Valero Energy Q3 2022 Earnings Call Transcript

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Provided by Quartr
October 25, 2022

Key Takeaways

  • Strong Q3 results: Net income of $2.8 billion (vs. $463 million), refining operating income of $3.8 billion (vs. $835 million), and renewable diesel segment income up to $212 million (vs. $108 million).
  • Robust refining fundamentals: Q3 utilization reached 95% amid constrained global capacity (~4 mbpd offline since 2020), strong product demand, low inventories, and wide sour crude differentials.
  • Renewable diesel growth: Record Q3 volumes, November start-up of DGD3 boosting capacity to ~1.2 billion gallons of renewable diesel plus 50 million gallons of naphtha, and on-schedule carbon sequestration pipeline progress.
  • Deleveraging and shareholder returns: Q3 debt cut by $1.25 billion (total $3.6 billion since pandemic), net debt/cap at ~24%, and 40% of operating cash returned via dividends and buybacks.
  • 2022 outlook: ~$2 billion capital investments (60% sustain, 40% growth), Q4 refining throughput targets set, refining OpEx ~$5.10/bbl, 750 million gallons of renewable diesel sales for 2022, and 4.1 million gal/day ethanol in Q4.
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Earnings Conference Call
Valero Energy Q3 2022
00:00 / 00:00

There are 20 speakers on the call.

Operator

Greetings and welcome to the Valero's Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Homer Voaler, Vice President, Investor Relations and Finance.

Operator

Thank you. Please go ahead.

Speaker 1

Good morning, everyone, and welcome to Valero Energy Corporation's Q3 2022 Earnings Conference Call. With me today are Joe Gorder, our Chairman and CEO Lane Riggs, our President and COO Jason Fraser, 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 1 on our website at investorvalero.com. Also attached to the earnings release are tables that provide additional financial information on our business segments and reconciliations and disclosures for adjusted 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 Expectations or predictions of the future are forward looking statements intended to be covered by the Safe Harbor provisions under federal securities laws.

Speaker 1

There are many factors that could cause actual results to differ from our expectations, including those we've described in our filings with the SEC. Now, I'll turn the call over to Joe for opening remarks.

Speaker 2

Thanks, Homer, and good morning, everyone. We're pleased to report strong financial results for the Q3, credited to our safe and reliable operational performance and continued strength And refining fundamentals, refining margins remain supported by strong product demand, low product inventories And continued energy cost advantages for U. S. Refineries compared to global competitors. Despite high refinery utilization rates, Global product supply remains constrained due to roughly 4,000,000 barrels per day of global refining capacity being taken permanently offline since 20 for a variety of reasons, including unfavorable economics or as part of planned conversions to produce low carbon fuels.

Speaker 2

Product demand across our system remains strong with gasoline and diesel demand higher than pre pandemic levels and jet fuel demand steadily Approaching 2019 levels. Our refining utilization increased to 95% in the 3rd quarter as we continue to maximize refining throughput. Our refining system also benefited from wider sour crude oil differentials to the Brent Light The wider sour crude oil differentials are attributed to increased sour crude oil supply. The impact of the IMO 2020 regulation for lower sulfur marine fuels and high natural gas prices in Europe that incentivize European refiners to process sweet crude oils in lieu of sour crude oils. And we remain on track with our refining growth projects that reduce cost and improve margin capture.

Speaker 2

The Port Arthur Coker project, which is expected to increase the refinery's throughput capacity, while also improving turnaround efficiency is expected to be completed in the first half of twenty twenty three. In our Renewable Diesel segment, we continue to optimize our operations, setting another sales volume record in the 3rd quarter. The new DGD3 renewable diesel plant located next to our Port Arthur refinery is currently in the start up process and is Expected to be operational in November. The completion of this 470,000,000 gallons per year plant It's expected to increase DGD's total annual capacity to approximately 1,200,000,000 gallons of renewable diesel And 50,000,000 gallons of renewable naphtha. And for our other low carbon fuel opportunities, The BlackRock and Navigators Carbon Sequestration Pipeline Project is progressing on schedule and is expected to begin startup activities in late 2020 4, we're expecting to be the anchor shipper with 8 of our ethanol plants connected to this system, which should provide a lower carbon intensity ethanol product And generate higher product margins.

Speaker 2

And we continue to evaluate other low carbon opportunities, such as sustainable aviation fuel, Renewable hydrogen and additional renewable naphtha and carbon sequestration projects. On the financial side, Our strong balance sheet remains the cornerstone of our capital allocation framework. In the Q3, we reduced our debt by an additional $1,250,000,000 bringing our total debt reduction to approximately 3,600,000,000 Since incurring $4,000,000,000 of incremental debt during the height of the pandemic in 2020, and we will continue to further evaluate deleveraging Looking ahead, refining fundamentals remain strong as global product supply remains constrained Due to capacity reductions and high natural gas prices in Europe, which are setting a higher floor on margins. In addition, we continue to realize the benefit from discounted sour crude oil and fuel oil feedstocks in our system. While geopolitical and macroeconomic factors may drive volatility in the market, we remain focused on what we can control, Maximizing refinery utilization in a safe, reliable and environmentally responsible manner to provide essential products.

Speaker 2

We also remain committed to advancing the growth of our low carbon fuels businesses to increase profitability and further strengthen our competitive advantage. So with that, Homer, I'll hand the call back to you.

Speaker 1

Thanks, Joe. For the Q3 of 2022, Net income attributable to Valero stockholders was $2,800,000,000 or $7.19 per share Compared to $463,000,000 or $1.13 per share for the Q3 of 2021. Adjusted net income attributable to Valero stockholders was $2,800,000,000 or $7.14 per share for the Q3 of 2022 Compared to $545,000,000 or $1.33 per share for the Q3 of 2021. For reconciliations to adjusted amounts, please refer to the earnings release and the accompanying financial tables. The refining segment reported $3,800,000,000 of operating income for the Q3 of 2022 compared to $835,000,000 for the 3rd Refining throughput volumes in the Q3 of 2022 averaged 3,000,000 barrels per day, which was 140 1,000 barrels per day higher than the Q3 of 2021.

Speaker 1

Throughput capacity utilization was 95 in the Q3 of 2022 compared to 91% in the Q3 of 2021. Refining cash operating expenses of $5.48 per barrel in the Q3 of 2022 We're $0.95 per barrel higher than the Q3 of 2021, primarily attributed to higher natural gas prices. Renewable diesel segment operating income was $212,000,000 for the Q3 of 2022 compared to $108,000,000 for the Q3 of 21. Renewable diesel sales volumes averaged 2,200,000 gallons per day in the Q3 of 2022, which was 1,600,000 gallons per day higher than the Q3 of 2021. The higher sales volumes were due to DGD-one downtime in the Q3 of 2021 resulting from Hurricane Ida and the impact of additional volumes from DGD2, which started up in the Q4 of 2021.

Speaker 1

The Ethanol segment reported $1,000,000 of operating income for the Q3 of 2022 compared to a $44,000,000 operating loss for the Q3 of 2021. Adjusted operating income for the Q3 of 2021 was 4,000,000 Ethanol production volumes averaged 3,500,000 gallons per day in the Q3 of 2022. For the Q3 of 2022, G and A expenses were $214,000,000 and net interest expense was 138,000,000 Depreciation and amortization expense was $632,000,000 and income tax expense was 8 $16,000,000 for the Q3 of 2022. The effective tax rate was 22%. Net cash provided by operating activities was $2,000,000,000 in the Q3 of 2022.

Speaker 1

Excluding the unfavorable change in working capital of 1,500,000,000 which was primarily due to our Q3 estimated tax payment and the other joint venture member share of DGG's 3,400,000,000 With regard to investing activities, we made 602,000,000 Capital investments in the Q3 of 2022, of which $185,000,000 was for sustaining the business, including costs for turnarounds, Catalyst and Regulatory Compliance and $417,000,000 was for growing the business. Excluding capital investments attributable to the other joint venture members' share of DGD and those related to other variable interest entities, Capital investments attributable to Valero were $479,000,000 in the Q3 of 2022. Moving to financing activities, year to date, we have returned 40% of adjusted net cash provided by operating activities to our stockholders Through dividends and stock buybacks, which is consistent with our guidance to be at the low end of our annual 40% to 50% target payout ratio, while focusing on deleveraging our balance sheet. With respect to our balance sheet, we completed another debt reduction transaction in the 3rd quarter that reduced Valero's debt by $1,250,000,000 As Joe noted earlier, this transaction combined with a series of debt reduction and refinancing Transaction since the second half of twenty twenty one have collectively reduced Valero's debt by approximately 3,600,000,000.

Speaker 1

We ended the quarter with $9,600,000,000 of total debt, dollars 1,900,000,000 of finance lease obligations and $4,000,000,000 of cash and cash equivalents. The debt to capitalization ratio, net of cash and cash equivalents, was approximately 24%, Down from the pandemic high of 40% at the end of March 2021, which was largely the result of the debt incurred during the height of the COVID-nineteen And we ended the quarter well capitalized with $4,900,000,000 of available liquidity excluding cash. Turning to guidance, we expect capital investments attributable to Valero for 2022 to be approximately 2,000,000,000 which includes expenditures for turnarounds, catalysts and joint venture investments. About 60% of that amount is allocated to Sustaining the business and 40% to growth. About half of the growth capital in 2022 is allocated to expanding our low carbon fuels businesses.

Speaker 1

For modeling our 4th quarter operations, we expect refining throughput volumes to fall within the following ranges: Gulf Coast at 1.73000000to1.78000000 barrels per day Mid Continent at 400 60,000 to 480,000 barrels per day West Coast at 250,000 to 270,000 barrels per day And North Atlantic at 440,000 to 460,000 barrels per day. We expect refining cash operating expenses in the 4th quarter to be approximately $5.10 per barrel. With respect to the Renewable Diesel segment, we expect sales volumes to be approximately 750,000,000 gallons in 2022 With the anticipated start up of DGD 3 in November, operating expenses in 2022 should be $0.45 per gallon, which includes $0.15 per gallon for non cash costs such as depreciation and amortization. Our ethanol segment is expected to produce 4,100,000 gallons per day in the 4th quarter. Operating expenses Should average $0.50 per gallon, which includes $0.05 per gallon for non cash costs such as depreciation and amortization.

Speaker 1

For the Q4, net interest expense should be about $140,000,000 and total depreciation and amortization Expense should be approximately $640,000,000 For 2022, we expect G and A expenses, Excluding corporate depreciation to be approximately $870,000,000 That concludes our opening remarks. Before we open the call to questions, please adhere to our protocol of limiting each turn in the Q and A to 2 questions.

Operator

A confirmation tone will indicate your line is in the question The first question is coming from Doug Leggate of Bank of America, please go ahead.

Speaker 3

Thanks. Good morning, everybody. Joe, I wonder if I could Take the opportunity to ask just your views on a couple of big picture macro issues. I mean, the quarter, your operational performance speaks for itself. I'm obviously delighted to see the cash returns back with the buyback.

Speaker 3

But my question, I guess, is your visit to the White House recently And your thoughts on the possibility of an export ban, product export ban that seems to be still rumbling on the table. So any color you are comfortable sharing there would be my first comment. And then my second question, if I may, maybe it's for Liam or one of the guys, but You did make a comment in your results about a higher floor on margins. I'm just wondering, I think you know our view on this. I'm wondering if you could elaborate on what you're

Speaker 2

Doug, that's great. Both good questions. So on the visit to the White House, Lane and I went in and of course there were 7 companies I think represented there. We ended up meeting with Secretary Granholm. And I would say that it was a constructive conversation.

Speaker 2

She was looking for Things that the industry might suggest that would try to bring down the cost of fuels. And so we did. We provided her with several Suggestions which would have an effect on increasing the supply of fuel into the marketplace, Thus far, I don't believe any of those have been embraced, but at least it was put on the table for her to give some consideration to. And so the team that we have involved in the process continues to work with her team. So the dialogue has continued.

Speaker 2

I know that our DC office has spent quite a bit of time continuing to work with them and then of course The supply folks back here also have been involved in those conversations. So the dialogue continues and I think they're looking for Just additional opportunities that they might have to reduce the fuel price. So, Rich, is there anything You would add to that? You or Lane?

Speaker 4

No, I don't think so. I mean, I think they understand the consequences of trying to Disrupt market flows and I think they realize that would probably be more harmful than helpful. And so I think that understanding is there. So I know They're looking at a lot of options, but I think that's the understanding they have from the industry at least.

Speaker 2

Yes. So that's as it relates to the potential ban on exports, Doug. I mean, I do think they understand the consequences of that. And I think the general consensus is it wouldn't have the effect That they're trying to achieve. So and then you want to take the second question?

Speaker 5

Yes, sure. Doug, this is Lane. From a work process, we define the mid cycle as being sort of the average margin with a few tweaks that we think are market anomalies that go in Through the entire business cycle, so we're not through the next business cycle yet, but we do believe structurally you have you've had entered a period where you have We've had refinery closures through the pandemic. You're going to have probably not as much investment in the fossil fuel In particular, refining going forward at a time when everybody is trying to understand exactly how the balances are going to work, but our view is there will be a higher call on refining capacity. So We don't we aren't prepared to quantify that, but we do believe the next mid cycle will be higher than the last mid cycle.

Speaker 3

Guys, forgive me for the quick follow-up, but there's a lot of concern, I guess, of Chinese exports hitting the market And obviously, new capacity expansion lane. So I just wonder if you could throw that into your consideration. Is that a concern for you guys in that definition of mid cycle? And I will leave Thank you.

Speaker 5

There has been a talk about we've seen some increases with respect to At least on the prompt that the Chinese are picking up purchases, but I don't know that we've really seen them in the market on products that much. I'm looking at Gary, by the way.

Speaker 6

No, I think our traders believe most of the Chinese exports are going to stay in the region. And then even if you kind of assume some of it comes into the North Atlantic Basin in Short term, the French refinery strikes are really offsetting any of that. And longer term, it looks like to us Any incremental volume coming out of China will be offset by further reductions in exports from Russia as the sanctions are ramped up.

Speaker 5

And then on a longer term basis, we just have an issue where the Europeans and North America and everyone else is just sort of under ES and G pressure aren't really trying To increase refining capacity. So if there is a region in the world that's going to raise refining capacity, it will probably be India and China.

Speaker 3

Thank you, Fose. Appreciate the answers.

Operator

Thank you. The next question is coming from John Royall of JPMorgan. Please go ahead.

Speaker 7

Hey, good morning guys. Thanks for taking my question. So you talked about bulletproofing your balance sheet In the prior quarter and you mentioned evaluating further reductions in your prepared remarks. How much lower would you like to get on your leverage before You kind of get to that bulletproof level where you can move off the low end of the 40% to 50% returns or do you think you're already there?

Speaker 2

John, that's a good question. We'll let Jason take a swack at it here.

Speaker 8

Yes, yes. As we've been talking about, we're still Working on paying down our COVID debt. We have about $432,000,000 left to have paid off the full $4,000,000,000 after accounting for the tender offer we did in This Q3, so we're working our debt down. And let's see on the cash side, we're at a $4,000,000,000 cash balance. We We talked about how going forward we like to hold more cash at $3,000,000,000 to $4,000,000,000 probably on the base level.

Speaker 8

But if you're looking at potentially higher flat price Levels or economic downturn, you maybe want to hold a little bit more, so we buy us to the upper end of that. So we're close to a good spot on both of those. On our long term debt to cap, we have a 20% to 30% range that we target. We're 24.5 Percent at the end of the 3rd quarter, down from a 40% at the highest point during COVID. So we've been working in the right direction.

Speaker 8

I'd like to be even lower. You'd like to be at the 20% range to give you even more financial flexibility going forward.

Speaker 5

So that's kind of An overview.

Speaker 2

So we're getting close to the point where, I mean, the low end of the range wouldn't necessarily be the target anymore.

Speaker 7

Okay. That's helpful. Thank you. And then, maybe you could talk about Refining Captures and how they're looking so far in 4Q. I know we have, We've seen October a rising price environment, but also you're seeing some tailwinds from heavy diffs.

Speaker 7

So, any color there just generally would be helpful.

Speaker 5

This is Lane. I are the heavy dips are baked into our margin indicators to some degree. So those will move with it. I think all things being equal, when you compare 3rd quarter to the 4th quarter and this is really in any given year, you'll see a blending of butane benefit. So If you hold all the other things constant, our capture rates are marginally improved because of we're going to blend more butane in the 4th quarter than we The Q3 and obviously if flat price moves up or down byproducts have an offset effect.

Speaker 5

So those are all still intact. But your biggest contributions to margin capture really is gasoline and diesel. So, we'll just see. But The main thing to always keep in mind going from Q3 to Q4 is blending of butane.

Speaker 9

Great. Thanks very much.

Operator

Thank you. The next question is coming from Theresa Chen of Barclays. Please go ahead.

Speaker 10

Good morning, everyone. I wanted to ask about your comments related to demand across your footprint first. Your wholesale volumes being very strong through last quarter and currently when you talk about demand surpassing 2019 levels for gasoline and diesel, Is that primarily driven by strength in your export channels? Is domestic demand in your areas of service equally strong? I'd like to get a sense of what's

Speaker 6

Theresa, this is Gary. Really, it's the domestic markets and our wholesale volumes have trended considerably higher. We set a wholesale volume record in August. We beat that in September and we're on pace to beat it again in October. So wholesale volumes continue to trend higher.

Speaker 6

If you look at the prompt market to our wholesale channels of trade, gasoline is trending about 8% above where we were pre pandemic levels. Diesel volumes are trending about 32% above where we were pre pandemic levels. So seeing really strong domestic demand through our wholesale channels of trade.

Speaker 10

Got it. Thank you. And in relation to the high European natural gas prices supporting Higher margins. Given the recent decline in TTF and your natural gas storage, over 93% Well, in lowering that Henry Hub to TTF spread, do you see any risk for a pullback of margins as a result over the Near term, while longer term, I imagine, just depends on the pace of liquefaction build out.

Speaker 5

I'll try. I'll take a shot at it and see if Gary can sort My comments, we still need to re inventory the Atlantic basin with diesel by and large. We're still when you look at inventory, stocks are slow. Most of what's happening in Europe, you have all these LNG ships that are sort of floating down. You still are Limited on the regasification of everything.

Speaker 5

So we'll just have to see how it plays out. But certainly in the last couple of weeks, at least for our Pembroke Refinery, natural gas prices Have

Speaker 10

fallen. Got it. Thank you.

Operator

Thank you. The next question is coming from Sam Margolin of Wolfe Research. Please go ahead.

Speaker 11

Good morning, everybody.

Speaker 2

All right,

Speaker 11

Sam. So we definitely see evidence, everybody does, of this structurally higher Margin environment. But more than just kind of through cycle margins being higher, the market is also sort of characterized by Anomalies like a very high frequency of sort of regional blowouts or single commodity events within the stream. And I was wondering if you could just Maybe speak broadly to that, not to ask too open ended of a question, but just is that are things like this a function of Kind of capacity coming down globally or just a very tight market on an underlying basis? Or is it really just a coincidence where we've had Kind of a bunch of one off things happen in sequence and that might not necessarily be a go forward trend.

Speaker 6

Yes. So I think some of it is structural. I think as Joe alluded to in his opening, we had a lot of refinery rationalization, Refining capacity converted to produce low carbon fuels and so much tighter supply demand balances, which structurally means a stronger market. Some of the things you talked about on market dislocation could be more transient in nature. A lot of that is just a function of very, very low product inventories, Especially in the domestic markets, I think we feel like through the winter period of time, you could see some restocking of gasoline, Which could prevent some of those market dislocations from happening at least in the short term.

Speaker 6

Diesel on the other hand looks to us to be remain very, very tight and I think you'll continue to see volatility in the markets due to very low inventory.

Speaker 11

Okay. Thanks for that. And then just a follow-up on DGD and the start up timing. In the past, when you guys start up a DGD unit, We can see feedstock prices or the veg oil complex sort of respond. And this year, I don't know if it's a timing issue where It hasn't really started yet in earnest or if the markets just adjusted to that demand ahead of time, but it seems like the feedstock Environment has tolerated starting new starting capacity a little bit better than in the past.

Speaker 11

If you have any thoughts about Just DGD 3 into the feedstock background, that would be helpful.

Speaker 12

Yes, this is Eric. I think what your observations are correct. We are not seeing The increase in feedstock prices like we did with DGD2 this time last year, thinking about what caused that, I think some of it is given refining margins, The conversion projects that had been announced, I think have largely been deferred or delayed. And with the drop in LCFS Divest prices, I think a lot of the projects have been deferred and delayed. So if you look, we just not we have not seen the increase in feedstock prices like we did last year With DGD 3 starting up, and we have bought feedstock for the startup in this quarter.

Speaker 11

Okay. Thank you so much. Have a great day.

Speaker 2

Sam.

Operator

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

Speaker 13

ahead.

Speaker 14

Thanks. Maybe one follow-up immediately on Diamond Green Diesel. You've been in pretty rapid expansion mode at DGD over the last couple of years. With the start up of DGD 3, will you take a pause here to Digest and evaluate for market conditions for a bit or how do you think about the strategic direction of Diamond Green Diesel unit over the next 5 years in terms of priorities there.

Speaker 12

Yes, I think like we've talked about this quarter and last quarter, LCFS prices continue to drop. And I think That is taking a lot of the fun away in this space. And so as you look across the industry, a lot of projects are getting deferred and delayed. And given the high energy prices across the world, everyone's kind of rethinking a lot of their policies. So we have to especially in Europe, you have Step back and see, are they going to continue the path and pace that they have been on historically?

Speaker 12

So I think, after DGD-three, we've said we will pause, Reassess the market, I think SAF is becoming a lot more interesting. But overall, I think there is a there will be a pause after DGD3.

Speaker 14

Good. Thanks. And then maybe you mentioned briefly in passing earlier, And I know it's a little speculative, but any thoughts on how you think trade routes and supply chains get impacted If Europe's ban on Russian product imports goes into effect early next year, is there a logical home for some of that Russian product To make its way to someplace else, South America or Africa, etcetera? Or do you think those Russian barrels just Going to go away and refining utilization falls

Speaker 13

dramatically there? Our view

Speaker 6

is that you will see a reduction in Russian of primarily diesel, they export a little bit of naphtha, not much gasoline. But on the diesel side, you will see a reduction in exports. You do have the potential For some of those barrels to find homes in South America and Africa, as you mentioned, but we kind of believe diplomatic pressures from the U. S. And from Europe, we'll kind of keep a lot of that from happening and you will see a reduction in exports from Russia.

Speaker 15

Great. Thank you.

Operator

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

Speaker 15

Hi, guys. Can you hear me, Jeff?

Speaker 2

Good morning, Paul.

Speaker 15

Can you hear me, Jeff?

Speaker 2

Yes, sir. We can.

Speaker 15

Could you talk a little bit about the strategic petroleum reserve releases, Joe? You mentioned a few things that made So our crude discounts wider, but my understanding was a lot of the drawdown in the SBR was crude. I was just wondering how much the SBR has affected you, I guess, operationally and from a profit point of view? And what your outlook is for the coming months? I would assume that you're anticipating that we taper and even stop releasing the crude.

Speaker 15

Thanks.

Speaker 6

Yes. So really, what we saw is with each of the SPR auctions, we have good logistics At our Gulf Coast assets to be able to receive the barrels, a lot of people really don't have the logistics in place to be able to take those barrels. Certainly early on, they were more sour barrels and we took a good volume of the SPR volume as it transitioned to more sweeter. We still saw value in our To take those barrels and we would expect that to continue moving forward as long as they're offering the barrels.

Speaker 15

Are you anticipating continuing drawdowns through, let's say, 2023? Or do you think they'll have to stop eventually?

Speaker 6

I think you'll continue to see drawdowns at least through this year and then start to see some restocking happen next year.

Speaker 15

Great. Thanks a lot. I'll leave it there. Thank you.

Speaker 2

Thanks, Paul.

Operator

Thank you. The next question is coming from Kiner Lapa of Morgan Stanley, please go ahead.

Speaker 16

Yes, thanks. I wanted to return to a topic that you had Mentioned briefly earlier, which is the suggestions that you made to the administration, on potential pathways for reducing fuel costs. I'm curious if you could just provide a little color on the things that the industry suggested.

Speaker 2

Well, Lane and I were both there. So you want to talk about it first?

Speaker 5

I think yes, this is Lane. So I think the main there was 2 main ones, which was one was increasing or relaxing the sulfur spec on fuels. Many of the U. S. Refiners didn't necessarily invest and it looks like either making ultra low sulfur diesel As much as maybe some others or Tier 3 gasoline.

Speaker 5

So consequently, they're in a posture of having to export Some of those some gasoline and some diesel to markets around the world that can handle the sulfur. So that was really, I think, the Two big ones. I mean, obviously, a part of that meeting was meant to see if there was any possibility somebody could start a refinery up. And we discussed The industry discussed the difficulty in doing that. And that was really the main ones.

Speaker 2

I mean, yes, waiving specs really on products was what we talked about. The one interesting thing, Conor, that came out of it too was Yes, there was consideration for the ability to restart refining capacity that had been shut down. And I think the general sentiment was That wasn't going to happen. Now, of course, we're not in that boat, but I mean, people had very good reasons for making the decisions that they made And they weren't in a position to unwind those decisions. So, the solution is going to probably have to come from some Waiving of regulation or just reduction in demand, which We just haven't seen to date.

Speaker 16

Makes sense. Semi related policy question, just given that the Inflation Reduction Act Just maybe had a bit of time to be digested by the market or players out there that you talk to. What types of opportunities are you seeing as more likely or more in the money, with the incentives in that bill?

Speaker 4

This is Rich Walsh. I'll take just a high level effort on it and then if we kind of give you an idea, I mean, really We're focusing on a number of things. One is that they have clean energy tax credits in there that are inactive that are really an extension of the BTC, See the blenders tax credit, which is helpful to us. There's also tax credits there for sustainable aviation fuel. And I think Eric had mentioned earlier that makes It's more interesting for us to look at.

Speaker 4

And additionally, there's additions for the 45Q tax credit, which we think strongly supports Carbon sequestration, and we think you're going to see more opportunities develop around that.

Speaker 16

Okay, got it. I'll turn it back here. Thank you.

Speaker 2

Thank you.

Operator

Thank you. The next question is coming from Paul Cheng of Scotiabank. Please go ahead.

Speaker 17

Hey, guys. Good morning.

Speaker 2

Hi, Paul.

Speaker 17

Two questions, hopefully Sean. First one is for Ming. I think back in the Q1 conference call, you gave a number of $8 in the diesel crack Advantage for U. S. Refiner versus Europe because of the natural gas price gap and at the time you're using, say, it is $25 gap.

Speaker 17

Since then, we have seen the European refiners essentially cut their natural gas consumption by half. So Q is that is there an update number you can share? And is it really that cut from $8 to For just linear or that we can't really do in that way. Secondly, that and also that if you can give us What is your natural gas exposure by operating region for you guys? The second question is on DGT.

Speaker 17

I think that the joint venture sold forward On the diesel contract, as a part of the hedge operation, so backwardation curve, you had heard it. In the 3rd Quarter, I think the penetration curve is substantially less than Q2. So we were surprised your margin captured didn't improve Comparing you to your benchmark indicator, is there anything going on we should be aware that lead to that or anything Any insight you can provide? Thank you.

Speaker 5

Hey, Paul. So, that was yes, I'll try to come back to that first question a little bit. But You're accurate in what I had stated in the Q1. Today, what we're seeing, at least in our timber refineries, natural gas prices have fallen. But I think What you're seeing in the Atlantic Basin, you're seeing in the diesel crack is the advantage is lower, but you still have a wide diesel crack and that's because a lot of the Finerys that are having to sort of re inventory the Atlantic basin are looking to running a lot of sweeter crude because they can't meet the fuel oil spec, right?

Speaker 5

So They end up bidding up the industry or at least the marginal guy out there is bidding up the sort of low sulfur crude price to try to meet the demand in the Atlantic Basin. So and you're seeing that in discounts, you're seeing medium sour getting cheaper, you're seeing heavy sour getting Cheaper. Part of that is also a function of redirection of all the Russian trade flow. So that's really in terms of a prompt basis what's driving the heat crack. I don't know that Europe solved this natural gas problem.

Speaker 5

We're just going to see. There's a lot of tankers sitting offshore trying to re gas. And so We'll just see how that goes.

Speaker 16

Eric, do

Speaker 17

you want to take that? Hey, Ming, before you go on that one, I just curious that, I mean, Yes. The advantage, U. S. Refiner versus Europe on the natural gas price gap, Does it impact that advantage when the European refinance cut their natural gas consumption?

Speaker 17

Or that doesn't we need that's not how you should be calculating or be aware?

Speaker 5

What I'm saying is versus the 4th quarter, 1st quarter really up until about 3 weeks ago, there was an advantage that you could see they were paying higher cost of fuel. We could also see when we use our Pembroke Refinery as a proxy, we were through that, right? In other words, even though now we had eliminated all of our natural gas purchases, but what we could see Was the profitability or at least your ability to what setting the marginal capacity out there in the Atlantic Basin is not So much around natural gas, I don't think today. I think what it is, is people are having to buy a very low sulfur crude oil to try to meet the low sulfur diesel spec And trying to avoid making a higher fuel oil spec. So in a simple term, some of it's being driven by IMO 2020 and the ability of some of these simple refiners can't deal with the crude oils that are available to them to restock the Atlantic Basin.

Speaker 17

I see. So, you actually don't think, yes, the natural gas is driving the advantage at all?

Speaker 5

Well, what I'm trying this is just a 3 week phenomena, Paul, I'm not sure I would jump out there and try to make it an annualized thing. I'm just saying, I think most of the for the last quarter, a lot of it's just being driven By the marginal economics of a simple refiner trying to buy having to buy low sulfur crudes to meet the Atlantic Basin diesel requirements.

Speaker 13

I see.

Speaker 17

Okay. Thank you.

Speaker 2

All right, Eric, you ready?

Speaker 12

Yes. So on DGD, What you said is correct that backwardation was less severe in the Q3 than the Q2. So the margin capture issue in the Q3 was more related to the feedstock slate that we ran. And As before, where we said we haven't seen an increase in feedstock prices, we did see and this is a little bit of a function of the margin indicator. We saw CBOT soybean prices drop $0.05 to $0.15 a pound below all of the waste oil feedstocks.

Speaker 12

And when you look at that Through the Q3, that was about 80% of the impact on the margin capture. So it's really related to What we're seeing is veg oils pricing at or below waste oil feedstocks. And so the only thing I would say Going forward to be aware of, we are increasing the amount of veg oil that we are running in the DGD complex, Not because waste oils are not available, just because we see flat prices of veg oils coming down to a point where the LCFS advantages Are not as strong versus what we see in waste oils. So We are incrementing veg oil into DGD because we see those prices are attractive.

Speaker 17

Eric, do you have a percentage? How much is the Vegetable oil, you're going to run-in the DGD3?

Speaker 12

Yes. We're not going to give out that level of detail. What I'll say is, Up until the Q4, we ran essentially 0 veg oil. So we're incrementing veg oil into the unit Because of this attractive price.

Speaker 17

I see. All right. Thank you. See you, Paul.

Operator

Thank you. The next question is coming from Roger Read of Wells Fargo. Please go ahead.

Speaker 9

Hello, everybody. Good morning.

Speaker 2

Hi, Roger.

Speaker 9

Maybe just to come back The cash returns to shareholders question, we're getting a lot of interest on Not just the 40% to 60% return, but how are you thinking about the split between those? And when should we think about Potential to raise the dividend, is it as simple as you get rid of the $4,000,000,000 that came With COVID or is there a step beyond that you want to see? And I think the question is growing more acute because as you look at the overall All crack spread environment, right? It's one that says you're earning above a typical mid cycle. Kind of an expectation I think here of greater than the mid cycle cash returns to shareholders is pushing on us.

Speaker 9

Just curious how you're thinking about it?

Speaker 8

Yes, this is Jason. I think Joe answered it pretty well. I ran through our Cash, we're up to $4,000,000,000 now, which is getting to where we'd like to be. The debt is getting to a good level of $24,500,000 We still like to do a little We have $430,000,000 left just to have paid off the COVID and prefer to be at the lower end of that 20% to 30% range. But Yes.

Speaker 8

We're getting into good shape, but I would say we're not declaring victory yet.

Speaker 2

Roger, it's and Jason answered correctly. We don't know what the Economic climate is going to be like going into next year. It's probably premature Certainly to make a commitment right now on anything that we're going to use the balance sheet to defend. And I think everyone clearly could see that we had stated in the past that we are going to defend the dividend with the balance sheet and we did that. And we will do that in the future.

Speaker 2

And so we just want to be sure that we don't need jerk And then we've got a line of sight that we get positioned where we want to be positioned and then we have line of sight to the way things look going into the next year before we would make That decision, but I do think we've got the flywheel of the buybacks and we talked about maybe not Moving up above and by the way, it's 40% to 50%. Okay. You took us up to 60%. I didn't notice that. Okay.

Speaker 2

But it's 40% to 50% And we'll see. We'll use that flywheel to drive the returns.

Speaker 9

Hey, got to try something here and there. Just this qualifies, right?

Speaker 13

All

Speaker 9

right. Well, let me try something else more on the Kind of the operational side, you brought it up as there is obviously a risk of a slowing economic Cycle out there. What level would you think about a typical Recession impact in terms of fuel demand, recognizing gasoline is already well below what we would call kind of a normal environment. Let's maybe think about diesel since that's the real strong part. When you think about industrial demand weakness, transportation related Weakness, right, whether it's just typical trucking, etcetera.

Speaker 9

How does that factor in? Like, what kind of would you expect to see A couple of 100,000 barrels go away. Is it a 10% sort of cut top to bottom? I'm just wondering how you think about The typical magnitude impact of a recession on fuel demand.

Speaker 6

Hey, Roger, this is Gary. I guess, you know, as the guys have kind of gone back and looked at At recessionary periods in the past, they see that product demand has kind of hit about 2x GDP. So whatever Kind of GDP assumption you're going to have, you would take twice that on the impact of fuel demand. And as you mentioned, more of that is going to be diesel, less on gasoline. I think there are some unique situations as we head into next year.

Speaker 6

1, jet demand hasn't fully recovered. And so you'll have A good increase in jet demand as we would anticipate. And then Chinese oil demand has been down 20%. At some point in time, they will come out of pandemic and you would expect to see Chinese demand recover. So the combination of both those things is that we would expect even with recessionary period you may see year over year global oil demand growth.

Speaker 9

All right. Thank you. Appreciate it.

Operator

Thank you. The next question is coming from Neil Mehta of Goldman Sachs. Please go ahead.

Speaker 13

Yes. Good morning, team. First question is just around The high sulfur fuel oil market and we're seeing these big heavy discounts showing up in the market. I love your perspective on What do you think is driving it? How much of that really is the later impacts of IMO versus other dynamics in the market?

Speaker 13

And are you changing Your configuration in refining at all to run some of that high sulfur fuel oil into the cokers, are you doing it more through WCS

Speaker 6

Yes. So this is Gary. As Joe touched on a few of these things, but there's a number of factors that have been really driving The heavy sour discounts, first, the sanctions put on Russia have caused some rebalancing. A lot of the Indian and Chinese refiners are running Urals, it's backed up Mars and Heavy Canadian into the Gulf, which are driving those discounts wider. So we've talked about the higher prices of natural gas around the World caused the operating expenses running heavy and medium salaries to be higher, so that causes the discounts to be wider.

Speaker 6

There's a higher naphtha content in heavy Canadian crude. Naphtha has been discounted, so that drives the discounts wider. We've seen some unplanned maintenance In the U. S, which has also contributed. But overall, I think we continue to see weakness in high sulfur fuel oil Combined with higher refinery utilization putting more product on the market.

Speaker 6

So some of that, what we expected in IMO 2020, we're finally Starting to see in the market, lack of Chinese demand is certainly also contributing to that. So for us, when we look at the market going forward, Seasonal maintenance in Western Canada is coming to an end. You'll see higher diluent volumes as we head into winter. So all of that's putting more heavy Canadian on the market. We expect to see even more rebalancing occur as sanctions are ramped up in Russia.

Speaker 6

And so we expect this market to continue. We're certainly maximizing heavy Canadian in our system today and seeing a lot of opportunity to buy high sulfur fuel blend stocks, As you mentioned that we're putting to our cokers.

Speaker 13

Yes. That makes a lot of sense. And the other Question is, you guys have really built a wonderful business here through organically, really haven't done much M and A In the better part of the last decade. And just your perspective on whether as you look forward, are there bolt on M and A opportunities As we are seeing some A and D in the downstream markets and in low carbon markets, or do you want to continue to build the business On an organic basis?

Speaker 2

Neil, we're very comfortable with the approach we've taken to building the business. I mean, we went through the period, of course, where we grew the business, and frankly, bolted on a lot of stuff to the portfolio, which we now have Largely operating to a level that we're comfortable with. And so we're very comfortable with the refining portfolio that we have in place today. We always look at opportunities that are out there and we'll continue to do that. But the strategy that we've employed with Really directing a significant part of the capital budget to the renewables businesses has made sense to us.

Speaker 2

We believe that they're very durable as is refining, but we're very comfortable with that approach and And we are comfortable with the way we've gone about doing it, which is certainly in the renewable diesel business from the ground up. So I think you should expect that We're not going to jump into the market for any kind of significant transaction, and we'll continue to do what we're doing.

Speaker 13

That makes a ton of sense. Thanks, Chip.

Operator

Thank you. The next question is coming from Jason Gabelman of Cowen. Please go ahead.

Speaker 18

Hey, thanks for taking my questions. I have 2. The first one kind of on near term dynamics. Just thinking into 4Q, I was hoping you could discuss a couple of things. 1, impacts to capture With the start up of DGD 3, the ability to capture strong West Coast cracks in Tobar gasoline margins were over $100 a barrel and then any impacts from the Mississippi River drought that You saw in your footprint, that could be ongoing?

Speaker 18

And I have a follow-up. Thanks.

Speaker 12

You want to start with DG3? Okay. On DG3, margin capture, I think, will be challenged. One of the details of this business is when you first start up a brand new unit, you have to start up on temporary pathways that are Somewhat generic to renewable diesel units, you got to run like that for the 1st several months until you gather the data to Get your actual carbon intensity numbers. So margin capture on DGD3 will be lower initially as we start up, because you have to line out, get Like I said, get the data to then submit your actual CI numbers.

Speaker 12

So I think that will be one of the main issues as we start So we'll certainly get volume, we'll certainly get more overall income, but if you look at it from a Well, you look at it through the margin indicator on a dollar per gallon basis on temporary CIs for the 1st several months, it will be lower. That will line out in the back half of 'twenty three as we submit our data to get responses from all The different jurisdictions that you have to submit your CI numbers to.

Speaker 5

This is Lane. On California, we have been executing a turnaround at our Venetia refinery, Some of which the turnaround was in the Q3 and we'll be wrapping up here in the Q4. So to the extent we still maximize gasoline even To the extent we could based on the operating posture we had for the turnaround, Wilmington ran at full rates. So That's really so we'll just see how the Q4 wraps up with respect to the gasoline crack on the West Coast.

Speaker 6

I guess the final one around Memphis. The river levels have been impacting us at our Memphis refinery, Both ability to clear the refinery and supply the river terminals as of this morning, both northbound and southbound traffic out on the river is wide open, expected to be there For the next couple of weeks, so we expect the situation to improve.

Speaker 18

Great, thanks. That color is all really helpful to think about 4Q. And then the other one just on low carbon opportunities within your portfolio. In addition to The DGD Venture, you also have an ethanol business and it seems like with the carbon capture project That you're installing there in the Inflation Reduction Act, maybe ethanol to jet is a technology that makes sense, Particularly given weaker ethanol margins. Is that something that you're looking at either to complement Any SAF growth you would pursue within DGD or as an alternative investment instead of pursuing SAF near term within DGD?

Speaker 18

Thanks.

Speaker 12

Yes. So that's definitely something on the radar for us. As you said, Ethanol carbon, carbon captured ethanol will be eligible to get into SAF and given our footprint in our navigator project, It will be in a SAF is a possibility with that ethanol product post sequestration. So that's definitely sort of So they're on the radar to look at sort of post 2025 when Navigator comes online.

Speaker 18

Thanks.

Operator

Thank you. Ladies and gentlemen, we're showing time The final question today is coming from Matthew Blair of Tudor, Pickering, Holt. Please go ahead.

Speaker 19

Hey, good morning. Thanks for squeezing me in here. I just had one question on the DGD guidance. If I heard correctly, it was still $750,000,000 for the year, Which, I believe implies that Q4 volumes will be lower quarter over quarter despite starting up the new plant in November. Could you help us understand that?

Speaker 19

Is that just being a little Conservative around the startup or is there a turnaround at the DGD-one or DGD-two that we should be keeping in mind?

Speaker 12

It's a little conservative. We are in start of a DGD 3. The plan is to ramp to full rates In November, so if you added that volume in, it will come in higher than the $750,000,000 but we're still lining the unit out and yet to Feed into the EcoFiner. So we won't know that detail until mid November or so. So from a guidance standpoint, we decided to keep the guidance at 7.50.

Speaker 12

It's proven that we see that rate.

Speaker 19

Sounds good. Thank you very much.

Operator

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

Speaker 1

Great. Thank you, Donna. We appreciate everyone joining us today. Obviously, feel free to contact the IR team if you have any additional questions. Thank you, everyone, and have a great week.

Operator

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time and enjoy the rest of your

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