Valero Energy Corp. Q2 2008 Earnings Call

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Valero Energy Corp. ( VLO )
Q2 FY08 Earnings Call
July 29, 2008, 11:00 AM ET
Executives
Ashley Smith - Director of IR
Michael S. Ciskowski - EVP and CFO
William R. Klesse - Chairman, CEO and President
Richard J. Marcogliese - EVP and COO
Joseph W. Gorder - EVP-Marketing and Supply
Analysts
Paul Cheng - Lehman Brothers
Paul Sankey - Deutsche Bank Securities
Roger Read - Natixis Bleichroeder
Jeff Dietert - Simmons & Company International
Neil McMohan - Sanford Bernstein
Michael LaMotte - JP Morgan
Chi Chow - Tristone Capital Inc.
Faisal Khan - Citigroup
Ann Kohler - Caris & Company
Mark Gilman - Benchmark Company
Presentation
Operator
Good morning. My name is Christy and I will be your conferenceoperator today. At this time I would like to welcome everyone tothe Valero Energy to announce Second Quarter 2008 ResultsConference Call. All lines have been placed on mute to preventbackground noise. After the speakers' remarks there will be aquestion-and-answer session. [Operator Instructions].
Thank you Mr. Smith, you may begin you call.
Ashley Smith - Director of Investor Relations
Thank you, Christy. Good morning and welcome to Valero EnergyCorporation's second quarter 2008 earnings conference call. With metoday are Bill Klesse, our Chairman and CEO; Mike Ciskowski our CFOand other members of executive management team.
If you have not received the earnings release and would like a copyyou can find one on our website at valero.com. There are alsotables attached to the earnings release which provide additionalfinancial information on our business segments. If you have anyquestions after reviewing these tables please feel free to contactInvestor Relations after the call.
Before we get started, I would like to direct your attention to theforward-looking statements disclaimer contained in the pressrelease. In summary, it says that statements in the press releaseand on this conference call that state the company's ormanagement's expectations or predictions of the future areforward-looking statements intended to be covered by the SafeHarbor provisions under Federal Securities Laws. There are manyfactors that could cause actual results to differ from ourexpectations, including those we've described in our filings withthe SEC.
Now I will turn the call over to Mike.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Thanks Ashley and thank you for joining us today. As noted in therelease, our second quarter 2008 earnings came in at $1.37 pershare. Second quarter 2008 operating income was $1.2 billioncompared to $3.2 billion reported in the same period last year. Thedecrease in operating income was obviously due to the company'slower throughput margin per barrel of $10.82 which was down $7.32per barrel or 40% versus the second quarter of 2007.
The key river of the decline was lower margins for gasoline andsecondary products, such as asphalt, fuel oils, petroleum, coke andpetrochemical feedstocks. Similar to the first quarter of 2008,these margins remained compressed in the second quarter as theprices for those products did not increase proportionately with theincrease in feedstock costs. However, throughput margins benefitedfrom strong margins on distillates and from wide differentials forthe heavy and sour crude feedstocks.
Second quarter 2008 operating income was also affected by $148million increase in refinery operating expenses from the secondquarter of 2007. This increase was mainly due to higher energycosts from the increase in the cost of natural gas and electricity.
Second quarter throughput volumes averaged around 2.7 millionbarrels per day, which was 48,000 barrels per day lower than thesecond quarter of 2007 but, nearly 140,000 barrels per day abovethe first quarter of 2008. The increase in volume from the previousquarter was primarily due to higher operating rates at Port Arthurwhere we completed the coke drum repairs and also at Aruba wherethe vacuum tire repairs were completed.
General and administrative expenses, excluding corporatedepreciation, were $117 million. The $18 million decrease from thefirst quarter was mainly due to decreases in expenses forenvironmental and legal reserves and incentive based comp expense.
For the second quarter, total depreciation and amortization was$369 million and interest expense net of capitalized interest was$83 million both in line with our guidance.
Our effective cash rate on continued operations was 33%.
Regarding cash flows for the quarter, capital spending was $741million, which includes $100 million of turnaround expenditures. Inthe second quarter, we continued our stock buyback program byspending $182 million to purchase 3.8 million shares of our stock.
We have also purchased 2 million shares in July, which takes ourtotal purchases to nearly 15 million shares for the year. Wecurrently have approximately $3.6 billion of re-purchasedauthorization in addition to our ongoing anti-dilution program.
With respect to our balance sheet at the end of June, our totaldebt was $6.5 billion. We ended the quarter with a cash balance ofabout $1.6 billion and our debt to capitalization ratio net of cashwas 20.5%, an improvement from the first quarter ratio of 21.7%.
As to third quarter operations, the following guidance assumes thatexcept for the closing of Krotz Springs transactions, which I willdiscuss in a moment, no other divestitures are expected to close inthe third quarter.
So for modeling purposes, you should expect Gulf Coast refinerythroughput of approximately 1.45 million to 1.5 million barrels perday; Mid-Continent throughput should be about 430,000 barrels perday. West Coast throughput should average between 280,000 and290,000 barrels per day. And the Northeast system should average inthe range of 540,000 to 550,000 barrels per day.
On refining cash operating costs, they're expected to be about$4.60 per barrel.
For some of the other items for the third quarter, we anticipateG&A expense to be around $135 million. Net interest expense shouldbe around $75 million. Total depreciation and amortization expenseshould be around $370 million. And for the third quarter weestimate a 34% tax rate, which excludes the effects of the gain onthe sale of Krotz Springs.
After reviewing our capital plans, we are reducing guidance for our2008 and 2009 expenditures on capital and turnaround costs. Weestimate 2008 expenditures will come in around at $3.8 billion,down $400 million versus our previous guidance of $ 4.2 billion anddown $700 million from our original estimate of $4.5 billion.
And although we're still developing our 2009 numbers, an earlyestimate is that next year's capital spending and turnarounds willbe in the $4.5 billion range. This estimate includes workassociated with the Hydrocracker projects at our St Charles andPort Arthur refineries.
The sale of the Krotz Springs refinery was effective July 1, anddue to the long-term product supply agreement between Valero andElan, the disposition does not constitute discontinued operations.In our prior period results for the Krotz Springs operations wewill not be re-classified as such.
Now, I'm going to turn the call over to Bill.
William R. Klesse - Chairman, Chief Executive Officer and President
Thank you, Mike. As Mike said, we ended the quarter with a balancesheet in excellent shape and an excellent cash position. Ouroperations continued to improve. At Port Arthur we had repaired thecracks in the coke drum and are pleased with the results. Thisshould allow us to defer replacing these drums until late 2009, orearly 2010.
Repairs to the Aruba Vacuum Tower were also completed and wecompleted the turnaround of the Delaware city coker. With strongdistillate margins and reasonable discounts for heavy sour crudeand feedstocks, the return of our complex coking refineries ishelping our earnings.
Also, as crude oil prices have been falling recently, thedifferentials or losses we incur on other products of thesesecondary products, about 20% of our output are also narrowed.
There is no question that gasoline margins continue very weak.Clearly, gasoline demand in the United States has slowed reflectingthe weak economy, the general feeling of less wealth, the highprices and the impact of ethanol.
Interestingly, ethanol is having very little impact on crude oilprices, but it's having a significant impact on refiners and a hugeimpact on food prices. Distillate demand is lower in the UnitedStates as well, but world demand primarily in Europe, SouthAmerica, and Asia is more than offsetting the weak domestic demand.
Lower refining operating rates, especially in cat crackers willcontinue. With an economic recovery, lower pump prices and thestabilization of the housing and financial industries, we expectgasoline and diesel demand domestically to recover.
Concerning our strategic review process for our modeling [ph]methods, we have not received an acceptable proposal that willjustify a sale. We will not undertake a transaction that is not inthe best interest of our shareholders and employees. We continue toevaluate our options.
For Aruba we continue to pursue a potential transaction. Clearly,we have not met our own schedule, as the asset strategicalternative effort is going slowly for a number of reasons, some ofwhich are the general economic situation, the availability of debtfinancing and the current financial situation of some of the otherindependent refiners.
We have already sold two refineries at values that are in ourshareholders' interest and we'll continue to review our assetportfolio to maximize long-term shareholder value.
Given our healthy balance sheet, improving earnings power in atough margin environment, we, as you, are disciplined that ourValero stock is trading at an equity market cap of about $17billion, about our inventory and cash values.
Adding our debt, we estimate our assets are being valued for lessthan 20% of replacement costs. If our refineries had the samecomplexity adjusted value that we received for Krotz Springs, ourstock price would be twice as high. Our current valuation appearsvery low.
Also, the world oil demand continues to grow. With expected growthof around 1 million barrels per day this year, which requiresadditional refining capacity. As always, location, configurationand the commitment to excellence are key to success. Our productsadd value to society; they improve the standard of living of allpeople around the globe.
We will now open the call for questions.
Ashley Smith - Director of Investor Relations
Christine?
Question And Answer
Operator
Thank you. [Operator Instructions] And our first question comesfrom Paul Cheng from Lehman Brothers. Your line is open sir.
Paul Cheng - Lehman Brothers
Hi. Good morning gentlemen. Mike, can you give me some of quickbalance sheet number, what is the working capital, long term debtand market value of your inventory in excess of the book value?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Okay, okay, right, our current assets are about a little over $15billion. And if you exclude the cash of about $1.6 billion thatwould be about 13.6 in current assets. Current liabilities 12, alittle under 12.8... little under $13 billion. And we have currentmaturities of $200 million. Net working capital is 24 but if youexclude cash and current debt, it's right at $1 billion net workingcapital.
Paul Cheng - Lehman Brothers
And what is the equity excluding the intangible value, intangiblegoodwill?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Goodwill is what about... 4. $4 billion is our goodwill, $14.7would be our equity without the goodwill.
Paul Cheng - Lehman Brothers
14.7.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Yes. You asked about the debt, or total debt is $6.5 billion.
Paul Cheng - Lehman Brothers
And you say that 200 is in the short-term, right?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
That's correct, we only have 200 in....
Paul Cheng - Lehman Brothers
So long term is 6.3.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
That's correct.
Paul Cheng - Lehman Brothers
How about the market value of your inventory in excess of the bookvalue?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Okay, it's about 10 at June 30, it's about $10 billion in excess ofour book value.
Paul Cheng - Lehman Brothers
Great, Thank you. I think it's also going from my... is there anymeaningful inventory gain or loss or trading or hedging gain orloss that in the quarter we should be aware?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
No, Paul there's not.
Paul Cheng - Lehman Brothers
Okay. And Bill or Mike you said for next year that the purchase isabout $4.5 billion, I think that is in line with what you guys havebeen saying. Let's assume under the worst case scenario, the marketcondition doesn't really improve much from here, what is theminimum capital spending that we may be talking about? I mean whatis already committed and what can be cut?
William R. Klesse - Chairman, Chief Executive Officer and President
Well, we are in the middle of our strategic planning process rightnow. And so $4.5 billion is where we would call our guidance goinginto 2009. And it has been what we have been saying. Our stay inbusiness, our maintenance capital is somewhere between $2 billionand $2.5 billion a year. Next year is a little higher turnaroundyear for us, and then you get into a question we have to do ascrubber at the Venetia refinery which is a large project, that'shalf-through regulatory project. So we get up around $3 billion.After that their projects that have economics and if it's as yousaid we are going to look at everything we are doing. The mostimportant thing that we will do is we will maintain our creditrating with the agencies.
Paul Cheng - Lehman Brothers
Bill, what... how much is the remaining spending in 2009 related toPort Arthur Hydrocracker?
William R. Klesse - Chairman, Chief Executive Officer and President
The spending this year on hydro-cracker?
Paul Cheng - Lehman Brothers
No, for 2009.
William R. Klesse - Chairman, Chief Executive Officer and President
2009.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Can you do that?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
For Port Arthur hydro-cracker that total project is $2.4 billionand I am going to guesstimate something like $600 million.
Paul Cheng - Lehman Brothers
600. So that means in that theory if we just look at what needs tobe spent for the hydro-cracker in your maintenance and the scrubberthat you are talking about 3.6, 3.7 that's probably the minimumthat you need to spend?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Well, we are also doing a hydro-cracker St. Charles and so tofinish through your question, but it depends on the economics toour cash flow next year.
Paul Cheng - Lehman Brothers
Okay.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
We will look at everything. The most important thing to us is thatwe'll maintain this credit rating.
Paul Cheng - Lehman Brothers
And
William R. Klesse - Chairman, Chief Executive Officer and President
And just see, Paul, we still are running our balanced approachhere. We have bought so far this year as Mike said 15 millionshares. And we intend to keep the balanced approach going forward.
Paul Cheng - Lehman Brothers
Sure. Yes I mean that's certainly the right thing to do. Bill, youtalked about the Aruba, I think previously you were hoping that topost a billion the second quarter. And can you give us maybe alittle bit more insight or color in terms of what is holding up? Isthere any major issue between you and the seller... and the buyer,that it still needs to be negotiated or that is just...?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Well we did hope to close it in the second quarter and we've beenunable to do that. We are still in discussion with the potentialbuyer that's gotten so much write up and everybody's pressed. Andwe are discussing the transaction.
Paul Cheng - Lehman Brothers
Is there anything that sticks out, is that... is the major hurdleat this point, or that is just in general?
William R. Klesse - Chairman, Chief Executive Officer and President
I think many of the articles that have been written that havelooked at the potential buyers, domestic refining versus foreignrefining, future oil production, where it gets consumed have beenissues that had been... for them to decide.
Paul Cheng - Lehman Brothers
Okay. All right, so it is not because of the price or anythingthat, you guys are negotiating?
William R. Klesse - Chairman, Chief Executive Officer and President
Well, I don't know, we haven't closed it.
Paul Cheng - Lehman Brothers
Okay, very good. Thank you.
Operator
Your next question comes from the line of Paul Sankey with DeutscheBank. Your line is open sir
Paul Sankey - Deutsche Bank Securities
Hi, good morning guys. You mentioned maintaining your credit ratingat the same time, it's got $1.6 billion in cash at the end ofquarter. Are you going to continue to run that kind of cash balanceor do you expect to work that down a little bit? And could you rollthat... the answer to that question forward into an expectation forbuyback, let's say, all things being equal in the second half giventhat you started Q3 quite strongly on that front? Thanks.
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
We've been running a cash balance that's been in this range. And soto be specific to you we will maintain cash, it's in this $1billion to $1.5 billion range.
Paul Sankey - Deutsche Bank Securities
And then further to that the buyback expectations?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
We intend to continue do the balance. We are also funding ourprojects because we believe these projects generate long-termshareholder value. And so we're going to do just what we've beendoing, first quarter we paid off $375 million of debt. We're goingto keep this effort going forward paying off some debt returningcash to the shareholders, maintaining some cash on our balancesheet and funding if long term projects that really have a lot ofvalue. So, I know that you're asking us but we're going to justkeep going... doing what we've been doing.
Paul Sankey - Deutsche Bank Securities
Is it fair to say that the step-up in July in the buyback was thefunction of Krotz Springs completing so that we could expect any...if you like about a larger buyback amount in the second-half to berelated to transaction as opposed to just redeploying free cashflow?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Krotz Springs did close and so we deployed the proceeds for theuses, I just got we're saying [ph]. We also had our stock pricefall in the early part of July and our window here from legal wasstill open. So we stepped into the market.
Paul Sankey - Deutsche Bank Securities
Okay, so basically you are saying you are going to try and completethe program by the end of the year?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Well, I'm going to continue to do a balanced approach. The program,I'm not sure what program we're talking about. We have $3.6 billionof authorization from our Board; we do not intend to buy that muchstock this year.
Paul Sankey - Deutsche Bank Securities
I got you. A second one if I could, it's notable that the heavylife spread is narrowed significantly as we start Q3. But at thesame time you had an announcement about obtaining Canadian heavycrude longer-term, Bill, could you just talk about the dynamicsthat caused the heavy lights get so wide in Q2 the extent whichthat helped your earnings and where... how you see that continuingwhether or not you think the tightness that we are now seeing inthat spread is going to continue and how it's going to behave overthe interim between where we are now and the first Canadian crudecoming, which I guess is beyond 2010, isn't it?
William R. Klesse - Chairman, Chief Executive Officer and President
As the heavy sour differential has narrowed, what has happened isthat, Mexico has stepped into fuel oil market to buy fuel oil forits electric utility business, that has strengthened fuel oilmarkets in the Gulf Coast significantly. They've been in thatmarket in July and they're in that market again in August. So wesee it more as a spot short term situation with that differentialnarrowing and also narrow seasonally with the asphalt business. Aswe get later in the year we would expect that differential to openback up.
Now long term, piece to your question, clearly the Maya productionover say five... next five years appears to be declining quiterapidly. You can get that from any consultant that publishes onMaya. And thus when we look strategically long term, we believethat Canadian crude oil, heavy Canadian crude needs to come to theUS Gulf Coast and that is why Joe Gorder and Gene Edwards and grouphave worked on our project here to bring Canadian crude with acouple other companies to the US Gulf Coast and why our Port Arthurrefinery will be configured to run, heavy Canadian sour. And thatis like five year out, four year out project. Are you still therePaul?
Paul Sankey - Deutsche Bank Securities
Yes sir, I was on the mute. So just to sum it up very quickly, youexpect the current tightening that we've seen in the spread towiden out towards the end of the year, perhaps start re-tighteningas we go into 2010 and then open up wider when get move Canadiancrude coming down in the future.
William R. Klesse - Chairman, Chief Executive Officer and President
Yes.
Paul Sankey - Deutsche Bank Securities
I'll leave it at that. Thanks a lot guys.
Operator
Your next question comes from the line of Roger Read with Natixis,your line is open sir.
Roger Read - Natixis Bleichroeder
Yes good morning gentlemen. Going after the commentary that was inthe press release regarding, and I think an evaluation of thefutures market can see the weaker gasoline margins in the back halffor the year run cuts, is that something more of a comment aboutwhat the industry has to do, what Valero would do, maybe somethingof a leader on this? Do you see it as a geographic or as a acrossthe nation kind of cut on the run side?
William R. Klesse - Chairman, Chief Executive Officer and President
Well, clearly the crack spreads in the markets are very weak goingforward for the rest of the year. For conventional there is apremium, remember for RBOB, CBOB and all the rest of it. But youare exactly right. And so, Europe is very low on gasoline. You cansee that looking at the East Coast cracks. So quite frankly thereis a lot of gasoline around. As we move into the Fall, vaporpressure restrictions lessen. And so there is more supply as butanegets back into the gasoline pool. So I think it's fair to say thatcat crackers as I said will continue to have reduced operatingrates. And also, you can make your own judgment as to the industry.
Roger Read - Natixis Bleichroeder
Okay. And what would that mean in terms of distillate productiongiven especially that's been the... the one true bright spot in theindustry in terms of how much can you improve the yield there ifyou're overall, having to make cuts on the gasoline, so I'd ...
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Sure I think, I can make some comments about that. So if you lookat our performance second quarter versus first quarter, weincreased distillate production by about 110,000 barrels a day andsome of that is throughput related because we had higher volumes inthe second quarter. But we can readily identify a distillate yieldshift of about 3% on input, It would represent about 75,000 barrelsa day. We think that we can expand that in the near term to about100,000 barrels a day of increased distillates. Full potential maybe as high as 200,000 barrels a day. But getting that second100,000 will require some capital retrofits which will take time toimplement and take some economic evaluation. But we're pretty wellpositioned particularly with some of the casual assets we'vebrought on stream last year that increased producibility.
Roger Read - Natixis Bleichroeder
Okay. And the say capturing the additional 25,000 barrels a daywill be more of a say 2010 event or something like that?
William R. Klesse - Chairman, Chief Executive Officer and President
To take it from the 75 to 100, I think that's capturable in thenear term within the next six months let's say.
Roger Read - Natixis Bleichroeder
Okay. But there is the additional 25 beyond that would be more of a2010... I mean I'm trying to think about maximum ability to takeadvantage of current market conditions we can see it go to 100 andthen 125 is more of 2010 event or something like that?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
No, I don't think that, it's going to extend into 2009, some ofwhat we have planned is we have some of our refineries thatactually are configured hardware wise to make large volume ofgasoline, this would pertain to Corpus Christi and to Venetia.There are retrofits that we have under consideration for 2009turnarounds that can give us another boost in distillateproducibility. So I think the way to look at this is
we are going to ship away this total potential of around 200,000barrels a day. And so we are going to just continue to makeprogress. When you get out to late 2010 is when we expect to bringon these new large hydro crackers at Port Arthur and St. Charlesand that will be another large boost in our distillateproducibility.
Roger Read - Natixis Bleichroeder
Okay, thank you.
Operator
Your next question comes from the line of Jeff Dietert fromSimmons. Your line is open sir.
Jeff Dietert - Simmons & Company International
Good morning. I was hoping you could talk a little bit about theexpansions of St. Charles and Port Arthur. I think if you look atthese expansions on a dollar per barrel a day capacity or dollarper complexity barrel they were more expensive than your stock 9months ago, and they are much more expensive than your stock atthis point trading as Bill talked about at 20% of replacementcosts. Obviously, your current portfolio and the feedstock andyield associated with St. Charles and Port Arthur refineries arenot the same. Could you talk about how those economics have evolvedover the last 6 to 9 months and why it's a better alternative toinvest in the expansions at St. Charles and Port Arthur than buyback your own stock?
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
Let me speak to the economics on these projects. And what I wouldsay is reflecting back on the last year, we feel even better aboutthese projects than we did when we requested approval for them now.Just bear in mind when we look at these projects we were in $65 abarrel crude environment, now we are much higher. These projectssince they are hydro-cracker based they result in significantvolume gains. So as a result they are far more attractive from thereturn on investment point of view than we even considered about ayear ago. So we continue to view these as key projects to supportearnings for open position as we go into the future.
William R. Klesse - Chairman, Chief Executive Officer and President
I think if you would add to what... or adding to what Rich says, ifyou think about our hydro cracker you take natural gas and you makehydrogen. The hydrogen then becomes liquid in the hydro cracker. Sothat is volume gain. If you look at the relative pricing ofeverything and the way to think about it, it really becomes the gasto liquid project.
Also, we're configuring these refineries which are key flagshiprefineries of ours, along with a couple of others so that to beconfigured to make products to the marketplace, we think we'redealing with. And because our hydro crackers and of course thecoker at Port Arthur running the Canadian crude oil, will have150,000 barrels a day of coke and capacity at Port Arthur, combinedwith this new hydro cracker in the same as St. Charles, we'll have80,000 barrels a day coke and capacity combined with the new hydrocracker that will increase our distillate yields.
So, the economics to these projects are very good, the lead time ishuge. I think some of know that we ordered these reactors, hydrocrackers each of these 10.2, 11 inch wall reactors, they've beenordered now for, say 18 months at least, and because the deliveryis so long, and they are going to add tremendously to the future ofour company. So when you stack this up with $32 stock price, Iunderstand the issue very clearly. We've done a balanced approachhere. We've already spent on those $800,000 million this yearbuying our stock. We continue to do what I mentioned in thequestion earlier from Paul. But we think these are key projects tothe future of Valero and to add tremendous value for ourshareholder.
Jeff Dietert - Simmons & Company International
And now if I am sorry. Am sorry, were you finished Bill?
William R. Klesse - Chairman, Chief Executive Officer and President
Yes, I am, and the other things I would add is we are eliminating alot of things and delaying a lot of things in our budgets to managethis capital spending with our cash flow if at all it demands on itand to maintain a buyback program. So I am done Jeff.
Jeff Dietert - Simmons & Company International
Okay. And so these two projects are two of your highest priorityprojects and you would... you are pushing other projects out of themix in order to maintain positive cash flow or cash flow...positive free cash flow for this year of '09 and 2010 factoring inthe potential for asset divestitures and the margin environmentover time.
William R. Klesse - Chairman, Chief Executive Officer and President
That's correct and we, as I said very clearly, we still are lookingat strategic options or alternatives for some of our refineries.And if the environment improves and some asset action is clearly inour shareholders 'interest we are interested. If it is not we donot have to do it. Our refineries are improving everyday in theliability safety and their performance.
Jeff Dietert - Simmons & Company International
You've issued some maintenance activity for the second half of theyear, were all these projects, planned maintenance or is there someunplanned maintenance or accelerated maintenance incorporated here?With specific interest on the hydro crackers looked like there afair number of those and those are your main distillates units?
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
Yes Jeff, we are really executing our base plans on turnarounds sothere really isn't anything due... there aren't any new issues thathave crept us. So we are implementing the programs that weanticipate in turnarounds in 2008. Our turnarounds activity willramp up in 2009 but we have been projecting that quite sometime.
Jeff Dietert - Simmons & Company International
Thank you for your comments.
Operator
Your next question comes from the line of Neil McMohan withBernstein. Your line is open sir.
Neil McMohan - Sanford Bernstein
Hello, just a few questions, first of all, maybe you commented onthis, it took me a while to get on the line. What part of thecapital program are you declining this year and is there any followon into the 2009 budget?
William R. Klesse - Chairman, Chief Executive Officer and President
Well we haven't declined so much this year, except we're just...things are a little bit behind, it takes longer to get equipmentnow from permitting equipment to labor, productivity continues tobe a problem. So we are... that's why we are issuing lower guidancebecause we are not going... we are going to spend somewhere in this$3.8 billion that we set.
But more importantly we're not starting projects at some of ourfacilities. For instance we had a project in Quebec to upgrade ourbombs [ph], we are now pushing that project off. We have a pipelineproject in Canada that we're re-assessing when that should be done.We have a paraxylene project at St. Charles that as we aredeveloping our strategic plan here, we are going to do certainextraction aspects of it, but we may not directly enter theparaxyline business here, we are just deferring it.
So we are in the middle of strategic planning and also looking atobviously the real world of the current cracks and maintaining andare looking at our cash flows and we are... and maintaining ourstrategic efforts here. So we are going through it project byproject and in this particular case, Rich Marcogliese, MikeCiskowski and I are directly involved in going through our capitalbudget line by line. And then our strategy meeting is in Octoberwith our Board.
Neil McMohan - Sanford Bernstein
Great. Just a second question is, I'd like to be honest, I knowwe've talked about, you shared in details around operatingperformance and what could be going on. But I think frankly and Idon't know if you would agree, it pretty much needs an uptick inthe refining environment for a tight up where less all [ph] boatscan get the stock price moving again. What do you think is going todifferentiate you over let's say if go through a sustainedreasonably weak period going forward, in particular I am looking atyour diesel strategy which seems to be totally differentiatedversus all the other independent refineries, and frankly versusmost of the integrated refineries in the U.S. Is that something youthink is going to really make you stand out versus others as wellas your exposure to make the light heavy and things like that?
William R. Klesse - Chairman, Chief Executive Officer and President
Well that is very good question. I think that we differentiateourselves right now Shawn [ph], we are still making money. We haveearnings power in our assets. If you actually look at our well... Iwill call our reliability starting from January through to today,once we got past this coker from we had at Port Arthur here in thatmajor repair we did that stretch out for almost four months, ourreliability has improve tremendously. So I do believe that we areexcellent operators.
We've had a lot of refineries that were under invested, undermaintained for years. And you can see us constantly improving ourperformance but clearly we had some refineries that can compete onthe world market. If you look at some of the actions that I justmentioned we're taking we also have export capability. People don'tlike to talk about exports but the facts are it's a world market.This is a global business; we've been sending distillate all overthe place to Europe, to South America. Our facilities along the USGulf Coast are gearing up to do that...
So being a good operator, spending our money wisely, we'vemaintained a balanced program here. We've increased our dividend,we've been buying shares, we are trying very hard to only spendmoney on projects that clearly hedge your all the value. And wecontinue to look at our portfolio. Some people criticized us threeyears ago, when we got out there looking disposing of some of ourrefineries. There I don't think too many people are second guessingthat action today. So, I think we are demonstrating that we can beprofitable in this business and we will be going forward.
And to your diesel question, we see the growth in the world ondiesel fuel. And so, thus our efforts as Rich just articulated tomake more diesel, to export diesel and also to add to ourfacilities to make more in 2010.
Neil McMohan - Sanford Bernstein
Great. Thanks for that and maybe just a comment, Bill thanks foryour comments in that press release today on what the... whatCongress should do in terms of Energy Policy in the US, as thereactually isn't an energy policy in the US. I think it's about timesomebody stood up and talked about it.
William R. Klesse - Chairman, Chief Executive Officer and President
Well I appreciate your comment but all of us are tax payers, whythey don't let, and we do not drill. So we feel very like we arenot compromising here. All we want to lower oil prices. We thinkit's good for our company, good for the shareholders, good for theconsumer. The government gets money selling leases, people go towork drilling, steel mills go to work making more pipe. This wholething is unbelievable.
Operator
Your next question comes from the line of Michael LaMotte with JPMorgan. Your line is open sir.
Michael LaMotte - JP Morgan
Thanks. Good morning guys. I was hoping you could provide somecomments on the flow patterns that you're seeing in distillatesexports today and how that's changed over the last few months,particularly as we start to come out of the winter season in theSouthern Hemisphere?
Joseph W. Gorder - Executive Vice President-Marketing and Supply
Well this is Joe Gorder. We have seen significant distillateexports here over the last several months in fact, reallythroughout all this year. But right now we are averaging over 25cargos and a month. So we do have significant export activity. Weknew that the Chile was the original recipient of a lot of that andthat was true for exporting now on a consistent basis also inNorthwest Europe, France is taking distillates, Italy is takingdistillates. So we got a lot moving out, we've exported some toTurkey. So we are seeing continued strong demand abroad not only inSouth America and also in Northwest Europe and the Med.
Michael LaMotte - JP Morgan
With Reliance fully up and running year end and couple ofrefineries coming online in China do you... are you fearful at allthat we could see some backing out of some of that demand aroundthe world satisfied by this more local capacity and some of thoseflows backing up into the US potentially next year?
William R. Klesse - Chairman, Chief Executive Officer and President
I don't know if they will back up into the US but your observationis correct. You're bringing on more refining capacity assuming itall starts up is planned and for instance Reliance puts 200,000barrels a day of diesel low sulfur diesel on the market it willclearly have an impact. But the world continues to grow and it isvery important to remember that whether it is a million barrelsthis year 900,000 barrels a day this year remains to be seen butthe world is still growing.
And also in the United States we shouldn't forget the diesel demandis down over 2% this year and gasoline is down depending on how youcalculate, ethanol is down somewhere between 3% and 4% that with abetter economy so you might say yes well you guys are hoping for animproved world economy. But clearly our products do, diesel fuel,economic growth, things like that we need a better economy. Italways comes down to the end of the day about the demand, becauserefineries typically can put on our products. So it's always aboutdemand. But your observation is correct, as supply comes in we needdemand to keep growing or we'll do what you said. We are optimisticthough that demand is going to keep growing.
Michael LaMotte - JP Morgan
Is that, which raises a question, Bill, on sort of whole notion ofcreative destruction that demands declining here domestically butoverseas growth still looking good and the need for capacityparticularly complex capacity overseas. I'm wondering if you'vetaken a look at some of the greenfield projects that have croppedup in the Middle East or parts of Latin America where you caninvest and maybe shed some light on you're thoughts on expansionoverseas potentially.
William R. Klesse - Chairman, Chief Executive Officer and President
Well, we're still interested, I mean this is our business, when youbuy our stock you buy our refiners. And so we're interested inthose kinds of transactions. But we also understand risk and theseprojects in the Middle East, the capital cost has gotten very, veryhigh. And so it boils down to at the end of the day where do theeconomics really look like, or is it just going to be a straightstandalone refining project in the Middle East. If it's that, it'sprobably not a play for Valero. If there is something else thatcomes with it, Valero would be interested in the right transaction.
As the world grows and the Middle East is resourced advantage, justlike the Far East, is consumer advantaged.
Michael LaMotte - JP Morgan
Petrobras in Brazil in particular, are stepping up their CapEx onthe downstream considerably over the next few years, and havelooked to do, I guess joint ventures or projects or partnering ofsome kind outside of Brazil, and I know reboot that aside, I'mwondering if there isn't something to be done with them, either inBrazil or outside... aside from Aruba?
William R. Klesse - Chairman, Chief Executive Officer and President
I think your observation on that then is right, they appeared tohave a lot of oil production is going to come on over the years.And they are dynamic, well managed company. So I think it justremains to be same.
Michael LaMotte - JP Morgan
Okay, thank you.
Operator
[Operator Instructions] Your next question comes from the line ofChi Chow from Tristone Capital Inc. Your line is open.
Chi Chow - Tristone Capital Inc.
Hi, thank you. Bill you talked a little bit about 2008, but couldyou give us your outlook for the gasoline market in the US for2009?
William R. Klesse - Chairman, Chief Executive Officer and President
You tell me where the price of oil is?
Chi Chow - Tristone Capital Inc.
Well, let's assume oil stays kind of where at that and we seemdemand destruction here in '08, do you expect that to continue ongasoline side in '09?
William R. Klesse - Chairman, Chief Executive Officer and President
If you say price oil is going to say $125 a barrel, I would say thegasoline demand is going to be declining. I also have to throw inthere though ethanol is in this mix. Ethanol this year is going toaverage 590,000 barrels a day under the RFS. And that is takingmarket share from refiners, at a huge cost to the works and to theUS tax payers. I think we'll see what the new administration doeswhen they get in there. If they have the will at all to look at atotally concede policy. But what happens when ethanol remains to beseen but this has taken significant market share from refiners,because as you know Chi, the US is still importing over a millionbarrels a day gasoline.
Chi Chow - Tristone Capital Inc.
Right. At what oil price do you think we avoid demand destructiongoing forward?
William R. Klesse - Chairman, Chief Executive Officer and President
I don't know for sure. Why don't you let me philosophize and saythat, as we started the year at a much lower price, what was it?Wherever we started the year,
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
$100 in January 1.
William R. Klesse - Chairman, Chief Executive Officer and President
$100 January, if you start thinking back when gasoline was $3 orless than $3 we lost the front page effect that was no longer anissue. But don't lose track of the fact that people are out ofwork. They don't feel as well there [ph]. Gasoline as for...gasoline as a percentage of disposable income is still not at thesame level it was in 1981. And so our products really do give youtremendous mobility. So I think we need prices to come down, I amthe first person to admit it. It is good for the consumer and begood for refiners.
Chi Chow - Tristone Capital Inc.
Okay, back on your answer to the question on the Port Arthur andSt. Charles projects, how sensitive are the project economics tothe availability of Canadian heavy crudes?
William R. Klesse - Chairman, Chief Executive Officer and President
They are not.
Chi Chow - Tristone Capital Inc.
Okay. Because that seems like.
William R. Klesse - Chairman, Chief Executive Officer and President
Because we clear... I can answer you this way. So you get, we arebasically looking at a Gulf Coast heavy sour crude price any way.
Chi Chow - Tristone Capital Inc.
Okay.
William R. Klesse - Chairman, Chief Executive Officer and President
So as you look at your economics we are basically doing that andremember the coking today has good economics as we all know. Andhydro-cracking as we've already gone through the economics areterrific.
Chi Chow - Tristone Capital Inc.
On those projects in the Gulf Coast, if you totaled up all yourcompetitors their expansion projects as well, we are probablytalking about what 800,000 of million barrels a day of newexpansion capacity down there by say between 2010 and 2012. Is thata concern on placing all that product into the market?
William R. Klesse - Chairman, Chief Executive Officer and President
I don't think it will all be placed in the United States and I'mnot sure about the number. Clearly multi [ph] is 300,000 and Garybuilds [ph] is 200 rounding off. But remember our projects areincreasing crude charge, a tremendous amount. We are really workingmuch harder on that whole product range. They go up but they don'tgo up with tremendous amount. So get adding those three projectstogether about 600 to 650, so there must be some other ones thatyou were referring to.
Chi Chow - Tristone Capital Inc.
All right. Got you. It remains to be seen how much of that comesonline but...
William R. Klesse - Chairman, Chief Executive Officer and President
I'll touch... it's right okay.
Chi Chow - Tristone Capital Inc.
Regardless it's a big number.
William R. Klesse - Chairman, Chief Executive Officer and President
And so when you look at us strategically, we are making surebecause we are on the US Gulf Coast and you don't think of USrefining as being in a sense of an export center. But we... thisbusiness is global, and we will have excellent capability to putour market... our products on the market for the best snapbacks andthat's part of our projects also.
Chi Chow - Tristone Capital Inc.
Okay I got one more, quick one maybe this is for Mike. Any furtherthoughts on repatriating proceeds in the event of Aruba'sdivestiture?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Yes we are in the process of I guess implementing a plan to returnthat money in the event that the divestiture goes ahead and happen.So we're in the process of putting that mechanism in place.
Chi Chow - Tristone Capital Inc.
Okay. Any guidance on what sort of tax that you may take there?
William R. Klesse - Chairman, Chief Executive Officer and President
I would say that we'll probably be able to bring that amount ofmoney back at o about 25% tax rate. So we would say it's roughly10%.
Chi Chow - Tristone Capital Inc.
Okay, great. Thanks for your comments.
William R. Klesse - Chairman, Chief Executive Officer and President
Yup.
Operator
Your next question comes from the line of Faisal Khan withCitigroup. Your line is open.
Faisal Khan - Citigroup
Good afternoon. There is a follow-up question on Aruba, while youcontinue to wait for the possible sales of that plant can youcomment on the level of profitability in Aruba right now?
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
Well, I don't think we get specific refinery details onprofitability but since we repaired the vacuum tower in late May oflast year the plant went very profitably in the month of June. Thathas narrowed some of the narrowing of the light heavy differentialsbut we are profitably operating the plant currently.
Faisal Khan - Citigroup
Thank you.
Operator
Your next question comes from the line of Ann Kohler with Caris.Your line is open.
Ann Kohler - Caris & Company
Yes good morning gentlemen. My question is kind of tied in a numberof the previous caller's questions. And that's kind of pertainingto one, the additional product that Chi alluded to with some ofexpansions occurring and then certainly Bill, from the pressrelease, you certainly indicated that the passage of CO2legislation would likely negatively impact the industry, from boththe gasoline and I would assume from the diesel demand as well.When you put all that together, how do you look at your businessand how do you look at capital spending, and I just feel theoverall refining environment and fundamentals as we move in to thenext decade, if that legislation comes to pass?.
William R. Klesse - Chairman, Chief Executive Officer and President
Well, Ann on the CO2 legislation, I guess, I don't think we knowwhat it looks like, if it's a cap and trade program, it's justbasically a tax. And long term, the reason I flag these climatechange issues when I speak is because long term, it's just going toexport refining jobs and these are good jobs for people that wantto work in our plants. But it just raises our costs depending onwhat the legislation looks like.
We have a lot of opportunity in refineries to reduce CO2 emissions.There's no question that we have all the ethers, boilers, furnacesthat as we go through we can improve upon. We'll look at extend ouroperations office, some of our cap. So we have opportunities toreduce CO2 and that's why we've mentioned earlier in the year thatif we use some incentives for all industry, and that could berefineries if CO2 drop significantly as opposed to just tax andstuff.
Now, as far as the business, the business is growing in the world.Chi's question was, give me the forecast, I think it has to do withpricing. Our products just unlike anybody, any other products andpeople's monthly budget, if our prices get down a lower percentageof disposable income, people are working, you got to get to work,we get choose to work the most sufficient way so that you can leaveon when you want to leave.
I am optimistic about our business but I also, as you've heard fromthe management here, we are preparing ourselves at our keyrefineries to make sure that we can also try in the export businessbecause the refinery has sunk and yet at the same time it is very,very efficient. So that's how we're doing this. We see total oilconsumptions are still increasing but I have already answered andsaid we are not... we wouldn't be roaring bolts here on gasolinedemand. We are optimistic about the business but you have to belean, mean tough competitive as the business that I've really knownmy whole career except for the last four, five years.
Ann Kohler - Caris & Company
So basically I mean I guess that it is sort of summarizing, I meanyou are basically looking than at Hungarian down an environment, ifCO2 legislation comes to pass and that would have certainly anegative demand impact on gasoline demand and an environment whereyou are basically prepared to position yourself with expertrefineries that are capable of moving product to the best availablemargin environment in the world?
William R. Klesse - Chairman, Chief Executive Officer and President
That is right, the only thing I will tell you is we don't know whatthe CO2 legislation looks like and the other thing is it takes along time to pass and if people are out of work and the housingbusiness is still in the dumps and people start talking about this.They better make sure they understand what it is going to do to theeconomy.
Ann Kohler - Caris & Company
Okay, thank you very much.
Operator
Your next question comes from the line of Eric Milky [ph] fromMerrill Lynch. Your line is open sir.
Unidentified Analyst
Hi good morning. I'm trying to be brief, I don't want you to haveto belabor this point. In your statement you talked about theimpact on industry utilization for the second half of the year andinto 2009 and most of the focus on the call has been on demand. I'mtrying to get a sense from you, what do you think can happen tosupply or what needs to having to supply in the US over the next 18months, if nothing happens to demand, if demand doesn't recover? Doyou expect competitors to be forced to take capacity off-line or onthe semi-permanent or as on a seasonal basis. And is there scopefor the industry to improve distillate yields along the lines ofwhat you have done and continue to do it?
William R. Klesse - Chairman, Chief Executive Officer and President
Well, I don't know what others will do and that's up to them. Iwill tell you that no one pays us to lose money. And there is nolaw that says we have to lose money. And so refiners, some of theother guys, integrators are reporting big earnings. Refiners,obviously with our earnings today are depressed. We manage ourbusiness here to make money; we are a business that purposes tomake money for our shareholders. And so as the cracks are outthere, we'll make our own determinations as to maximize our profit.But the key point would be, we... there is a law or regulation thatsays we have to make our product at a loss.
Unidentified Analyst
Okay, thanks.
William R. Klesse - Chairman, Chief Executive Officer and President
Right.
Operator
[Operator Instructions]. Your next question comes from the line ofMark Gilman with Benchmark Company. Your line is open sir.
Mark Gilman - Benchmark Company
Guys good morning. Hey I had a couple of things, Bill what woulddetermine whether or not you take an equity position in theKeystone pipeline?
William R. Klesse - Chairman, Chief Executive Officer and President
Probably if we get a look at it long term but one is the rate ofreturn at the end of the day what we really think equity return'sgoing to be and then secondly if we have structure here that takesadvantage of the tax benefits for owning that type of asset, andMark I would like to leave it there. If you want to talk aboutthis, if you call to guys they'll talk some more about it.
Mark Gilman - Benchmark Company
Okay. Bill what were the Maya volumes that you ran in the secondquarter and what specific crudes have you identified for the systemas being satisfactory alternates.
William R. Klesse - Chairman, Chief Executive Officer and President
Joe Gorder will answer you.
Joseph W. Gorder - Executive Vice President-Marketing and Supply
Yes, we were in around 450,000, 460,000 barrels a day in Maya. Asfar as alternate crudes, Mark you know there's a lot of heavy sourcrudes are available in the Gulf. We've got a lot of Venezuelancrudes that we've run and added to the system, we've got someColombian crudes and then Brazilian. So, we really haven't had anyproblem at all as far as securing heavy sour crudes and frankly asprices that are superior to the discounts we are getting on Mayatoday. We also increased the volume of Canadian crudes that we randuring the quarter. So we run some 25,000 barrels a day of Canadianheavy, sour crude now.
William R. Klesse - Chairman, Chief Executive Officer and President
As oil refiners we run our LP on all these plants and so weobviously by a lot of the M-100s besides Moray out of Venezuela.We've got some Napa, but we run our LPs, and we work the wholething, combined with a couple of our contracts.
Mark Gilman - Benchmark Company
Bill, on the West Coast, it seems to me that Alaskan and SanJoaquin heavy have gotten to be comparatively expensive crudes. Howmuch of that are you running out there, and have you done anythingabout trying to change that crude slate over?
Joseph W. Gorder - Executive Vice President-Marketing and Supply
Well, we're running more foreign crudes out there Mark as we go.I'd tell you what, I need to look and see what the exact volumes ofthose crudes are though, then we'll get that back to you.
William R. Klesse - Chairman, Chief Executive Officer and President
But we've been... I can give you some flavor there Mark. We havebeen reducing our A&F volumes and we'll continue to do that,because you're exactly right, A&F is, have the time it's selling ata premium to WTI. So, we have that effort under way. Are they longterm? Our long term strategy if you look at it today it's MiddleEast crude or maybe some of the Venezuelan, Arabian, Braziliancrudes are going to wind up on the West Coast. And that's whatwe've been doing to get our crude cost down at both Venetia andWilmington. We no longer run Maya crude on the West Coast atWilmington as that crude's been... it's not on the West Coastanymore, it's all in the Gulf Coast. So your point is correct.We... those are high priced crudes and we are strategicallycontinuing to go to alternates. We have a contract on A&F andthere's another date that comes up later in the year here; adds tothe volume. But based on my comments you can figure out what we aregoing to do.
We are also building two crude tanks at our Venetia refinery thatwill be operational --
Joseph W. Gorder - Executive Vice President-Marketing and Supply
December, January.
William R. Klesse - Chairman, Chief Executive Officer and President
At the end of this year or 1st of January. These are large tanks,650,000 each which will give us 1.3 million barrels of additionalcrude storage at the Venetian refinery so that we can execute thestrategy I just was articulating.
Unidentified Analyst
Does that still apply to San Joaquin, also?
William R. Klesse - Chairman, Chief Executive Officer and President
Yes, we're not as familiar, we don't run that much there. Is it 25?
Joseph W. Gorder - Executive Vice President-Marketing and Supply
25,000 to 40,000 barrels a day.
William R. Klesse - Chairman, Chief Executive Officer and President
25,000 to 40,000 at that plant. But the A&S has been a high pricecrude.
Joseph W. Gorder - Executive Vice President-Marketing and Supply
Yes, I mean that's still an attractive crude relative to A&S. So wetypically maximize as SJV.
Mark Gilman - Benchmark Company
Okay, how do you... how is your Arabian crude priced? You price itFOB, is it price delivered? When... where there any timing effectsin this quarter that might have impacted the North East margins inparticular? Or was the North East margin effect that we saw almostexclusively the impact of the coke return at Del city?
William R. Klesse - Chairman, Chief Executive Officer and President
I would say... we're going to say, yes, there is no impact, and thecoke return at the Delaware City was an extremely long turnover. Wehad... you had the proper, you can criticize us for execution here.The turnaround itself lasted about 35, 40 days. But then, we had awaste deep boiler problem and it took us basically 60 days to getthat coker up and that negatively impacted us tremendously.
Now in defense of our people who work diligently to get it up, thisis a fluid coker and when these... when you do this, it'scomplicated. So, we couldn't run without getting the waste deepwater up and so it took us... we had one leak after another on thetubes, but it did take us 2 months to get the coker turned aroundand back up.
Mark Gilman - Benchmark Company
So on the pricing in Arabian, is it FOB or delivered?
Joseph W. Gorder - Executive Vice President-Marketing and Supply
Delivered, we bought delivered.
Mark Gilman - Benchmark Company
And do you hedge it at all?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
Only above our LIFO.
Mark Gilman - Benchmark Company
And there was no adverse impact on results associated with theprocedure in that regard?
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
No that I would know. And the only... I'm going to correct onething. Don't we buy when it comes in to San Astasia?
Mark Gilman - Benchmark Company
When it comes in to San --
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
When it comes in to San Astasia, and then we do ship it up to theEast cost where we use Arabian crude on the East coast.
Unidentified Company Representative
Only a few day [ph].
Michael S. Ciskowski - Executive Vice President and Chief FinancialOfficer
But it's only a couple of days and we have not changed our policieson how we manage our price risk.
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
Mark if you're also looking for another element in looking at theNorth East profitability, the other factor associated with Delawarecity is when the coker's down you don't own the coke gasifier andthe coke gasifier has a major impact on energy pricing at therefinery. So in a sense the Delaware city profitability has adouble whammy, it's not only the coker that you lose but you cannotrun the coke gasifier when the coker's in turnaround.
Mark Gilman - Benchmark Company
Okay Rich thanks. I just have one more. It seems to me that toachieve the increase in the distillate yield what I did principallywas lower Brazilian and heavy sour in favor of Arabian lightmedium. Is that accurate? Maybe some cut point changes as well, Idon't know?
Richard J. Marcogliese - Executive Vice President and ChiefOperating Officer
Well, yes let me, Mark, I could talk about our general approachabout how are we increasing distillate yield across all of ourplants and we actually look at it this way.
Some of this relates to cut point maximization. Put as much frontend naptha into the distillate pool as you can and pull as muchheavy material off the cat crackers as you can and you generally dothat to a cetane limit in 2-way sulfurization limit. So we've donethat.
Additionally your cat crackers are usually fine tuned to makegasoline. We have detuned them largely through catalyst formulationchanges to have them favor just to what yields over cat napthayields; we have done that. Thirdly a new higher treating capacitythat we put in place to meet the original overall sulfur dieselregulations. We've already de-bottlenecked the new hardware much ofwhich was installed last year. So we have done a number of thingsto increase distillate yields. We always tried to maximize ourmargins by running the heaviest most discounted slates. So we havenot appreciably lightened up in order to maximize distillates. Thisis distillation cat cracking operations and distillate hydrotreaterdebottlenecks.
We are going to further look at whether certain of our hydrocracker operations such as Corpus and Venetia, whether we canchange the conversion levels of those to continue to increasedistillate yields.
William R. Klesse - Chairman, Chief Executive Officer and President
And the hydro... the two main hydrocrackers Rich mentioned wherewe... hydrotreaters, which we call mild hydrocrackers, at Houstonand St. Charles have had a major profit impact on us that'sfavorable.
Mark Gilman - Benchmark Company
Okay guys, thanks an awful lot.
Operator
We have no more questions in queue.
Ashley Smith - Director of Investor Relations
Thank you Christine, and to everyone who listened to our call,thank you for listening. Please contact our Investor Relationsdepartment if you have any other questions, Thank you.
Operator
This concludes your Valero Energy Corporation conference call fortoday. You may now disconnect your line.
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