And I think Gary has made the comment in several of the meetings that we've had that the natural home for a lot of the heavy sour crudes tends to be the U. S. Gulf Coast refining system. And so I don't know that, that changes in any material way.
Yes. No, absolutely. And I guess the other question is we would assume that the gasoline price of the pump would go up pretty much by the amount of the tax in the short
term? Look, that is certainly what we have read also, okay. And I think your friends at Goldman did a report here recently that I haven't gotten to study, but it thought, okay, maybe they move up and then they move back down as the markets adjust to it. So Paul, the interesting thing is because this is kind of the topic du jour, right? But none of us they've got the skeleton out there and the house seems very committed to this today, but they don't have the flesh on the bones.
There's a lot of conversations that are taking place around, do you have carve outs, don't you have carve outs and so on. I think what I've encouraged our investor base to do is just to let's be patient, not overreact to this and let's just see how it shakes out. We will adjust to maximize the value to the company. But I don't think anybody knows enough yet to really understand what the full implications are. And then when we have seen changes like this, the markets tend to respond.
So here again, we don't have great deal of concern and consternation around this right now. We're just trying to understand it better.
Yes, I totally understand Jeff. Thank you very much.
You bet.
And thank you. This concludes the question and answer session. I will now turn the call back over to Mr. John Locke for closing remarks.
Okay. Well, thanks everybody. We appreciate you joining us today. Please contact me after the call if you have any additional questions. Thanks.
And thank you. Ladies and gentlemen, this concludes today's conference. We thank you for participating and you may now disconnect.