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TSO > SEC Filings for TSO > Form 10-Q on 3-May-2012All Recent SEC Filings

Show all filings for TESORO CORP /NEW/

Form 10-Q for TESORO CORP /NEW/


3-May-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See "Important Information Regarding Forward-Looking Statements" on page 49 for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. This section should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2011.

BUSINESS STRATEGY AND OVERVIEW

Strategy and Goals

Our vision is to be the premier low-cost supplier of transportation fuels in the refining and marketing business within our markets, providing value for our customers while delivering industry leading returns for our shareholders and conducting ourselves responsibly in the communities in which we operate. To achieve these goals we are pursuing the following strategic priorities:

improve operational efficiency and effectiveness by focusing on safety and reliability, system improvements and cost leadership;

drive commercial excellence by strengthening our supply and trading activities to provide additional value to the business;

strengthen our financial position by exercising capital discipline and focusing on improving our liquidity; and

capture value-driven growth through a focus on our logistics assets and growing our marketing business.

Our goals were focused on these strategic priorities and we accomplished the following in the first quarter of 2012:

                                                      Operational                        Value
                                                     Efficiency &  Commercial Financial  Driven
                                                     Effectiveness Excellence Discipline Growth
Decreased manufacturing costs per barrel by
approximately 5% compared to the first quarter of          l
2011
Leveraged our logistics operations to strategically
source advantaged crude and provide market                             l
optionality for the sale of refined products
Completed planned turnaround activity at our
Martinez refinery and made significant progress on         l                               l
our large capital refinery projects
Began to purchase shares of common stock to offset
the dilutive effects of new stock-based compensation                              l
awards granted in 2012
Amended the TLLP Revolving Credit Facility and
increased the capacity up to $300 million to support                              l        l
logistics growth
Strengthened refining and marketing integration with
the successful acquisition of 49 retail stations                                           l
during the first quarter


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Tesoro Logistics LP
As part of our business strategy, we formed Tesoro Logistics LP ("TLLP") to own, operate, develop and acquire logistics assets to gather crude oil and distribute, transport and store crude oil and refined products. Tesoro Logistics GP, LLC ("TLGP"), a 100% consolidated subsidiary, serves as the general partner of TLLP. As of March 31, 2012, TLLP's assets consist of a crude oil gathering system in the Bakken Shale/Williston Basin area, eight refined products terminals in the western United States, a crude oil and refined products storage facility and five related short-haul pipelines in Utah. We held an approximate 52% interest in TLLP, including the interest of the general partner, as of March 31, 2012.
Effective April 1, 2012, we contributed the Martinez Crude Oil Marine Terminal to TLLP for total consideration of $75 million, consisting of $67.5 million of cash and $7.5 million of TLLP equity. The terminal consists of a single-berth dock, five crude oil storage tanks with a combined storage capacity of 425,000 barrels, two firewater tanks with 48,000 barrels of shell capacity and related pipelines that receive crude oil from third-party marine vessels for delivery to our Martinez refinery and a third-party terminal. Total throughput capacity for the terminal is estimated to be approximately 145,000 barrels per day ("Mbpd").

TLLP amended its senior secured revolving credit agreement ("TLLP Revolving Credit Facility") effective March 30, 2012. Concurrent with the execution of the amendment, and pursuant to the terms of the original agreement, TLLP exercised its option to increase the total loan availability under the TLLP Credit Agreement from $150 million to an aggregate of $300 million. The amendment allows TLLP to request that the availability be increased up to an aggregate of $450 million, subject to receiving increased commitments from the lenders, compared to the original agreement which allowed an aggregate capacity of $300 million. On April 2, 2012, TLLP borrowed and distributed to us $67.5 million from the TLLP Revolving Credit Facility, for the contribution of the Martinez Crude Oil Marine Terminal discussed above. The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP, and is guaranteed by all of TLLP's subsidiaries and secured by substantially all of TLLP's assets. For additional information regarding our credit facilities, see "Capital Resources and Liquidity."

Labor Negotiations

The collective bargaining agreements for hourly represented employees located at six of our seven refineries expired in 2012. We have been engaged in negotiations with the United Steelworkers ("USW") local representatives at our Anacortes, Washington; Kapolei, Hawaii; Mandan, North Dakota; Martinez, California; Los Angeles, California and Salt Lake City, Utah refineries. Negotiations resulted in ratification of the three-year contracts at our Kapolei, Hawaii and Salt Lake City, Utah refineries. We are continuing negotiations with hourly represented employees at our Anacortes, Washington; Mandan, North Dakota; Martinez, California and Los Angeles, California refineries. We have offered contract terms, consistent with the terms of the national pattern agreement already accepted by the refining industry and the international USW at three locations covering approximately 800 employees. We believe that our offers at these refineries are fair, competitive and consistent with other national agreements accepted by the USW. Negotiations with the USW local representatives at our Los Angeles, California refinery are at an earlier stage of the process since the agreement, which covers approximately 250 employees, expired on April 30, 2012.

We continue to bargain in good faith at all remaining locations and work toward ratification of these agreements; however, there is no assurance an agreement will be reached without a strike, work stoppage or other labor action at any of these locations. In the event of a work stoppage, we plan to safely operate our refineries at Anacortes, Washington; Mandan, North Dakota and Los Angeles, California. We initially plan to operate our Martinez, California refinery as a product terminal, allowing us to meet customer commitments while we begin training to return the refinery to production. Any prolonged strike, work stoppage or other labor action at any of these locations could have an adverse effect on our financial condition or results of operations.


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Industry Overview

Our profitability is heavily influenced by the cost of crude oil and the aggregate value of the products we make from that crude oil and is affected by changes in economic conditions. Product values and crude oil costs are set by the market and are outside of the control of independent refiners.

West Coast Average Key Commodity Prices and Differentials
(Dollars per barrel)

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Crude Oil and Product Price Analysis

Persistent moderate to high unemployment in the U.S. and high retail gasoline prices continue to suppress demand. Global concerns, including the on-going European debt crisis and heightened tensions in the Middle East contributed to market volatility during the first quarter of 2012. The nationwide unemployment rate fell by 0.3% over the course of the first quarter of 2012. In California, a key market area for Tesoro, the state's unemployment rate was 11.0% at the end of the quarter, down from 11.9% in the 2011 first quarter.

Global product demand growth continues to be driven largely by emerging markets as Asia and Latin America continue to show stronger growth than developed countries. This strong growth rate combined with refinery reliability issues in those emerging markets, primarily in Latin America, have provided an export opportunity for U.S. light products, particularly diesel exports. Exports to these markets continue to provide an outlet for U.S. refining capacity, which has supported margins during this time.

During the first quarter of 2012, seasonal declines in demand were offset by lower refinery production due to refinery turnarounds and downtime. Average U.S. West Coast benchmark diesel fuel margins remained relatively flat compared to the fourth quarter of 2011. Increased diesel exports to foreign countries have driven refiners to shift production capacity to capture these opportunities. The resulting increase in inventories, coupled with seasonally low domestic demand kept diesel fuel margins in line with the fourth quarter of 2011. However, U.S. West Coast benchmark gasoline margins more than doubled to almost $14 per barrel compared to $6 per barrel in the fourth quarter of 2011. West Coast refiners also benefited from lower prices for heavy California crude oils relative to the fourth quarter of 2011, as discounts relative to Brent crude oil ("Brent") increased to about $8 per barrel.


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Mid-Continent Average Key Commodity Prices and Differentials
(Dollars per barrel)

[[Image Removed]]
The price differential between Mid-Continent crudes and waterborne crudes rebounded during the first quarter of 2012, contributing to strong refining margins in the Mid-Continent region. The West Texas Intermediate ("WTI") to Brent differential widened to nearly $19 per barrel at the end of the first quarter of 2012, compared to only $8 per barrel at the end of December 2011. During the first quarter of 2012, we began to base the pricing of a portion of our waterborne crude oil purchases off of Brent. Also contributing to strong refining margins in the Mid-Continent and Pacific Northwest regions, were advantaged price differentials for Bakken and Canadian crudes in the first quarter of 2012. The Bakken to WTI differential widened to $12 per barrel at the end of the first quarter, compared to $3 per barrel at the end of December 2011. Our North Dakota refinery currently runs 100% Bakken crude oil. The Canadian Light Sweet to WTI differential widened to $11 per barrel at the end of the first quarter, compared to $4 per barrel at the end of December 2011. Our Washington refinery runs a significant amount of Canadian Light Sweet crude oil.

Outlook

Volatility in commodity prices, disruptions to supply chains and general uncertainty has impacted businesses across the globe, slowing the recovery in both mature and emerging markets. It is to be expected that commodity price volatility will continue to remain high. In the outlook for 2012, demand for oil is expected to weaken slightly because of slower economic growth in developed countries, offset by increased energy needs of developing countries, as well as the restocking of inventories in anticipation of summer driving months. Although political turmoil has eased in the Middle East and North Africa, there remains the possibility that oil supplies from one or more countries could be disrupted as mounting tensions with Iran could yield a sharp increase in prices.

In addition to current market conditions, there are long-term factors that may impact the supply and demand of refined products in the U.S. including:

world crude oil prices;

increased federal fuel efficiency standards for motor vehicles;

increased volumes of renewable fuels, mandated by the federal Clean Air Act;

various regulations of greenhouse gas emissions from stationary and mobile sources by the U.S. Environmental Protection Agency ("EPA") pursuant to the Federal Clean Air Act and California statute;

potential enactment of federal climate change legislation; and

possible promulgation of national regulations relative to gasoline composition and ozone standards under the federal Clean Air Act.


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RESULTS OF OPERATIONS - THREE MONTHS ENDED MARCH 31, 2012, COMPARED WITH THREE MONTHS ENDED MARCH 31, 2011

A discussion and analysis of the factors contributing to our results of operations is presented below. The accompanying condensed consolidated financial statements, together with the following information, are intended to provide investors with a reasonable basis for assessing our historical operations, but should not serve as the only criteria for predicting our future performance. Revenue and income generated by TLLP was not significant to our consolidated results of operations.

Summary

Our net earnings were $56 million ($0.39 per diluted share) for the three months ended March 31, 2012 ("2012 Quarter"), compared with net earnings of $107 million ($0.74 per diluted share) for the three months ended March 31, 2011 ("2011 Quarter"). The decrease in net earnings of $0.35 per diluted share during the 2012 Quarter was primarily due to the following:

lower throughputs and gross refining margins in the California region as a result of a major planned turnaround at our Martinez refinery; and

lower industry margins in California as a result of increased crude oil prices relative to refined product prices.

The decrease in net earnings during the 2012 Quarter relative to the 2011 Quarter was partially offset by the following:

strong gross refining margins in the Mid-Continent and Pacific Northwest regions driven by feedstock advantages from local crude discounts and increased throughputs;

higher throughputs in the Mid-Continent and Pacific Northwest regions; and

a $30 million decrease in incentive and stock-based compensation expense, primarily resulting from less significant increases in Tesoro stock prices during the 2012 Quarter as compared to the 2011 Quarter.


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Refining Segment
                                                                        Three Months Ended
                                                                            March 31,
                                                                  2012                       2011
                                                         (Dollars in millions except per barrel amounts)
Revenues
Refined products (a)                                     $          7,562            $            6,270
Crude oil resales and other (b)                                       156                           155
Total Revenues                                           $          7,718            $            6,425
Throughput (thousand barrels per day)
Heavy crude (c)                                                       142                           186
Light crude                                                           358                           338
Other feedstocks                                                       29                            37
Total Throughput                                                      529                           561
% Heavy Crude Oil of Total Refining Throughput (c)                     27 %                          33 %
Yield (thousand barrels per day)
Gasoline and gasoline blendstocks                                     253                           289
Jet fuel                                                               83                            79
Diesel fuel                                                           105                           126
Heavy oils, residual products, internally produced fuel
and other                                                             114                           100
Total Yield                                                           555                           594
Gross refining margin ($/throughput barrel) (d)          $          12.15            $            14.33
Manufacturing Cost before Depreciation and Amortization
Expense ($/throughput barrel) (d)                        $           4.97            $             5.22


________________


(a) Refined products sales includes intersegment sales to our retail segment at prices, which approximate market of $1.3 billion and $1.1 billion for the three months ended March 31, 2012 and 2011.

(b) Crude oil resales and other includes third-party revenues earned by TLLP. Consolidated revenues for the refining segment include $1 million from TLLP for the three months ended March 31, 2012, and $1 million from TLLP's predecessor for the three months ended March 31, 2011. Amounts recorded for TLLP are included in our regional refining operating data.

(c) We define heavy crude oil as crude oil with an American Petroleum Institute gravity of 24 degrees or less. The decrease in heavy crude oil throughput and heavy crude oil as a percentage of total refining throughput during the three months ended March 31, 2012, was primarily a result of the turnaround at the Martinez refinery which runs a high proportion of heavy crude oil.

(d) Management uses gross refining margin per barrel to evaluate performance and compare profitability to other companies in the industry. There are a variety of ways to calculate gross refining margin per barrel; different companies may calculate it in different ways. We calculate gross refining margin per barrel by dividing gross refining margin (revenues less costs of feedstocks, purchased refined products, transportation and distribution) by total refining throughput. Management uses manufacturing costs per barrel to evaluate the efficiency of refining operations. There are a variety of ways to calculate manufacturing costs per barrel; different companies may calculate it in different ways. We calculate manufacturing costs per barrel by dividing manufacturing costs by total refining throughput. Investors and analysts use these financial measures to help analyze and compare companies in the industry on the basis of operating performance. These financial measures should not be considered alternatives to segment operating income, revenues, costs of sales and operating expenses or any other measure of financial performance presented in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP").


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Refining Segment
                                                                 Three Months Ended
                                                                     March 31,
                                                                2012              2011
                                                          (Dollars in millions except per
                                                                  barrel amounts)
Segment Operating Income
Gross refining margin (e)                                $            585     $       724
Expenses
Manufacturing costs                                                   239             264
Other operating expenses                                               52              56
Selling, general and administrative expenses                            9               8
Depreciation and amortization expense (f)                              91              91
Loss on asset disposals and impairments                                 3               2
Segment Operating Income                                 $            191     $       303
Refined Product Sales (thousand barrels per day) (g)
Gasoline and gasoline blendstocks                                     342             325
Jet fuel                                                               94              86
Diesel fuel                                                           131             130
Heavy oils, residual products and other                                90              74
Total Refined Product Sales                                           657             615
Refined Product Sales Margin ($/barrel) (g)
Average sales price                                      $         127.11     $    113.33
Average costs of sales                                             117.75           99.98
Refined Product Sales Margin                             $           9.36     $     13.35


_______________


(e) Consolidated gross refining margin combines gross refining margin for each of our regions adjusted for other amounts not directly attributable to a specific region. Other amounts resulted in a decrease of $1 million and increase of $5 million for the three months ended March 31, 2012 and 2011, respectively. Gross refining margin includes the effect of intersegment sales to the retail segment at prices, which approximate market. Gross refining margin approximates total refining throughput multiplied by the gross refining margin per barrel.

(f) Includes manufacturing depreciation and amortization expense per throughput barrel of approximately $1.80 and $1.72 for the three months ended March 31, 2012 and 2011.

(g) Sources of total refined product sales include refined products manufactured at our refineries and refined products purchased from third-parties. Total refined product sales margins include margins on sales of manufactured and purchased refined products.


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Refining Data by Region
                                                                    Three Months Ended
                                                                        March 31,
                                                               2012                   2011
                                                          (Dollars in millions except per barrel
                                                                         amounts)
California (Martinez and Los Angeles)
Refining throughput (thousand barrels per day) (h)                   189                    248
Gross refining margin                                    $           138       $            372
Gross refining margin ($/throughput barrel) (d)          $          7.98       $          16.66
Manufacturing cost before depreciation and amortization
expense (d) ($/throughput barrel)                        $          7.34       $           6.68
Pacific Northwest (Washington and Alaska)
Refining throughput (thousand barrels per day)                       155                    135
Gross refining margin                                    $           183       $            163
Gross refining margin ($/throughput barrel) (d)          $         12.96       $          13.39
Manufacturing cost before depreciation and amortization
expense (d) ($/throughput barrel)                        $          3.83       $           4.08
Mid-Pacific (Hawaii)
Refining throughput (thousand barrels per day)                        67                     69
Gross refining margin                                    $            13       $            (19 )
Gross refining margin ($/throughput barrel) (d)          $          2.07       $          (3.05 )
Manufacturing cost before depreciation and amortization
expense (d) ($/throughput barrel)                        $          3.51       $           4.69
Mid-Continent (North Dakota and Utah)
Refining throughput (thousand barrels per day)                       118                    109
Gross refining margin                                    $           252       $            203
Gross refining margin ($/throughput barrel) (d)          $         23.51       $          20.77
Manufacturing cost before depreciation and amortization
expense (d) ($/throughput barrel)                        $          3.47       $           3.65


____________________


(h) We experienced reduced throughput due to a scheduled turnaround at our Martinez refinery during the 2012 first quarter.

Three Months Ended March 31, 2012, Compared with Three Months Ended March 31, 2011

Overview. Operating income for our refining segment decreased by $112 million, or 37%, to $191 million during the 2012 Quarter as compared to the 2011 Quarter. The decrease is primarily due to lower industry margins, lower refinery throughput rates and negative yield impacts as a result of major planned turnaround activity at our Martinez refinery during the 2012 Quarter.

Gross Refining Margins. Our gross refining margin per barrel decreased by $2.18 per barrel, or 15%, to $12.15 per barrel in the 2012 Quarter as compared to the 2011 Quarter, in line with lower industry margins. Industry distillate margins on the U.S. West Coast decreased approximately 13% as a result of seasonally high inventory early in the 2012 Quarter and lower diesel demand driven by lower West Coast port container traffic. Industry gasoline margins on the U.S. West Coast declined approximately 3% during the 2012 Quarter as compared to the 2011 Quarter as a result of lower demand due to high unemployment and rising retail street prices driven by increased crude costs. In the California region, gross refining margin per barrel was negatively affected by lower light product yields impact as a result of the planned turnaround at our Martinez refinery.

Partially offsetting lower industry margin product yields were advantaged crude costs relative to industry benchmarks and benefits from ethanol blending during the quarter. Mid-Continent crude oil logistic constraints continued to elevate the price spread between crude oil priced off WTI as compared to crude oil priced off waterborne crude oil benchmarks, such as Brent, during the 2012 Quarter. This situation has decreased the relative crude oil costs for our Mid-Continent refineries, which increased refining margin per barrel 13% in this region. The increase in gross refining margin per barrel positively impacted total Mid-Continent gross refining margins by $49 million during the 2012 Quarter as compared to the 2011 Quarter.


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We use non-trading derivative instruments to manage exposure to commodity price risks associated with the purchase or sale of crude oil and finished products. We also use non-trading derivative instruments to manage price risks associated with inventories above or below our target levels. Losses associated with our commodity derivative instruments are included in gross refining margin. Our losses totaled $21 million and $51 million during the 2012 and 2011 Quarter, . . .

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