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TSO > SEC Filings for TSO > Form 10-Q on 2-Aug-2012All Recent SEC Filings

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Form 10-Q for TESORO CORP /NEW/


2-Aug-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 half of 2012:

                                                      Operational                        Value
                                                     Efficiency &  Commercial Financial  Driven
                                                     Effectiveness Excellence Discipline Growth
Decreased manufacturing costs per barrel by                l
approximately 5% compared to the first half of 2011
Leveraged our logistics operations to strategically
source advantaged crude oil and place refined                          l
products
Completed planned turnaround activity at our
Martinez, Hawaii and Alaska refineries and made            l                               l
significant progress on our large capital refinery
projects
Purchased shares of common stock to offset the
dilutive effects of new stock-based compensation                                  l
awards granted in 2012
Amended the Tesoro Logistics LP Revolving Credit
Facility and increased the capacity up to $300                                    l        l
million to support logistics growth
Strengthened refining and marketing integration with
the acquisition of 49 retail stations and the                                              l
successful transition of 165 leased retail stations
Completed the sale of the Martinez Crude Oil Marine                                        l
Terminal to TLLP


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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 June 30, 2012, TLLP's assets consist of a crude oil gathering system in the Bakken Shale/Williston Basin area of North Dakota and Montana, eight refined products terminals in the midwestern and western United States, one crude oil marine terminal in California, 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 June 30, 2012.

Effective April 1, 2012, Tesoro entered into a transaction (the "Martinez Terminal Sale") to sell to TLLP the Martinez Crude Oil Marine Terminal (the "Martinez Terminal") and associated pipelines for $75 million, comprised of $67.5 million in cash financed with borrowings under the TLLP Revolving Credit Facility and the issuance of equity with a combined fair value of $7.5 million. The Martinez 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 Martinez Terminal is estimated to be approximately 145 thousand 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 Martinez Terminal Sale 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."

Long Beach Marine Terminal and Los Angeles Short-haul Pipelines

We intend to offer the Long Beach Marine terminal and Los Angeles short-haul pipelines to TLLP and plan to complete the transaction during the third quarter of 2012. These assets, located near our Wilmington refinery, consist of a two-vessel berth dock, leased from the City of Long Beach, six storage tanks with combined capacity of 235,000 barrels and six related pipelines with 70,000 bpd throughput connecting the marine terminal, our Wilmington refinery and other third party facilities.

Unit Train Unloading Facility

We intend to offer the Anacortes, Washington unit train unloading facility to TLLP in the fourth quarter of 2012. The project includes unloading facilities for dedicated trains of rail cars ("unit trains") and is expected to deliver up to 50,000 bpd of Bakken crude oil to our Washington refinery. The construction of the facility is expected to be completed in September 2012.

Completion of North Dakota Refinery Expansion

We recently completed a project to expand the crude oil throughput capacity at our Mandan, North Dakota refinery from 58 to 68 Mbpd. The expansion allows the refinery to process additional crude oil from the nearby Bakken Shale/Williston Basin area delivered via the TLLP High Plains System (the "High Plains System").

Labor Negotiations

In June 2012, we completed the negotiation of the collective bargaining agreements covering approximately 1,300 full-time represented employees at the six of our seven refineries covered by collective bargaining agreements. The agreements for approximately 1,060 of the employees will expire in the first quarter of 2015 . The agreements covering the remaining employees will expire in the second quarter of 2015. We believe that the contracts ratified at these refineries are fair, competitive and consistent with other national agreements accepted by the United Steelworkers union.


Table of Contents

Hawaii Operations

In January 2012, we announced that we intend to sell our Hawaii operations as part our strategy to focus on the Mid-Continent and West Coast markets. The assets for sale include the 94 Mbpd Kapolei refinery, 31 retail stations and the associated logistical assets. As of June 30, 2012, the net working capital of the Hawaii operations was approximately $70 million. The estimated market value of the inventory exceeded the carrying value by more than $240 million at June 30, 2012.

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)

[[Image Removed]]

Crude Oil and Product Price Analysis

The nationwide unemployment rate was down 0.9% to 8.2% at the end of the second quarter of 2012 compared to the end of the second quarter of 2011. In California, a key market area for Tesoro, the state's unemployment rate dropped to 10.7% at the end of the second quarter of 2012, down from 11.9% at the end of the second quarter of 2011. The drop in unemployment rate, strong retail margins and unplanned refinery outages contributed to the improved market conditions on the U.S West Coast.

Emerging markets, primarily in Latin America, have provided an export opportunity for U.S. light products, particularly diesel exports. Exports to these emerging markets continue to provide an outlet for U.S. refining capacity, which has supported margins during this time.

Significant turnaround activity and downtime on the U.S. West Coast reduced production during the first half of 2012. The resulting low gasoline inventories supported U.S. West Coast benchmark gasoline margins, which rose to nearly $18 per barrel in the second quarter of 2012 compared to about $14 per barrel in the second quarter of 2011. However, overall global economic activity has slowed during the 2012 quarter leading to lower margins for distillate products. Average U.S. West Coast benchmark diesel fuel margins decreased about 20% compared to the second quarter of 2011.


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

[[Image Removed]]

The price differential between Mid-Continent crude oil and waterborne crude oil remained high during the second quarter of 2012, contributing to strong refining margins in the Mid-Continent region. The West Texas Intermediate ("WTI") discount to Brent remained flat during the second quarter of 2012, compared to the second quarter of 2011. Also contributing to strong refining margins in the Mid-Continent and Pacific Northwest regions, were advantaged price differentials for Bakken and Canadian crude oils in the second quarter of 2012. During the second quarter of 2012, the Bakken to WTI discount averaged $6 per barrel, compared to a $6 per barrel premium during the second quarter of 2011. Our North Dakota refinery currently runs 100% Bakken crude oil. The Canadian Light Sweet to WTI discount averaged $8 per barrel during the second quarter of 2012, compared to a $4 per barrel premium during the second quarter of 2011. Our Washington refinery runs a significant amount of Canadian Light Sweet crude oil.

Product Supply and Demand Factors

There are long-term factors, in addition to current market conditions, 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.


Table of Contents

RESULTS OF OPERATIONS

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 material to our consolidated results of operations.

Summary

Our net earnings were $387 million ($2.75 per diluted share) for the three months ended June 30, 2012 ("2012 Quarter"), compared with net earnings of $218 million ($1.52 per diluted share) for the three months ended June 30, 2011 ("2011 Quarter"). The increase in net earnings of $1.23 per diluted share during the 2012 Quarter was primarily due to the following:

an increase in gross refining margins in the Mid-Continent and Pacific Northwest regions of $121 million and $60 million, respectively, driven by feedstock advantages;

high utilization in the California and Mid-Continent regions of 102% and 97% respectively, which allowed us to capture attractive market conditions;

a $48 million impairment charge in the 2011 Quarter related to a change in scope of a capital project at our Wilmington refinery;

a $36 million increase in income from retail operations as compared to the 2011 Quarter as a result of strong retail margins and increased refining and marketing integration; and

a $26 million reduction in interest and financing costs primarily due to charges in the 2011 Quarter to write-off the remaining unamortized discount associated with the early redemption of our Junior Subordinated Notes and premiums paid in connection with the repurchase of a portion of our 6 1/4% Senior Notes.

The increase in net earnings during the 2012 Quarter relative to the 2011 Quarter was partially offset by net expense of $18 million related to legal matters.

For the year-to-date periods, our net earnings were $443 million ($3.14 per diluted share) for the six months ended June 30, 2012 ("2012 Period"), compared to net earnings of $325 million ($2.26 per diluted share) for the six months ended June 30, 2011 ("2011 Period"). The increase in net earnings of $0.88 per diluted share during the 2012 Period was primarily due to the following:

an increase in gross refining margins in the Mid-Continent and Pacific Northwest regions of $170 million and $80 million, respectively, driven by feedstock advantages;

a $48 million impairment charge in the 2011 Period related to a change in scope of a capital project at our Wilmington refinery;

a $33 million reduction in interest and financing costs primarily due to charges in the 2011 Period to write-off the remaining unamortized discount associated with the early redemption of our Junior Subordinated Notes and premiums paid in connection with the repurchase of a portion of our 6 1/4% Senior Notes; and

an $11 million decrease in incentive and stock-based compensation expense, primarily resulting from smaller increases in Tesoro stock prices during the 2012 Period as compared to the 2011 Period.

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

lower throughputs in the Pacific Northwest, Mid-Pacific and California regions as a result of planned turnarounds at our Alaska, Hawaii and Martinez refineries;

$37 million of property and business interruption insurance recoveries related to the Washington refinery incident collected in the 2011 Period; and

net expense of $18 million related to legal matters.


Table of Contents

Refining Segment
                                                 Three Months Ended                 Six Months Ended
                                                      June 30,                          June 30,
                                                2012              2011             2012          2011
                                                  (Dollars in millions except per barrel amounts)
Revenues
Refined products (a)                      $      7,780        $    7,635       $   15,342     $  13,905
Crude oil resales and other (b)                    135               186              291           341
Total Revenues                            $      7,915        $    7,821       $   15,633     $  14,246
Throughput (thousand barrels per day)
Heavy crude (c)                                    175               160              159           173
Light crude                                        365               382              361           360
Other feedstocks                                    39                36               34            37
Total Throughput                                   579               578              554           570
% Heavy Crude Oil of Total Refining
Throughput (c)                                      30 %              28 %             29 %          30 %
Yield (thousand barrels per day)
Gasoline and gasoline blendstocks                  296               276              275           283
Jet fuel                                            74                77               78            78
Diesel fuel                                        129               131              117           128
Heavy oils, residual products, internally
produced fuel and other                            113               124              114           112
Total Yield                                        612               608              584           601
Gross refining margin ($/throughput
barrel) (d)                               $      20.32        $    16.61       $    16.42     $   15.49
Manufacturing Cost before Depreciation
and Amortization Expense ($/throughput
barrel) (d)                               $       4.83        $     5.13       $     4.89     $    5.17


________________


(a) Refined products sales includes intersegment sales to our retail segment at prices, which approximate market of $1.4 billion and $1.3 billion for the three months ended June 30, 2012 and 2011, respectively, and $2.6 billion and $2.3 billion for the six months ended June 30, 2012 and 2011, respectively.

(b) Crude oil resales and other includes third-party revenues earned by TLLP.

(c) We define heavy crude oil as crude oil with an American Petroleum Institute gravity of 24 degrees or less.

(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").


Table of Contents

Refining Segment
                                                Three Months Ended               Six Months Ended
                                                     June 30,                        June 30,
                                                2012             2011           2012          2011
                                                (Dollars in millions except per barrel amounts)
Segment Operating Income
Gross refining margin (e)                 $         1,071     $     873     $    1,656     $   1,597
Expenses
Manufacturing costs                                   255           269            494           533
Other operating expenses                               63            51            115           107
Selling, general and administrative
expenses                                               10             8             19            16
Depreciation and amortization expense (f)              94            94            185           185
Loss on asset disposals and impairments                 4            52              7            54
Segment Operating Income                  $           645     $     399     $      836     $     702
Refined Product Sales (thousand barrels
per day) (g)
Gasoline and gasoline blendstocks                     358           344            350           334
Jet fuel                                               91            89             93            87
Diesel fuel                                           153           139            142           135
Heavy oils, residual products and other                82            85             85            80
Total Refined Product Sales                           684           657            670           636
Refined Product Sales Margin ($/barrel)
(g)
Average sales price                       $        125.22     $  128.67     $   126.14     $  121.29
Average costs of sales                             110.96        117.01         114.29        108.82
Refined Product Sales Margin              $         14.26     $   11.66     $    11.85     $   12.47


_______________


(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 an increase of $3 million and $5 million for the three months ended June 30, 2012 and 2011, respectively, and $2 million and $10 million for the six months ended June 30, 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 $1.71 and $1.70 for the three months ended June 30, 2012 and 2011, respectively, and $1.75 and $1.71 for the six months ended June 30, 2012 and 2011, respectively.

(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.


Table of Contents

Refining Data by Region
                                                Three Months Ended               Six Months Ended
                                                     June 30,                        June 30,
                                               2012              2011           2012          2011
                                                (Dollars in millions except per barrel amounts)
California (Martinez and Wilmington)
Refining throughput (thousand barrels per
day) (h)                                            268             227            229           238
Gross refining margin                     $         322      $      316     $      460     $     688
Gross refining margin ($/throughput
barrel) (d)                               $       13.20      $    15.25     $    11.04     $   15.98
Manufacturing cost before depreciation
and amortization expense (d)
($/throughput barrel)                     $        5.70      $     7.72     $     6.38     $    7.18
Pacific Northwest (Washington and Alaska)
Refining throughput (thousand barrels per
day) (h)                                            143             168            149           152
Gross refining margin                     $         280      $      220     $      463     $     383
Gross refining margin ($/throughput
barrel) (d)                               $       21.64      $    14.39     $    17.12     $   13.95
Manufacturing cost before depreciation
and amortization expense (d)
($/throughput barrel)                     $        4.02      $     3.04     $     3.92     $    3.50
Mid-Pacific (Hawaii)
Refining throughput (thousand barrels per
day) (h)                                             56              68             61            68
Gross refining margin                     $          73      $       60     $       86     $      41
Gross refining margin ($/throughput
barrel) (d)                               $       14.43      $     9.76     $     7.70     $    3.33
Manufacturing cost before depreciation
and amortization expense (d)
($/throughput barrel)                     $        4.46      $     3.97     $     3.94     $    4.33
Mid-Continent (North Dakota and Utah)
Refining throughput (thousand barrels per
day)                                                112             115            115           112
Gross refining margin                     $         393      $      272     $      645     $     475
Gross refining margin ($/throughput
barrel) (d)                               $       38.54      $    26.07     $    30.83     $   23.51
Manufacturing cost before depreciation
and amortization expense (d)
($/throughput barrel)                     $        3.95      $     3.73     $     3.71     $    3.69


____________________


(h) We experienced reduced throughput due to scheduled turnarounds at our Martinez refinery during the 2012 first quarter and 2011 second quarter, and our Alaska and Hawaii refineries during the 2012 second quarter.

Three Months Ended June 30, 2012 Compared with Three Months Ended June 30, 2011

Overview. Operating income for our refining segment increased by $246 million, or 62%, to $645 million during the 2012 Quarter as compared to the 2011 Quarter. The increase is primarily due to strong operating performance, improved market conditions and advantaged crude oil discounts during the 2012 Quarter.

Gross Refining Margins. Our gross refining margin per barrel increased by $3.71 per barrel, or 22%, to $20.32 per barrel in the 2012 Quarter as compared to the 2011 Quarter, driven by improved industry gasoline margins and advantaged crude oil cost relative to industry benchmarks. Industry gasoline margins on the U.S. West Coast and the Pacific Northwest increased approximately 26% and 48%, respectively, during the 2012 Quarter as compared to the 2011 Quarter due to . . .

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