Valero Energy Corporation

Greetings, ladies and gentlemen, and welcome to the Valero's third quarter 2021 earnings conference call. At this time, all participants are on a listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question, please press star 1 on your telephone keypad. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Homer Bowler, Vice President of Investor Relations and Finance. Thank you, sir. Please go ahead.

Good morning, everyone, and welcome to Valero Energy Corporation's third quarter 2021 earnings conference call. With me today are Joe Gorder, our Chairman and CEO, Lane Riggs, our President and COO, Jason Frazier, our Executive Vice President and CFO, Gary Simmons, our Executive Vice President and Chief Commercial Officer, 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 one on our website at InvestorValero.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 now 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 Jill for opening remarks.

Thanks, Homer, and good morning, everyone. We saw significant improvement in refining margins globally in the third quarter as economic activity and mobility continued to recover in key markets. Finding margins were supported by strong recovery in product demand, coupled with product inventories falling to low levels during the quarter. In fact, total U.S. light product inventories are now at five-year lows, and total light product demand is over 95% of the 2019 level. Across our system, current gasoline sales are at 95% of the 2019 level, and diesel sales are 10% higher than in 2019. And on the crude oil side, medium and heavy sour crude oil differentials widened during the quarter as OPEC Plus increased supply. Hurricane Ida resulted in some downtime at our St. Charles and Miro refineries and the Diamond Green diesel plant. We immediately deployed emergency teams and supplies after the storm to help our employees, their families, and the surrounding communities in the restoration and recovery effort. The affected facilities did not sustain significant damage from the storm, and once power and utilities were restored, the plants were successfully restarted. I'm very proud of our team's efforts and the ability to safely shut down and restart our operations. Despite the impacts of the hurricane, we also completed the Diamond Green Diesel Expansion Project, DGD2, in the third quarter, ahead of schedule and on budget, and are in the process of starting up the new unit. DGD2 increases renewable diesel production capacity by 400 million gallons per year, bringing DGD's total renewable diesel capacity to 690 million gallons per year. In addition, we successfully completed and started up the new Pembroke cogeneration unit in the third quarter, which is expected to provide an efficient and reliable source of electricity and steam and further enhance the refinery's competitiveness. Looking ahead, the DGD3 project at our Port Arthur refinery continues to progress and is still expected to be operational in the first half of 2023. With the completion of this 470 million gallons per year plant, DGD's total annual capacity is expected to be 1.2 billion gallons of renewable diesel and 50 million gallons of renewable naphtha. The large-scale carbon sequestration project with BlackRock and Navigator is also progressing on schedule. Navigator has received the necessary board approvals to proceed with the carbon capture pipeline system as a result of a successful binding open season. Valero is expected to be the anchor shipper with eight ethanol plants connected to this system, which should provide a higher ethanol product margin uplift. The Port Arthur Coker project, which is expected to increase the refinery's utilization rate and improve turnaround efficiency, is still expected to be completed in 2023. On the financial side, we remain disciplined in our allocation of capital, which prioritizes a strong balance sheet and an investment-grade credit rating. We redeemed the entire outstanding principal amount of our $575 million floating rate senior notes due in 2023 in the third quarter. And we ended the quarter well capitalized with $3.5 billion of cash and $5.2 billion of available liquidity excluding cash. Looking ahead, we continue to have a favorable outlook on refining margins as a result of low global product inventories, continued demand recovery, and global balances supported by the significant refinery capacity rationalization seen over the last year and a half. In addition, the expected high natural gas prices in Europe and Asia through the winter should further support liquid fuels demand as power generation facilities, industrial consumers, and petrochemical producers see incentives to switch from natural gas to refinery oil products for feedstock and energy needs. Continued improvement in earnings of our core refining business, coupled with the ongoing expansion of our renewables businesses, should strengthen our competitive advantage and drive long-term shareholder returns. So with that, Homer, I'll hand the call back to you.

Thanks, Joe. For the third quarter of 2021, net income attributable to Valero stockholders was $463 million or $1.13 per share compared to a net loss of $464 million or $1.14 per share for the third quarter of 2020. Third quarter 2021 adjusted net income attributable to Valero stockholders was $500 million or $1.22 per share compared to an adjusted net loss of $472 million or $1.16 per share for the third quarter of 2020. For reconciliations to adjusted amounts, please refer to the financial tables that accompany the earnings release. The refining segment reported $835 million of operating income for the third quarter of 2021 compared to a $629 million operating loss for the third quarter of 2020. Third quarter 2021 adjusted operating income for the refining segment was $853 million compared to an adjusted operating loss of $575 million for the third quarter of 2020. Refining throughput volumes in the third quarter of 2021 averaged 2.9 million barrels per day, which was 338,000 barrels per day higher than the third quarter of 2020. Throughput capacity utilization was 91% in the third quarter of 2021 compared to 80% in the third quarter of 2020. Refining cash operating expenses of $4.53 per barrel were 27 cents per barrel higher than the third quarter of 2020, primarily due to higher natural gas prices. The renewable diesel segment operating income was 108 million for the third quarter of 2021, compared to 184 million for the third quarter of 2020. Renewable diesel sales volumes averaged 671,000 gallons per day in the third quarter of 2021, which was 199,000 gallons per day lower than the third quarter of 2020. The lower operating income and sales volumes in the third quarter of 2021 are primarily attributed to plant downtime due to Hurricane Ida. The ethanol segment reported a 44 million operating loss for the third quarter of 2021 compared to 22 million of operating income for the third quarter of 2020. Excluding the adjustments shown in the accompanying earnings release tables, third quarter 2021 adjusted operating income was $4 million, compared to $36 million for the third quarter of 2020. Ethanol production volumes averaged 3.6 million gallons per day in the third quarter of 2021, which was 175,000 gallons per day lower than the third quarter of 2020. For the third quarter of 2021, G&A expenses were $195 million, and net interest expense was $152 million. Depreciation and amortization expense was $641 million, and income tax expense was $65 million for the third quarter of 2021. The effective tax rate was 11%, which reflects the benefit from the portion of DGD's net income that is not taxable to us. Net cash provided by operating activities was $1.4 billion in the third quarter of 2021. Excluding the favorable impact from the change in working capital of $379 million and our joint venture partner's 50% share of Diamond Green Diesel's net cash provided by operating activities, excluding changes in DGD's working capital, adjusted net cash provided by operating activities was $1 billion. With regard to investing activities, we made $585 million of total capital investments in the third quarter of 2021, of which $191 million was for sustaining the business, including costs for turnarounds, catalysts, and regulatory compliance, and $394 million was for growing the business. Excluding capital investments attributable to our partners' 50% share of Diamond Green Diesel, and those related to other variable interest entities, capital investments attributable to Valero were $392 million in the third quarter of 2021. Moving to financing activities, we returned $400 million to our stockholders in the third quarter of 2021 through our dividend, resulting in a payout ratio of 40% of adjusted net cash provided by operating activities for the quarter. With respect to our balance sheet at quarter end, total debt and finance lease obligations were $14.2 billion and cash and cash equivalents were $3.5 billion. And as Joe mentioned earlier, we redeemed the entire outstanding principal amount of our $575 million floating rate senior notes due in 2023 in the third quarter. The debt to capitalization ratio and net of cash and cash equivalents was 37%. And at the end of September, we had $5.2 billion of available liquidity, excluding cash. Turning to guidance, we still expect capital investments attributable to Valero for 2021 to be approximately $2 billion, which includes expenditures for turnarounds, catalysts, and joint venture investments. About 60% of our capital investments is allocated to sustaining the business and 40% to growth. And over 60% of our growth capital in 2021 is allocated to expanding our renewable diesel business. For modeling our fourth quarter operations, we expect refining throughput volumes to fall within the following ranges. Gulf Coast at 1.67 to 1.72 million barrels per day, Mid-continent at 455,000 to 475,000 barrels per day. West Coast at 230,000 to 250,000 barrels per day. And North Atlantic at 435,000 to 455,000 barrels per day. We expect refining cash operating expenses in the fourth quarter to be approximately $4.70 per barrel. With respect to the renewable diesel segment, we expect sales volumes to average 1 million gallons per day in 2021. Operating expenses in 2021 should be 50 cents per gallon, which includes 15 cents per gallon for non-cash costs such as depreciation and amortization. Our ethanol segment is expected to produce 4.2 million gallons per day in the fourth quarter. Operating expenses should average $0.43 per gallon, which includes $0.05 per gallon for non-cash costs such as depreciation and amortization. For the fourth quarter, net interest expense should be about $150 million, and total depreciation and amortization expense should be approximately $600 million. For 2021, we still expect G&A expenses excluding corporate depreciation to be approximately $850 million. 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&A to two questions. If you have more than two questions, please rejoin the queue as time permits. Please respect this request to ensure other callers have time to ask their questions.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Once again, that's star one to register a question at this time. Our first question is coming from Doug Leggett of Bank of America. Please go ahead.

Thanks. Good morning, everyone. Hi, Joe and team. Good morning, Homer. Thanks for getting on the call. Joe, I want to start with a balance sheet question and then a macro question, if I may. So this might be for Jason, but When you think forward to 2022, you've obviously completed the renewable diesel expansion at this point. Your capital this year obviously had growth capital in there still, and your balance sheet is still probably above where you'd like to see it mid-cycle. How should we think about CapEx and prioritizing the right level of debt or balance sheet that you'd like to have as we think about 2022? Go ahead, Jason.

Okay. Yeah, on CapEx, I mean, our CapEx budget going forward, we're forecasting to be pretty consistent with as we've done in the past, so really no change there. Then as we end up with extra, as you said, excess cash flow, we have our commitment to shareholders to return to 40% to 50%. That really hadn't changed. We have our dividend, which we think is in a pretty good place relative to the peers, and then we'll have buybacks to make up to our targets. And then cash beyond that, we are going to look at delevering a bit. That's a commitment we made. We bought back to 575 of floater rate notes just last month, and we're looking to do more next week. I mean, sorry, next year as we move forward.

Where would you like that to be, Jason, I guess is my point. Where do you want net debt to come to be?

But we hadn't changed what we have in our frameworks to 20%, 30%. So we hadn't changed that. But we're definitely working down from where we are now. I don't know that we've changed the end point at this time.

Okay, thank you. Joe, my micro question is really, I want to try and phrase it like this. There's a ton of moving parts for you guys in particular with cap line reversing and obviously OPEC plus adding back oil and all the rest of it. So you've got the spread side of it. And then you've got the product side of it with jet fuel perhaps being the missing link. Maybe the simplest way to ask this question is, do you see for Valero 2022 at this point, from what you know, as an above mid-cycle year or a below mid-cycle year in terms of EBITDA? I'll leave it there. Thanks. Thanks, Colin.

Yeah, Doug, this is Gary. You know, I would tell you on the demand side of the equation, our view of 2022 has been fairly consistent. You know, we see gasoline and diesel demand returning to pre-pandemic levels. Our view is jet, it probably is the latter part of the year before jet demand recovers to pre-pandemic levels. The real change on 2022 has come from the fact that inventories are just so low. You know, inventories domestically are low, but globally they're low as well. And when you look at the fourth quarter turnaround activity, it's difficult for us to see that we're going to replenish clean product inventories before next year. And so going into next year with inventories low, we're starting to move to a view that we could see some fairly strong crack spreads. I think in addition to that, the high cost natural gas also comes into play. You know, when you look at places around the world that are paying $30 a million BTU for natural gas, it pressures that refining capacity and kind of raises the incremental crack spreads needed for them to run, which also pushes margins higher. So, you know, I would tell you that, you know, we probably came in looking at 2022 slightly below mid-cycle and it's trending now more above mid-cycle type levels.

Appreciate the answers, guys. We'll talk to you in a couple weeks. Thank you.

Thanks, Doug.

Thank you. Our next question is coming from Theresa Chen of Barclays. Please go ahead. Hi there.

Morning, everyone.

Morning, Theresa.

Thanks for taking my question. Morning. Gary, I wanted to follow up on your comments about the natural gas pressures internationally. And clearly we're seeing some of it domestically as well. So first, maybe just on the competitive dynamics between domestic and refiners elsewhere, Europe, for example, how do you think this affects the competitive positioning of your assets? And where do you see that export are potentially going to?

Well, that's a good question. I guess, you know, might ask for some lane help here. So natural gas is what, about 25% of our OPEX? Oh, something like that. Yeah. So, you know, you kind of figure $4 a barrel and a dollar, that's natural gas. And if you're paying, you know, $30 versus five, you can see what that does for overall refinery cash operating expenses, which does give us a very significant advantage into those export markets. And we're seeing that today. You're not seeing much flow from Europe. into those Latin American markets, and we're seeing a big pull into those markets.

Got it. And maybe switching gears a little bit, I would love to get an update on your outlook on renewable diesel economics as DGD2 is now starting up. And specifically, it looks like LCFS prices have hit a trough and now are seeing some signs of life consistent with Martin's previous expectations. Is this largely because of demand recovering for petroleum products in California leading to higher deficit generation? Is there something else going on here? Would love it if, you know, Martin can look into his crystal ball again and give us a sense of where prices could go from here.

Okay, Teresa, this is Martin. I'll give that a shot. I think, yeah, we've seen the LCFS prices rebound to $1.75 a metric ton now. I think some of that's due to the expectation of getting the second half data out. Second quarter of 21 data will be published at the end of the month. But if you go back and look, it's really obvious that deficits after 2019 just stopped increasing. And at that time, the carbon reduction goal was moving from 6.25% to 7.5% to 8.75%. So historically, each year, you'd see a step change in deficits. We've seen nothing happen since 2019 and credits are keeping up with deficits in the credit banks flat. So that kind of explains why the pricing went away. It's not an over generation of credits. It's a lack of deficits. It's clear. And I think, you know, with the Delta variant now, hopefully in the rear view mirror and mobility improving, you know, we would expect to see some pretty big changes in the deficit picture in California going forward. And I think that's what the, the market is beginning to expect. As far as the renewable diesel economics, the DGD, you know, as we signaled, we expected the margins to moderate versus the record margins in the first half of 2021. You know, part of this is DGD2 getting into the marketplace. You know, we're impacting the waste feedstock market at this point because we're changing the flows. And anytime you change the flows and change the inertia of the market, you're going to see a temporary increase in price. Once the new flows work through the market, we expect those prices to moderate. And, you know, I go back to what we always talk about, the annual margins. You know, we've been very consistent the past three years. Our annual margins only moved from 218 a gallon to 237 a gallon in that three-year period. And we believe that margin history is a good indication of what to expect in the future.

Thank you. Thank you. Our next question is coming from Roger Reed of Wells Fargo. Please go ahead.

Yeah, good morning, everybody.

Hey, Roger.

Just let's go ahead and beat the natural gas horse here completely to death. I know you've got the COGEN plan that helps you sort of mitigate things a little bit over in Europe. As you step back and look at both your operations and think about it, you were somebody else, what are the options for mitigation of higher natural gas costs? Do you hedge? Do you think others hedge? Another way to come at it is mentioned in the intro, Joe, I think you said was probably demand for some other liquid products. What are some of the ratios we should think about there as to how that could pull additional product demand? And, you know, what are maybe trigger points for why you would do that over natural gas?

So, hey, Roger, this is Lane. So I'll take a shot at some of this. One is, yeah, we have completed our cogent project over in Pembroke. And so you'd sort of ask yourself, hey, at $30 gas, is this still – And it does. I mean, our FID economics on that unit was about $105,000 a day of benefit. And today we're somewhere between $130,000 to $150,000 a day. And it just has to do with who's the marginal supplier of electricity in that market versus sort of an efficient co-gen. So we have that margin that we have running it, and it does help. Now, particularly in the U.K., a lot of those guys have co-gens as well. I don't know how efficient they are because that's work. these relative economics lie is how efficient your cogent is versus the marginal guy in that market. But as Gary alluded to earlier, what you're seeing is you need margin in the Atlantic Basin because there's a call on their capacity to essentially run oil and satisfy the market. So what that means is Europe and the UK are going to be very marginal in their economics, but that gives a substantially larger margin to people on this side of the Atlantic. In terms of ways to mitigate it through hedging, there's a few ways. One is you can just minimize gas. You can start burning propane. You can do other things. Most of our refiners, because of our complexity, we're long gas. So we can always get into a place where we're just essentially deriving our natural gas requirements from oil. And so we play that arbitrage and signal around to try to see where that is. And the other thing is to use option strategies. You can go out and Buy call options for gas and various ways of using options to mitigate your exposure and then obviously you can go out and buy the forward contract. I don't know how many people do that. It's an interesting question. We look at it all the time and we compare. We look at it a little bit as insurance because it's not free. So you have to take a view, am I trying to use this to lower my exposure from a cost perspective? Am I trying to prevent a shock? And so then, in other words, something like we saw during winter storm Uri or something like that. So you have to sort of frame what are you trying to do here. Because it isn't free, and if it doesn't translate into something, that cost for somebody our size ends up being just additional operating costs that we essentially paid as insurance. And so you have other ways to do it. You can decide to fix or float as you're getting closer into the month. So there's a lot of tools in our tool bag to mitigate this. But at the end of the day, to try to lock in lower prices going forward, there's almost always structural contango. If you look at the curve right now, it's kind of crazy looking. And so everybody's staring at this because you can see the futures activity in the first quarter. And so it's difficult, but we do have tools to do that. Did you speak to fuel switching?

I did.

I mean, that's what I was saying. We fuel switch. Propane, yeah, okay. Mainly propane, but we also make gas from our operations. Okay.

Thanks. Let's look at it from a happier standpoint, the product demand side. It appears jet fuel should get a lift with some of the international travel restrictions coming off next month. And then we obviously have supply chain issues in trucking. I was just curious, you mentioned earlier that it looked like diesel demand was up versus 19 levels. Do you think there's another lift up focused on logistics and just general trucking demand? And then how do you see the jet fuel demand picture hopefully improving as we go into year end?

Yeah, so Roger, I think there is a good chance some upside to diesel. We've seen, you know, good harvest demand. A lot of it depends on the fourth quarter, what happens in weather. But, you know, specifically on the trucking side, you know, still a lot of companies struggling to find drivers to drive the trucks and get products moved around. So I think as we work through that and and get drivers back to work, there is a chance that you see more highway demand for diesel, which is encouraging. On the jet side, you know, we saw a nice step change in the third quarter. You know, we were trending 71, 72% of 2019 levels, and that jumped into the 80s, so that's nice to see. You know, at that level, Your kind of overall total light product demand is about 300,000 barrels a day below where it was in 2019, but you've got 675,000 barrels a day less refining capacity. So already, you know, you're really tighter supply-demand balances, at least domestically, than we were pre-pandemic. And then we are seeing encouraging signs on the jet side. You know, you look, we don't have, you know, a lot of transparency there. But the nominations that we're seeing from the airlines that we supply seem to, you know, show that they're anticipating a pretty heavy holiday travel season. And so we would expect an uptick there with jet demand.

Great. Thank you.

Thank you. Our next question is coming from Phil Gresh of J.P. Morgan. Please go ahead.

Yeah, good morning. Just following up on the last commentary around the domestic supply-demand picture, how are you thinking about the export markets right now? It seems like the Brazilian demand is really starting to pick up from recent data points. So just in general, what are you seeing? And then how do you think about the competitive dynamics in those export markets, given the you know, situation with European refineries right now?

Yeah, so I would tell you that, you know, our export demand has returned to pre-pandemic levels. Very good mobility in Latin America, and we're seeing very strong export demand. On the diesel side, the same type thing, very good export demand, and the ARB to Europe is swinging kind of open and clear, seeing pull to Europe as well. So, again, you know, trade flows seem to have completely normalized to where they were pre-pandemic.

Got it. Okay. And then my second question is just, you know, there's been a lot of discussion of the impact of higher natural gas on European refineries and the effect it's had on crack spread. So if we were to see a scenario where natural gas prices were to come back down in Europe, do you feel like the underlying diesel crack would still be, you know, stronger than where it was before all this happened just because of underlying demand improvements? Or just curious how we should think about that?

Yeah, so I suspect you would see some fall off in the crack spread as natural gas weakened. However, the inventory situation will continue to keep and support crack spreads. It looks to us, especially in Europe, even if they ramp up utilization and you look at where demand is versus the inventory draw that's been trending, it's going to be very difficult for Europe to really replenish their stocks. And as long as that's the case, we would expect it to support the cracks. Okay, got it. Thank you.

Thank you. Our next question is coming from Prashant Rao of Citigroup. Please go ahead.

Hi. Good morning. Thanks for taking my question, guys. Good morning. I wanted to ask first just a little bit on the capital allocation policy. Given the commentary around EBITDA looking like it could be a little bit above mid-cycle next year, and what you said about a comfortable place on the dividend and looking to maintain your capital allocation framework. I'm just curious how DGD's earnings and specifically the distributions from JV fit into that. I think many of us have been expecting maybe that the distributions up to the partners come later, given that you've got CapEx on DGD3 coming and that project is set for a 2023 start. But is that a factor in how you think about potentially – putting more money back to shareholders and specifically to the dividend? Or is the distribution not really that material versus the other sources of cash flow that you have?

Okay, this is Jason. I can take a shot. And you're right, it's definitely a positive development and going to get bigger and bigger as the DGDs or units come online. So it is significant. It doesn't change our math, you know, how we look at it. We get half of the the distributions and that's cash in to us and we, you know, we still apply our 40 to 50% target and our normal analysis in that aspect. But it's definitely a growing stream of EBITDA to us which we're very excited about and will help us going forward.

Thanks, Jason. I wanted to ask about something we haven't touched on yet, ethanol and CCUS project. Good progress there. A couple of questions here in one. How soon could you FID or what do you need to see to be able to roll in the remainder of the footprint into a CCUS project? And then from a macro standpoint or I guess from more of a revenue standpoint, you know, we've got some news about 45Q increases for certain industries. We've also got some volatility around the RFS and what that means for overall ethanol demand and support from the government for ethanol blending. I was just wondering if the second part of the question, if you could address sort of how all those factors kind of might affect your thoughts about the project. Thanks.

Yeah, Prashant, this is Martin. Well, we're operating 12 ethanol plants now, and, you know, eight of them are going into the navigator system. And the ones on the eastern side, the four on the eastern side, we're moving forward with sequestration plans at three of the four and potentially all of them. A little bit down the road, but the geology on the eastern side of the U.S. So this is Indiana and Ohio is eastern side of the Corn Belt, I should say, is good for CCUS. So we're planning to do sequestration at the actually on site. So now that's going through our gated process and still hurdles to get through there. But that's the plan. So that's where we're headed on that. And we're excited about CCUS. You know, as you stated, the 45Q is an uplift of about 15 cents a gallon. And just on a gross basis, the low carbon getting to a 40 CI versus a 70 is worth almost 50 cents a gallon on a gross basis. So as far as if we look at demand for ethanol, you know, we're feeling, I think, pretty good about – Maybe something happening with the fuel spec in the U.S. to get to a 95 RON, you know, higher efficiency engine, good for the autos, good for ethanol, good for oil. So we're kind of more optimistic about that than we probably have been in the past. That would increase the ethanol blending. You know, ethanol is definitely in the fuel mix to stay in the United States. And we're seeing now we're getting into a situation, too, with pretty good export demand again that's kind of picking back up post the big impacts of COVID. So we're pretty optimistic about the future there. But it's really what's driving our optimism is the low carbon. We're deep into corn fiber ethanol at this point, producing that at several sites and the outlook for the carbon sequestration.

Got it. Thanks, Martin. Appreciate that. Thank you very much, guys. I'll leave it there. Thanks.

Thank you. Our next question is coming from Manav Gupta of Credit Suisse. Please go ahead.

Hey, guys. A little bit follow-up on Doug's question. When we go back and look at 18 and 19, and specifically your Gulf Coast crack, it was averaging about 1072. Your indicators are indicating it's closer to 13 right now. Brent WCS is almost nine. I know we have still some time to go in this quarter, but the way things are shaping up, is it fair to say your strongest Gulf Coast quarter in probably two to three years is now approaching?

Well, again, we don't know how the quarter is going to shape up, but certainly if you look at the month-to-date indicator, it is significantly above mid-cycle. We would agree with you on that.

Okay, and a quick follow-up here is there are a number of commercial technologies out there to produce sustainable aviation fuel, but nothing works like HEFA, and nobody works HEFA better than Valero does. And so we are seeing out there, you know, smaller players come out with lesser commercial technologies, get big off-take agreements with airlines, big companies, and the guy who can do it at best is still sitting on the sidelines. So I was wondering what gets Valero involved in sustainable aviation fuels.

Sure, Bernal. This is Martin. Well, we're progressing our SAF production through our gated engineering process, and we're currently developing, you know, talking with customers. And as you stated, there's plenty of customers who are interested in SAF, so it's not really a demand issue. And I also want to say that, you know, a DGD-4 is not required for SAF, as we can retrofit DGD-1, 2, or 3, or any combination thereof. The thing about SAF is it does require additional investment, a fractionator at a minimum, and maybe additional equipment beyond that. So the price of SAF needs to be such to justify that incremental investment. So we're not waiting engineering-wise for the final outcome on the SAF blender's tax credit, but we do think a favorable tax credit compared to the dollar a gallon that you get on the blender's tax credit So a favorable one to that is likely needed to proceed beyond engineering. And as you say, it's not a question of if we're going to produce and sell sap. It's a question of when. But again, we're looking for, you know, positive incremental EBITDA out of this and not just to do it. So that's kind of what the holdup is right now.

Thank you.

Thank you. Our next question is coming from Paul Sankey of Sankey Research. Please go ahead.

Morning, everyone. It's a long time since we've worried about natural gas prices. Can you remind me what the sensitivity, the sort of rule of thumb you guys use for how bad or good it is and how much that's changed since it's been 10 years or so since it's really been a problem? Has your asset base changed in terms of its sensitivity? Thanks.

This is Lane. So still about a dollar change per million B2 is about 20 cents, 20, 22 cents per barrel for us. Great.

Lane, while I have you, the crude slate has changed a lot over that period as well. You know, nothing from Venezuela, very low Saudi, plenty from Canada, issues with Mexico. Can you just talk about, and also notably some significant discounts, for example, West Africa to Brent. Dubai to Brent. Can you talk a bit about how you're managing the crude market? Thanks.

I'll let my good friend Gary answer that question.

So far today, you know, if you look, we're seeing the widest margin in some of the heavy feedstocks we run. You mentioned Heavy Canadian has good margins. Some of the fuel blend stocks that we're running today have good margin. In terms of the other light sweet to medium sour It kind of comes and goes. If you look at today's market, it would favor light sweet over medium sours. But in general, what we're seeing is kind of in our Gulf Coast assets, as you move east in the Gulf, you tend to have better economics on the medium sours. And as you move west, it favors running more light sweet.

But has the lower amount of crude coming out of the U.S. itself had a major impact?

No, you know, as long as we are still exporting crude, that really kind of sets the Brent TIR been more a long ways from getting to a point where we're not in the export markets. Yeah, that makes sense.

Back to the rule of thumb for my final part. What's your sensitivity to jet fuel if there's a way of framing that? Because obviously if we see that come back, I would have thought it's the highest margin product you guys produce. I just wondered how. maybe what the opportunity cost has been of the lost jet fuel or what the issues have been around operations. Thanks.

This is Lane. So I would tell you that I don't know if I would – Gary, I wouldn't consider – it's all a matter of optimization. If you look at it historically, it's had the RIN in it, so you can compare jet to ULSD, and you can sort of see what it – almost always the industry adds that out to the penny. So I would say most of the time, unless there's something unusual, the market is essentially indifferent to ULSD between jets. Now with that said, our operation is such that we can actually almost go down to zero jet, and the way we were configured. So I wouldn't say there's been a big opportunity cost not making jet. Now obviously what that means to the industry is that jet has been going into diesel, and so to the extent it created length and potentially hurt the crack. But as you've heard throughout the call, diesel demand is actually above where it was, so there's been some offsets to all that. But, you know, specifically, I don't think us not being able to make jets has been a big hit to us.

Yeah, that makes sense. And it's just you make an interesting point about how much latent diesel demand there is with the shortage of truckers and everything else. The diesel market looks really, really tight, right? Yes. Yes. Great. Thanks, guys.

Thank you. Our next question is coming from Paul Chang of Scotiabank. Please go ahead.

Hey, guys. Good morning. I want to also ask a question on the natural gas. Ling, I think you talked about earlier when Sankey asked about the cost, say, $0.22 per barrel. How about on the gross margin capture? Given that the hydrocrack, probably for every barrel of output, you use about 0.56 BCF of gas, and hydrotreater also uses gas. How should we look at the higher natural gas price, the impact on the gross margin? After that, I have another question.

Yeah, it's about 10 cents a barrel in cost of goods.

Yes, 10 cents per barrel for every $1?

Yes.

Okay. And the second question is that I think this is for Martin. When we look at the DGD we saw in the third quarter and ethanol. They both come in the gross margin worse than what the benchmark indicator will be. Benchmark indicator, at least in our number, that for renewable diesel seems like it's pretty flat, but your gross margin actually dropped quite substantially. And then for ethanol, it's actually up. on the gross margin indicator, but you guys actually did not. It's actually down. I think for ethanol, it's the feedstock issue, and I think there's a bit of the feedstock issue on the renewable diesel in the third quarter also. So can you maybe elaborate a little bit, help us to understand what happened, and also whether those trends continue into the fourth quarter? And also, if you can tell us that what is the current DGD to occur in one way. Thank you.

All right, Paul, I might need some help in keeping those straight, but here we go. I'm going to start with ethanol. You're busted, Paul. So the third quarter, as you stated, the indicator margin was 70 cents a gallon, which was up 30 cents a gallon versus the second quarter. But what you have to remember about that indicator margin, is it's based on the CBOT corn price and does not include the corn basis. In most years, that's a fine approximation to our corn cost, but due to the low corn-to-stocks use ratio, the stocks-to-use ratio this year, basis was extremely high. If you look at some of the USDA reports, basis was $1, $1.20 a bushel, so that takes 30 to 40 cents out of the indicator. So at the end of the day, the indicator was just artificially high and that kind of EBITDA was not achievable. So the good news is now with the new corn crop, while the CBOT price is still high, the basis has broken. So those indicator margins you're seeing now, which are over a dollar a gallon, are pretty indicative of where the industry would be. So it's not an ongoing issue. But this corn price is going to stay high. And we're going to go through this period probably again next year where basis, as you get to the end of the corn crop, really gets high. But right now, the basis is broken. On DGD, the indicator was down to like $2.84 in the third quarter, pretty flat the second quarter. But on DGD, You know, there's quite a few things moving. The first thing I would tell you, you know, we signaled that we would have lower margins in the third quarter. Some of that was we expected this prices, as prices are going up, the product prices, fat prices, all that's going up. The rent goes up immediately, but we've got a lag in our cost of goods with the fat. So when you break over and that price quits increasing or starts decreasing, then your rent falls immediately and you're still consuming a higher price feedstock. So we had some of that in the third quarter. The other thing that's happened in the third quarter is we were out buying for DGD2 and we're entering the market and I went through that earlier. Anytime you go into the market in a big way and change these flows, you've got inertia in the market and it's going to take a while for it to get back down. So we expect these waste feedstock prices how they price relative to soybean oil to come off. And we're seeing a little, you know, good news there now. So we expect that to correct itself too. And I'm trying to think what else I missed here.

What's the DGD2 current runway?

Okay, we're just in the process of starting it up, Paul, but we're moving along well. Everything looks good, but we don't have a run rate yet.

Oh, okay. So you haven't actually stopped running yet.

Yeah, so this is Lane. We actually started it up about three days ago.

I see. Okay. We do. Thank you.

Thanks, Paul. Thank you. Our next question is coming from Sam Margolin of Wolf Research. Please go ahead.

Hey, morning, everyone. Hi, Sam. Follow up on capital allocation as the cycle kind of gets firmer here. In the past, the buyback and dividend growth worked together, right? It was sort of partially enabled to grow your dividend as much as you did because you took out 30% of your shares. As we think about entering kind of the next phase of the cycle here into a potentially stronger period, do they have to be together or can you do one component of increasing capital returns without the other.

Oh, Jason's going to let me take this one. You know, Sam, I mean, we don't necessarily link them together, right? We do use the 40% to 50% target based on how we make our decisions. And as Jason said earlier, we've got the dividend yield kind of towards the high end of the peer range right now, maybe at the high end of the peer range. So we'll continue to look at it going forward. And he laid out the priorities really for our use of cash as we go forward. And he wants to deliver a little bit. I guess we're at what, like somewhere around 37% total debt to CAF. We'd like to push it back down closer to that 30% number we had. And you can do that in a multitude of ways. But anyway, that's one of our top priorities. And then we haven't given up on buybacks by any stretch of the imagination. We see them as playing a part in this capital allocation framework. going forward. You know, it's funny because you guys love us when we do it. And then sometimes we do it and the price is high and the stock comes up and you say, oh, why don't you do buybacks, right? So anyway, it's a fine balancing act for us. And I think if you just revert back to the capital allocation framework and the way we've executed it in the past, I think right now that's our plan for execution going forward.

Okay. Thanks. Very helpful. And then just Just a follow-up for Martin on the dynamics in the renewable diesel space. This may have been a coincidence, but at the time that DGD and a competitor plant in the same area were down, the whole complex of bean oil and waste oils came down too. Some people interpreted that as a signal of just how tight the market is. A couple of plants can bring down that complex by 20 cents a pound. Is your feeling the same thing, or was that just a coincidence? And, you know, there's actually some spare capacity in feedstock that's underappreciated. Thanks.

Sam, this is Martin. It's a coincidence, definitely on the bean oil side. I mean, when you look at that, if you look at bean oil prices, soybean oil, just look at any veg oil price. And veg oil price, whether it's palm oil, bean oil, or canola oil, that's the big three globally. You know, they're up. They have doubled since the fall of 2019. And all that was led by a shortage of palm oil. The palm oil stocks got low in Malaysia. So to put it in perspective, if you look at Malaysia and Indonesia palm oil, that production is six times as large as soybean oil in the United States. So palm oil drives veg oil pricing. So anytime you see soybean oil, just crude degum, soybean oil move, it's a lot more about palm oil lately than anything else. So now that said, the waste feedstock price relative to soybean oil, as I said earlier, you know, I think DGD's had an impact on that. It gets complicated because you get into all kinds of tallow and slaughter rates and the weight of animals and all this information. But, you know, we do expect that to come back out. Certainly, you've got a situation now where the waste feedstock prices are on an energy content or way above the value of corn on an energy content. So the people feeding waste oils are trying to figure out ways not to feed waste oils. So we're still optimistic about waste feedstock in the future. And I'm really glad we have all this pretreatment capacity to handle it.

Thanks so much. Have a great day.

Thank you. Our next question is coming from Ryan Todd of Piper Sandler. Please go ahead.

Good. Thanks. Maybe this is a natural follow-up on your last comment there, but over the last 12 months, we've seen a lot of headlines about potential capacity additions in renewable diesel. But I think we've also seen a shift amongst a lot of those additions towards what I would characterize as kind of a capital light entry to renewable diesel. targeting vegetable oils and avoiding the cost of pretreatment facilities. So how do you see these trends impacting RD markets over the next few years, given your increasingly differentiated position on feedstock flexibility and sourcing? Sure.

Yeah, well, I would say that this higher veg oil prices, given what's going on in palm oil, there's kind of a structural shortage there now. The Plantations, the trees are getting older, the yields getting less. So there's a little bit of a veg oil issue that's been coming for years. So we don't see the veg oil price moderating. But what you have to remember that for Diamond Green Diesel, for our renewable diesel business, a high veg oil price is met with a higher D4 REN. And the absolute veg oil pricing doesn't dictate margin for us. And also the spread between RBD soybean oil and crude D gum soybean oil does not impact DGD. So being in this waste feedstock position with robust pre-treatment just puts us in a lot better position than the guys that are coming in and running veg oils and not, so that position I think is going to be a little tough, but we feel pretty good about our position.

Great, thanks. And then maybe a follow-up on, or a shift to refining. I assume we know your answer to you specifically, but there are quite a few, a lot of refineries currently being marketed out there. What would it take for you to seriously consider adding another asset to your portfolio? And if not for you specifically, how do you see this shaking out with a lot of these assets? Do you see more closures or I guess how do you see this kind of asset long position right now playing out over the next 12 to 18 months?

All right. Well, I'll answer it this way and then Rich can say whatever he wants, Rich Lashway. But, you know, we're very comfortable with the portfolio that we have today. And when, as you know, we've got a strong track record of having grown through acquisition in the past. And there was a time and place for that strategy to be executed and we executed it really well. And then we spent the last 10 years plus just getting the assets up to a standard that we were comfortable operating them in. And we realized that any acquisition like that, that we would make, we would end up going through the same process. And so, It would have to be an incredibly compelling case for us to give that any consideration. And so although we continue to look at what's in the market just to be sure we don't miss opportunities, I wouldn't anticipate that you should expect us to be doing anything on that front. I'd rather invest in the assets that we know, continue to optimize the assets that we have and build the renewables business right now than invest in additional refining capacity.

Makes sense. Thanks, Joe.

Thank you. Our next question is coming from Jason Gabelman of Cowan. Please go ahead.

Thanks. I guess the first one, just an easy modeling one. Is this lower tax rate? Is that a good rate to use moving forward? I think you mentioned the lower rate was driven by the DGD non-op impact. So just wondering if that's a good rate and if anything else drove the lower effective tax rate for the quarter. And secondly, I just wanted to go back to the LCFS price volatility in California. It seems like there's a lot of renewable fuel capacity coming online next year. And I'm wondering, in the market we're in right now, at what price does the LCFS price have to go to in order to maybe consider selling some of your renewable diesel into Europe rather than in California. I'm asking because you guys have a good position in terms of your U.S. Gulf Coast optionality, so I'm wondering if you could give any insight to that. Thanks.

Yeah, this is Mark Smeltikoff. I'll take the question on the tax rate and then hand it over to Martin for your second question. Yeah, the tax rate for the quarter does look low. It was 11%. It's a little challenging to tell you kind of what to expect in the future, but in the near future, I would say it would be somewhat under 21%. Just as a reminder, as we said in the earnings release, you have to remember the impact that the DGD earnings have on the effective tax rate. So Our consolidated pre-tax income includes 100% of DGD's income. And while tax expense only reflects taxes on a portion of that income, there's no tax expense on our share of the blender's tax credits included in DGD's income, nor is there any tax on our partner's half of DGD's income. So that impact has an outweighed impact on our overall effective rate. And I just also want to remind you that our partner's share of DGD's income is excluded from our net income by backing it out in non-controlling interest. So if you look at it just from a purely EPS or cash standpoint, the only benefit Valera is getting is not being taxed on our share of the blender's tax credit, which is quite a bit lower than I think some of the analysts are thinking that it is. So what it tells you is that our results are not driven as much by the perceived tax benefit as they were by underlying recovery and margins. And so I'll hand it over to Martin. Sure. Thanks, Mark.

Yeah, I would say on the LCFS, if you look at it, it's really to get to the root of your question, it's, again, this has been a lot more about deficits out there driving the price down than too many credits. In the first quarter of 21, renewable diesel blending was 23% in California. The highest in the previous quarter was 18%. But still, the credits aren't just exploding in California. It's just a lack of deficits. And I think as the we get out of the COVID and the Delta variant and back to work. And, you know, we've got a big data lag right now in California, right? We don't know what second quarter data is. We'll know that at the end of October. So, but, you know, so we, and credit prices are up, you know, they've hit a low of what a dollar, $158 a ton, now they're 175. But to get to your question, We routinely go to Europe and Canada with our fuel already. We're always looking at the different markets and, you know, working for the highest net back. And, you know, given our long-term contracts, we, you know, will sometimes be constrained. But, you know, we're always in those markets.

All right. Thank you.

Thank you. Our next question is coming from William, I'm sorry, Matthew Blair of Tudor Pickering Holt. Please go ahead.

Hey, good morning. Thanks for squeezing me in here. I was wondering if you anticipate being a shipper on cap line to your Louisiana refineries, and if so, would that be WCS or perhaps some other crude? You know, looking at that cap line tariff filing from earlier this week, expected volumes are only 102,000 barrels per day, which just seemed kind of low. So just trying to suss out if that's due to a lack of interest from Louisiana refineries or That's due to the lack of supply with the connector pipeline not going through. Thanks.

Yeah, so this is Gary. You know, with most of the pipelines and cap line, really not too much different for us. Our focus has been on getting good connectivity to those pipelines, but not necessarily taking a shipper commitment. We let the producer ship, and then we buy at the other end, and I think that's what we would plan to do with cap line as well.

And do you think those volumes will be WCS coming down or something else?

Well, that's a good question. I think, you know, it looks like initially it will be mainly a light sweep group, but certainly with the Line 3 replacement, we could see Heavy Canadian making its way into cap line at some point in time, and that would be good for us, you know, a more efficient way to get Heavy Canadian to our St. Charles refinery.

Indeed. Thanks. I'll leave it there. Thanks, Matthew.

Thank you. At this time, I'd like to turn the floor back over to management for any additional or closing comments.

Thanks, Donna. I appreciate everyone dialing in today. If you have any questions you want to follow up on, please feel free to reach out to the IR team. Thanks, everyone, and please stay safe and healthy.

Ladies and gentlemen, thank you for your participation and interest in Valero. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.