Valero Energy Corp (VLO) — Q4 2021 Earnings Call Transcript

Good morning, everyone, and welcome to Valero Energy Corporation's fourth quarter 2021 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 one 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 metrics mentioned on this call. If you have any questions after reviewing these tables, please feel free to contact our Investor Relations team after the call. I would now like to direct your attention to the forward-looking statement disclaimer contained in the press release. In summary, it says that statements in the press release and on this conference call that state the company's or management's expectations or predictions of the future are forward-looking statements intended to be covered by the Safe Harbor provisions under federal securities laws. There are many factors that could cause actual results to differ from our expectations, including those we've described in our filings with the SEC. Now, I'll turn the call over to Joe for opening remarks.

Thanks, Homer, and good morning, everyone. We saw continued improvement in our business during the fourth quarter with refining margins supported by strong product demand. In our system, we ended the year with gasoline demand at pre-pandemic levels and demand for diesel actually higher than pre-pandemic levels. We also saw a significant jet fuel recovery as domestic and international travel opened up, increasing from approximately 60% of pre-pandemic levels at the beginning of the year to approximately 80% at the end of the year. Product inventories were low as a result of the refining capacity rationalization that's taken place in the last 2 years and weather-related impacts from Winter Storm Uri and Hurricane Ida. On the crude oil side, OPEC+ increased production throughout the year with improving demand supplying the market primarily with sour crude oils, resulting in wider sour crude oil discounts to Brent crude oil. As a result of all these dynamics, we saw a steady recovery in margins throughout the year, particularly for our complex refining system. In regards to our ethanol segment, ethanol prices were near record highs in the quarter, supported by strong demand and low inventories. Strong margins, coupled with solid operational performance across all of our segments, generated record quarterly operating income for our ethanol segment and record overall fourth quarter earnings for Valero. I am proud to say that 2021 was our best year ever for employee and process safety. In fact, we've set records for process safety for 3 consecutive years. These milestones are a testament to our long-standing commitment to safe, reliable and environmentally responsible operations. And despite the pandemic and weather-related challenges in 2021, our growth projects remained on track. We started up the Pembroke cogeneration unit in the third quarter of '21, which provides an efficient and reliable source of electricity and steam, and enhances the refinery's competitiveness. In addition, the Diamond Green Diesel expansion project, DGD 2, commenced operations in the fourth quarter on budget and ahead of schedule. The expansion has since demonstrated production capacity of 410 million gallons per year renewable diesel as a result of process optimization, above the initial nameplate design capacity of 400 million gallons per year. This expansion brings DGD's total annual renewable diesel capacity to 700 million gallons. Looking ahead, the DGD 3 project at our Port Arthur refinery is progressing ahead of schedule and is now expected to be operational in the first quarter of 2023. With the completion of this, 470 million-gallon per year plant, DGD's total annual capacity is expected to be 1.2 billion gallons of renewable diesel and 50 million gallons of renewable naphtha. BlackRock and Navigator’s large-scale carbon sequestration project is also progressing on schedule and is still expected to begin start-up activities in late 2024. Valero is expected to be the anchor shipper with 8 ethanol plants connected to the system, which should provide a higher ethanol product margin. The Port Arthur Coker project, which is expected to increase the refinery's utilization rate and improve turnaround efficiency, is expected to be completed in the first half of 2023. On the financial side, the guiding framework underpinning our capital allocation strategy remains unchanged. We remain disciplined in our allocation of capital, which prioritizes a strong balance sheet and an investment-grade credit rating. In 2021, we took measures to reduce Valero's long-term debt by approximately $1.3 billion. We ended the year well capitalized with $4.1 billion of cash and $5.2 billion of available liquidity, excluding cash. And our net debt to capitalization was 33%. We continue to honor our commitment to stockholders, defending the dividend across margin cycles and delivering a payout ratio of 50% in 2021. And as recently announced, the Board of Directors has approved a quarterly dividend of $0.98 per share for the first quarter of 2022. Looking ahead, we remain optimistic on refining margins, with low global light product inventories, strong product demand, global supply tightness due to significant refining capacity rationalization and wider sour crude oil differentials. We also remain optimistic on our low-carbon businesses, which we continue to expand with the growing global demand for lower carbon intensity products. We've been leaders in the growth of these businesses and maintain a competitive advantage with our operational and technical expertise. In closing, our team's simple strategy of pursuing excellence in operations, deploying capital with an uncompromising focus on returns and honoring our commitment to stockholders, has driven our success and positions us well. So with that, Homer, I'll hand the call back to you.

Thanks, Joe. For the fourth quarter of 2021, net income attributable to Valero stockholders was $1 billion or $2.46 per share compared to a net loss of $359 million or $0.88 per share for the fourth quarter of 2020. Fourth quarter 2021 adjusted net income attributable to Valero stockholders was also $1 billion or $2.47 per share compared to an adjusted net loss of $429 million or $1.06 per share for the fourth quarter of 2020. For 2021, net income attributable to Valero stockholders was $930 million or $2.27 per share compared to a net loss of $1.4 billion or $3.50 per share in 2020. 2021 adjusted net income attributable to Valero stockholders was $1.2 billion or $2.81 per share compared to an adjusted net loss of $1.3 billion or $3.12 per share in 2020. For reconciliations to adjusted amounts, please refer to the financial tables that accompany the earnings release. The refining segment reported $1.3 billion of operating income for the fourth quarter of 2021 compared to a $377 million operating loss for the fourth quarter of 2020. Fourth quarter 2021 adjusted operating income for the refining segment was $1.1 billion compared to an adjusted operating loss of $476 million for the fourth quarter of 2020. Refining throughput volumes in the fourth quarter of 2021 averaged 3 million barrels per day, which was 483,000 barrels per day higher than the fourth quarter of 2020. Throughput capacity utilization was 96% in the fourth quarter of 2021 compared to 81% in the fourth quarter of 2020. Refining cash operating expenses of $4.86 per barrel in the fourth quarter of 2021 were $0.46 per barrel higher than the fourth quarter of 2020, primarily due to higher natural gas prices. The renewable diesel segment operating income was $150 million for the fourth quarter of 2021 compared to $127 million for the fourth quarter of 2020. Adjusted renewable diesel operating income was $152 million for the fourth quarter of 2021. Renewable diesel sales volumes averaged 1.6 million gallons per day in the fourth quarter of 2021, which was 974,000 gallons per day higher than the fourth quarter of 2020. The higher operating income and sales volumes were primarily attributed to the start-up of Diamond Green Diesel expansion project, DGD 2, in the fourth quarter. The ethanol segment reported record operating income of $474 million for the fourth quarter of 2021 compared to $15 million for the fourth quarter of 2020. Adjusted operating income for the fourth quarter of 2021 was $475 million compared to $17 million for the fourth quarter of 2020. Ethanol production volumes averaged 4.4 million gallons per day in the fourth quarter of 2021, which was 278,000 gallons per day higher than the fourth quarter of 2020. And as Joe mentioned earlier, the higher operating income was primarily attributed to higher ethanol prices, which were supported by strong demand and low inventories. For the fourth quarter of 2021, G&A expenses were $286 million and net interest expense was $152 million. G&A expenses of $865 million in 2021 were largely in line with our guidance. Depreciation and amortization expense was $598 million and income tax expense was $169 million for the fourth quarter of 2021. The annual effective tax rate was 17% for 2021, which reflects the benefit from the portion of DGD's net income that is not taxable to us. Net cash provided by operating activities was $2.5 billion in the fourth quarter of 2021 and $5.9 billion for the full year. Excluding the favorable impact from the change in working capital of $595 million in the fourth quarter and $2.2 billion in 2021, and the other joint venture members, 50% share of Diamond Green Diesel's net cash provided by operating activities, excluding changes in DGD's working capital, adjusted net cash provided by operating activities was $1.8 billion for the fourth quarter and $3.3 billion for the full year. With regard to investing activities, we made $752 million of total capital investments in the fourth quarter of 2021, of which $353 million was for sustaining the business, including costs for turnarounds, catalysts and regulatory compliance and $399 million was for growing the business. Excluding capital investments attributable to the other joint venture members, 50% share of Diamond Green Diesel and those related to other variable interest entities, capital investments attributable to Valero were $545 million in the fourth quarter of 2021 and $1.8 billion for the year. Moving to financing activities. We returned $401 million to our stockholders in the fourth quarter of 2021 through our dividend and $1.6 billion through dividends in the year, resulting in a 2021 payout ratio of 50% of adjusted net cash provided by operating activities for the year. And our Board of Directors recently approved a regular quarterly dividend of $0.98 per share, demonstrating our sound financial position and commitment to return cash to our investors. With respect to our balance sheet at year-end, total debt and finance lease obligations were $13.9 billion and cash and cash equivalents were $4.1 billion. The debt-to-capitalization ratio, net of cash and cash equivalents was 33%. In the fourth quarter, we completed a series of debt reduction and refinancing transactions that together reduced Valero's long-term debt by $693 million. These debt reduction and refinancing transactions, combined with the redemption of $575 million floating rate senior notes due 2023 in the third quarter, collectively reduced Valero's long-term debt by $1.3 billion. At the end of the year, we had $5.2 billion of available liquidity, excluding cash. Turning to guidance. We expect capital investments attributable to Valero for 2022 to be approximately $2 billion, which includes expenditures for turnarounds, catalysts and joint venture investments. About 60% of our capital investments is allocated to sustaining the business and 40% to growth. Approximately 50% of our growth capital in 2022 is allocated to expanding our low-carbon businesses. For modeling our first quarter operations, we expect refining throughput volumes to fall within the following ranges: Gulf Coast at 1.66 million to 1.71 million barrels per day; Mid-Continent at 395,000 to 415,000 barrels per day; West Coast at 185,000 to 205,000 barrels per day; and North Atlantic at 430,000 to 450,000 barrels per day. We expect refining cash operating expenses in the first quarter to be approximately $4.80 per barrel. With respect to the renewable diesel segment, we expect sales volumes to be approximately 700 million gallons in 2022. 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 4.2 million gallons per day in the first quarter. Operating expenses should average $0.44 per gallon, which includes $0.05 per gallon for non-cash costs such as depreciation and amortization. For the first quarter, net interest expense should be about $150 million and total depreciation and amortization expense should be approximately $600 million. For 2022, we expect G&A expenses, excluding corporate depreciation to be approximately $870 million. That concludes our opening remarks. Before we open the call to questions, we again, respectfully request that callers adhere to our protocol of limiting each turn in the Q&A to 2 questions. If you have more than 2 questions, please rejoin the queue as time permits. Please respect this request to ensure other callers have time to ask their questions.

Joe, I'd like to revisit your comments earlier about the refining margin outlook through 2022. I mean clearly, we seem to have a pretty positive setup with lean global inventories and significant amount of refining rationalization that's happened since and even slightly before the pandemic began while demand continues to recover and remain resilient. So looking through the rest of this year, can you just give us a sense of puts and takes on the variables that could detract from this thesis, either risk to the downside or upside from here?

Sure, Theresa. Thank you. Let's have Gary address this.

Sure, Theresa. Let me go through some observations from our system. We saw a solid recovery last year in gasoline, diesel, and jet fuel demand, and we anticipate this rebound will keep going through 2022. We started the year with gasoline demand slightly lower than expected, partially due to seasonality. If we compare it to 2019, we were down about 7% at this time of year because of the rise in COVID cases and some weather factors affecting gasoline demand. However, our 7-day average is only down about 3% compared to 2019, indicating that we're already emerging from the recent surge in COVID cases. Given the current gasoline inventories, the outlook for gasoline is very promising moving forward. As you mentioned, we expect gasoline demand to return to 2019 levels, which were near peak demand, while we will have significantly less refining capacity, leading to a tight gasoline market. Turning to diesel, inventories are low both in the United States and globally. Diesel demand in our system has been about 7% below 2019 levels, but the negative weather impacts on gasoline have positively affected diesel demand. We see strong demand for diesel and do not foresee a clear path to replenish inventories soon due to turnaround activities in the industry and the rationalization that has taken place. Therefore, both gasoline and diesel appear to be in a strong position as the year progresses. Jet fuel demand remains uncertain; we expect domestic air travel to rebound quickly after this wave of COVID, but international travel will take longer to recover. While we expect to approach 2019 levels by the year's end, a full recovery is unlikely. The big uncertainty for this year is the crude market. There's significant tightness in the crude markets currently, impacting differentials. We are watching for when OPEC will begin to increase production. As global oil demand rises, we expect OPEC to respond by ramping up production, mainly focusing on medium and heavy sour barrels, which should positively affect differentials throughout the year as well.

That's great color. So I got to ask the capital allocation question. You have been so consistent on your messaging as well as execution around this. And with the progress that you've made on reducing debt, generating free cash flow for the past couple of quarters and generally positive momentum on the near-term refining outlook. Are we at an inflection point where we may soon see a step-up in cash return to shareholders?

Jason?

Yes, this is Jason. I'll address that. You're correct that we've made substantial progress towards our goals. As we began to emerge from this situation, we aimed to rebuild our cash reserves, targeting around $3 billion on hand. We achieved that, ending the year with $4.1 billion. We also committed to focusing on reducing our debt. In the third and fourth quarters of last year, we completed deleveraging transactions that paid off about $1.3 billion net, reducing our net debt to capitalization ratio to 33% by year-end. Our long-term target remains between 20% and 30%, and the pace of progress will depend on our margins and cash flow generation. Regarding buybacks and returning cash to shareholders, we see positive trends now. In 2021, the payout was 50%, primarily from dividends and a few minimal buybacks related to employee plans. However, with the margin increase in the fourth quarter and continued strength in the first quarter, if this recovery pattern persists, we expect to initiate buybacks this year to achieve our target. We believe we can continue our aggressive debt reduction while also fulfilling our commitment to return cash to shareholders through buybacks. We do not see these objectives as mutually exclusive, and our approach has been guided by a framework and targets we've maintained for several years.

I had a question about DGD. We are observing a number of projects facing delays and long lead equipment not arriving on time. It seems that everyone is lagging behind. However, your project is progressing as planned. You often mention that you have the best people, but aside from that, what additional factors are contributing to your ability to advance the timeline while others are falling behind?

Wow! Should we even say anything?

I'm confident that we have the best team. This is Lane. We also finished Diamond Green 2, so we have a solid understanding of the project's execution. We're working with the same business partners who mainly executed Diamond Green 2. We've significantly improved the schedule, and since we've completed two of these projects and are now working on the third, it's clear we have a great team overall, including our business partners. Additionally, we're better at the permitting process.

Yes. There have been many lessons learned as we progressed through the project.

We've built one, completed two, and learned a lot along the way. We definitely have the advantage of being an early mover in this space.

Perfect, guys. My second follow-up very quickly here is it looks like your partner is moving ahead with kind of an acquisition, which would give you guys more used cooking oil, more animal fats. At this stage, I think there was a point to get in more animal fats from international to feed DGD 3. How is the feedstock situation looking for DGD 3? Are you very close to what you would need when DGD 3 is up and running in terms of feedstock now?

Yes, Manav, this is Martin. Our plan is to continue supplying DGD 1, 2, and 3 with waste feedstock, and we feel good about that. The feedstock market has become tighter compared to soybean oil, which we anticipated with the startup of DGD 2. We have adjusted trade flows, which has affected the market. When we planned for DGD 2 and 3, we expected the value of feedstock to rise relative to soybean oil, along with increases in carbon pricing. We are currently where we expected to be. The feedstock situation is constantly changing, but it is closely linked to global GDP growth. In summary, we expect to be able to secure the necessary feedstock.

The Gulf Coast refining margins in the fourth quarter were the best since 2015, if I have that right. And they're even better than 4Q '19 when we were talking about IMO 2020 and feedstock advantages and things like that. So I was just curious if there's anything more to elaborate on about the strength of the Gulf Coast margins that we saw in the quarter and how you think about the sustainability of that?

Yes. I believe that in the Gulf Coast, stronger capture rates are generally linked to feedstock optimization. We've been focusing on some of those fuel oil blend stocks and utilizing more of them in our system, which has contributed to higher capture rates.

Got it. Okay. And then second question, just a follow-up on some of the commentary there on renewable diesel. The gross margins there, down sequentially. It sounds like you expected some of that, but the capture rate, the indicator there was, I think, a bit lower than maybe some had expected. Were there any transitory factors there, in your opinion, in the quarter as you started up Phase 2 and whether it's with feedstock or other factors? Or is this how you think about kind of a run rate moving forward?

Sure, Phil. This is Martin. So margin capture in 2021 was all about the feedstock price. In first half of '21, feedstock prices were low relative to soybean oil, which resulted in some really high margin capture. In the fourth quarter, the prices were high relative to soybean oil and that gave us a lower margin capture at 75%. With the start-up of DGD 2, we're going to have tighter prices for a while. We expect feedstock to be around soybean oil going forward for the immediate future. And then we'll see how that plays out in the next few months after that. But we expect it to be right around soybean oil, which would incur closer to this 100% type margin capture. And that's what we experienced throughout 2019. If you go back and look at those numbers, we averaged right around 100% margin capture. So that's kind of how we expect things to shake out in the next few months.

I want to come back, if possible, to the crude tightness comments, just what you're seeing in terms of differentials, what you'd expect? And then are we highly dependent here on OPEC putting more oil in the market? Or is there some other factor at work? And one of the reasons I ask is some of the closures that we saw on the refining side tended to be a light suite unit. So if physical demand is down on that side, is that also accounting for some of the tightness of the differentials?

Yes, it's Gary. I believe there are several factors that contributed to the tightness, not just OPEC. The winter weather affected heavy production in Western Canada, and we experienced supply disruptions in Ecuador. Additionally, the pipeline issues between Iraq and Turkey took barrels off the market. Looking ahead, we expect OPEC production to increase and for Western Canadian production to rebound and potentially grow with the return of some logistics projects. Most of the production that was previously off the market is coming back. Along with the increased production, the growth in OPEC production will alleviate some of the pressure on the crude markets and the crude differentials.

And then my unrelated follow-up question is coming to you, Jason. Like the insight on the possibility of getting back to more normal cash returns model in '22. I was curious, though, given the significant improvement in working capital in '21, are we at risk of seeing some of that reverse in '22? Or when you think about the outlook, do you assume a neutral working capital event and maybe we should assume something going the other way?

Yes. Well, our movements in working capital generally follow flat price. So when we're forecasting, we just assume neutral cash on working capital as our basis.

So just a quick reminder. If prices go up, positive prices go down, it's going to eat working capital?

Right. That's right.

I wanted to circle back on the capital allocation piece a little bit. You've done a great job reducing debt. It looks like you'll be able to take another chunk out this year, got high balance sheet cash. And it sounds like you're very positive on buybacks. I just sort of wanted to ask about the dividend. I know if it might be a bit premature at this point, but given that we're looking at what could be an above mid-cycle here in earnings. You've gotten debt controlled and the yield is starting to come in. Currently, just i annualized a little under 5% and tighter than that if the share price continues to work, is taking a hard look at the dividend, something that potentially increase something that you might think of this year? Or is it too soon to start talking about that?

Yes. This is Jason. It's probably a little soon given what we just came through. But we always look at it. Our commitment is to have a sustainable dividend with a yield at the high end of our peer group, and that's where it is now, where the peers are and the market is, we think it's in a good place.

Prashant, at this time last year, there was a big question on sustainability of the dividend, right? A lot can change in a short period. Now you never questioned it. You always had faith, stuff like that. But anyways, it’s interesting how things come around.

It's true. It's like a different world altogether, right, Joe?

Yes. There it is.

I have a quick question about ethanol, which has shown strong performance historically. This quarter is the best we've seen for ethanol since we started reporting results quarterly. I'm curious about the potential carryover of this strength. A couple of months ago, we discussed some caution regarding the outlook for 2022 due to the volatility in the ethanol market and various influencing factors. I'm looking for insights on how to assess our position as we enter 2022 and what the expected trends might be. While some strength may carry over, there are many other factors, including policy changes and gasoline demand, to consider. Could you provide some insights and clarity on how we should approach this as we look ahead to 2022?

Prashant, this is Martin. The fourth quarter was exceptional for ethanol. The third quarter began with weak margins and there were low corn stocks available, which led to many run cuts and early maintenance across the industry, not just at Valero. Plants only started to recover in early October, exceeding the 5-year averages. However, despite the higher rates, inventory never built up. Low inventory typically leads to high margins, which we experienced. In the last few weeks of the year and early 2022, we saw a significant inventory build, causing margins to drop significantly. Despite this, we are still within our typical range for ethanol margins in the first quarter. Our focus for ethanol is on the long-term, particularly carbon capture, which presents great opportunities through the 45Q and LCFS incentives. We're also increasing our production of cellulosic ethanol from corn fiber, which we are optimistic about. We believe ethanol will continue to be a part of the domestic fuel mix, with expectations for higher octane blends in the future, specifically 95 RON, leading to increased ethanol blending. Additionally, global renewable fuel mandates are expected to drive export growth. We feel positive about the future of ethanol, albeit not just in this quarter or the next, but in the long run.

Joe, I want to revisit the capital allocation question from a different perspective. I'm specifically interested in the balance between dividends and buybacks. You could potentially repurchase over 5 percent of your stock, which signifies strong dividend growth for a typical business. I'm curious about your approach to maintaining the right level of debt and achieving the desired balance between the 40% to 50% cash allocation for returns through dividends and buybacks. I know this is a broad question, but it's worth mentioning that in the past, there has been criticism regarding buybacks when prices are high. I'm wondering if you view buybacks as a strategy to help manage the burden of dividends in the future.

Yes. No, Doug, it certainly would be and when you think about where the yield has been particularly last year, I mean, we've been flushed with cash last year, we had bought back a ton of shares, but we weren't. And you're right, it is a double-edged sword, right? We end up with good cash flows and typically a high stock price all at the same time. So that's why it's hard to create a formulaic approach to how we look at doing this. And so I think Jason has laid it out, coming out of COVID, we had a very specific set of priorities that we wanted to put in place. And I think he covered those. What I'll do is, look, we got a good strong CFO. We'll see what he thinks here. You've got anything you'd like to share?

Yes, everything you said was accurate. We need to maintain a balanced dividend because, as we've demonstrated during the last downturn, we will protect it in difficult times. We should be cautious about increasing it too much. The buybacks contribute to our momentum.

Yes. So Doug, we always consider the dividend, and we would like to increase it. There will be a right time to do that. It's a burden we've managed, and it's easier in a favorable margin environment like we have now. However, as Jason mentioned, we've defended it during challenging margin situations, and it has been somewhat of a load. We are committed to it, but we want to ensure we don’t overextend ourselves.

And it's well positioned versus the peers. Our first step is to look versus our peers, we committed to be up near the top of the end and as long as we're the highest, that box is checked.

I want to be respectful to everyone else, and I'm going to take my second question on the same topic, if you don't mind, because I'm looking at, for example, what some of the Canadians have done, think about actual companies that have long-life sustainable assets. Obviously, your business is very similar to that in some respects in terms of the annuity nature. So I wonder then, with some folks did question your dividend last year, I know that’s on my hat, but why then wouldn't you use your balance sheet, take your balance sheet to a much stronger level, so that kind of concern can be taken out of the investment case. So in other words, why is 20% to 30% the right level? Why not go lower given the drop that we all saw in the past year? And I'll leave it there.

Doug, that's a fair question. And I can tell you, that's 1 of the things that Jason and Homer are looking at consistently. The capital markets were very accessible last year, even in the downturn. And rates were so attractive that we were able to really do a good job of financing the business through this. But again, you never really know. Jason?

Yes. That's right. One thing we do to address this is hold a higher cash balance. But we also want to have an efficient capital structure and debt is pretty cheap right now. The 1 to 0 debt would give you the maximum flexibility and kind of resilience, but then you have a cost of a higher cost.

But Doug, are you proposing that we would like lever up to buy back shares or something along those lines?

Well, it's really more about being strategically positioned to utilize the balance sheet when necessary without the market speculating on the dividend. I believe your business can support a dividend approach based on an annuity discount model, but the balance sheet needs to be adjusted to achieve that. The goal is to remove volatility from future investment considerations. I've taken my time, Joe, so I appreciate the answers.

Okay. We'll see you soon.

Can I ask you guys about Europe? Just from your perspective, as a major refiner there. What's going on as regards demand, the impact of natural gas prices, crude slates, the whole bit?

Yes. So this is Gary. I guess what we're seeing in terms of demand is they're kind of ahead of where we are in recovery from the latest spike in COVID cases. If you look at our 7 day in the UK, we're up about 10% of where we were month to date. So starting to see good recovery in mobility and gasoline demand in the system. Again, very similar situation on diesel. ARA stocks are very low. So diesel looks very constructive as well. On the natural gas side, you see some switching of crude diets as a result of the high natural gas prices still $30 an MMBtu in Northwest Europe. So you see some people kicking out medium and heavy sour grades of crude running more light sweet. I think where we've seen it the most is optimization around hydro processing capacity. So people idling and cutting hydrocracking capacity as a result of very high natural gas prices, which again puts less diesel in the market and is 1 of the reasons why we're experiencing all the tightness around diesel that we are.

Excellent answer. Can I just follow up with California. We've seen margins come off quite a bit there. But more importantly, could you talk a bit about how renewable diesel will play through in that market where you're exposed to both sides. I just wonder what your perspective is because we could see a situation, obviously, where the market gets quite challenged, I think, by renewables.

Yes, Paul, this is Martin. Renewable diesel has performed very well in terms of demand in California. It's remarkable to see how it has held up throughout COVID. Naturally, the deficits have decreased due to lower consumption of carbon, gasoline, and diesel. However, renewable diesel has accounted for about 23% of the diesel pool in California for the first half of the year, which is impressive. There has also been a significant amount of imports of renewable diesel into California. The situation has held up quite well. While one could argue that this contributes to the lower credit price, I believe the credit price is more influenced by the reduction in deficits rather than by the increase in credits from renewable diesel. This market remains strong for us. The demand was more negatively impacted in Europe and likely in Canada, as there is a wait for the Clean Fuel Standard. We anticipate a rebound in those two regions, leading to increased global demand.

Understood. Could you just throw the answer forward a little bit? As we look over the next couple of years in terms of how the supply demand, the balance might play out? And I'll leave it there. Sorry, not to make you laugh today, Joe, but...

Paul, I'll tell you what. We'll have a chance for that here pretty soon, won't we?

I believe that in the future, nothing prevents renewable diesel from being blended at virtually any rate. Currently, 85% of renewable diesel is sold in California. CARB's projections aim for approximately R40 by 2030, and many expect it could exceed that. While California leads, other states are also exploring LCFS, and we anticipate the CFS in Canada by the end of this year, which will rival the size of California's market. This creates a significant opportunity for us, and we expect early credit generation similar to what occurred in California, which will enhance the demand for renewable diesel.

Two questions, please. First for Martin. Regarding renewable diesel, there seems to be increasing interest in SAF among some of your peers. I'm curious if the company has any plans related to this market and what changes in the economy would make it feasible for you to consider it. Additionally, what type of investment would be required to transition to this product? The second question is for Lane. The margin capture in the North Atlantic for the fourth quarter was impressive. Were there any one-off events contributing to this? Also, could you clarify which of the two facilities in Europe had stronger margin capture in the fourth quarter?

Okay. It's Martin. I'll get started there, Paul. I think we were all looking at the Build Back Better Bill and what was in that on a tax credit basis for SAF and what we saw that incentive level proposed in that bill was not sufficient to attract additional investment to make SAF versus the base case of producing renewable diesel with an existing unit. However, we're still progressing SAF production through our gated engineering process; and concurrently, we're developing customers. There are plenty of customers interested in SAF but a favorable tax credit, something else is going to be required or tax credit or something else to really get over the hump to where SAF is economic to produce relative to producing renewable diesel. That being said, we're still confident that SAF production is a question of when and not if. We think the margins will eventually work. The SAF is the only way to reduce the carbon intensity of air travel.

All right. So yes, what's interesting about the 2 refineries we have in the Atlantic Basin is Quebec is seasonally stronger in the fourth and the first quarter, it's largely a distillate, very specialized distillate producing refinery configured, whereas Pembroke is really more of a gasoline producing configured refinery. So that's kind of how they work out. So really, in terms of the fourth quarter performance, it's really Quebec well on their margin capture. And obviously, you have the issues with around high natural gas prices over in the UK Obviously, that helped sort of hurt their margin capture in Pembroke.

And Lane, are there any one-time items that are benefiting you this quarter, or is it simply that your team has done an outstanding job in operations and effectively capitalized on that in the market?

I agree with the second answer, but it's definitely a yes. Quebec performed very well in the quarter. So...

Wanted to just circle back to the industry capacity questions. A few other analysts on the call have alluded to a lot of closures over the past 12 months, but there are some third parties and some management in the industry that are suggesting that the number of closures is even higher than any of us are aware of or any kind of report that we would see might confirm. And so I wonder what your thoughts on that are? And then secondly, there's a 2-part question, but only one. Theoretically where cracks are today, you would think that capacity rationalization would stop here or slow down. But there's other factors that may be driving some closures. So if you think that this trend could continue based on noneconomic factors, would love your input on that, too?

Sam, it's Lane. We're currently analyzing the data because we're noticing a similar issue regarding utilization and closures. It appears there may be some slowdowns occurring, possibly due to maintenance or turnaround deferrals in the industry. While that's just a theory we have, it's definitely something we're considering. As for margins, capacity is nearly maxed out. Except for the turnarounds and outages, refinery utilization should be in the 90% to 95% range, assuming all the Department of Energy data is accurate and all refineries are accounted for. That's our perspective on the situation.

Maybe just 1 quick follow-up on your comments on California from earlier. I know you had talked about some of the longer-term lease issues of low carbon fuel standard credits. Do you have a view on for the next 12 months where you think the LCFS credit go from here? We've gone from 200 to 150-ish. Do you see further downside? Or do you think we stabilize here?

That's a good question. This is Martin. The challenge is that we are always reflecting on past data, which lags by six months. While this is understandable due to the volume of information, it means we are in a constant process of assessing previous trends. By the end of this month, we'll receive the third-quarter data. Notably, credit prices are influenced by the balance between credit generation and deficit generation, and COVID has certainly impacted deficit generation since the second quarter of 2020. This suggests that credit prices have been suppressed due to the pandemic. Interestingly, in the second quarter of 2021, credit generation exceeded my expectations. Upon analyzing this further, two specific components in the credit generation are prominent. First, bio compressed natural gas accounted for 13% of all credits in the second quarter of 2021 and surged by 190% compared to 2019. Second, off-road electricity contributed 9% of the credits and was up 146% relative to 2019. Notably, 71% of the credits from off-road electricity came from e-forklifts. Considering bio CNG, off-road electricity, and e-forklifts, one wonders if the current pace of credit generation can be sustained given the infrastructure challenges. It's uncertain how many times one can replace a forklift to implement e-forklifts, suggesting a potential limit to this growth. Those two categories alone represent around 21% to 22% of credits in California, despite being quite minor previously. Additionally, biodiesel, renewable diesel, and on-road electricity credit generation flatlined in the second quarter of 2021 compared to the entirety of 2019. This provides some perspective, and I hope it offers clarity.

That's great. And then maybe just one overall. I know you've talked a lot about what you've seen generally in terms of demand, particularly here in the U.S. Any comments in terms of what you're seeing on the product export side that may indicate what you're seeing on international product demand, particularly in your primary export markets?

Yes, this is Gary. We're not seeing the recovery in Latin America as quickly as in North America or the UK. Demand is still somewhat down, but we are experiencing good export demand in the region. I expect that in the first quarter, our exports will decrease slightly, which isn't really a reflection of demand in Latin America but rather due to maintenance activity happening, especially in the U.S. Gulf Coast during that quarter, along with strong domestic demand. However, demand remains present in Latin America's typical export markets.

I wanted to dovetail off a comment that was just made, maintenance in the Gulf Coast. It looks like guidance or throughput is down quarter-over-quarter for 1Q from 4Q about 300,000 barrels a day. Can you just discuss if what maintenance activity you're going to have on 1Q, if there are other one-time items impacting that guidance? And if you think that's indicative of the industry as a whole, just given it seems like there was a lot maintenance delayed due to COVID over the past couple of years. And then my second question is, hopefully, one you can answer kind of on geopolitics and what's going on with Russia. Valero imports a lot of intermediate feedstock from Russia and can you just discuss maybe the margin kind of enhancement that provides and how you're more broadly thinking about both the risks and opportunities these geopolitical issues with Russia present for your company?

This is Lane. I'll address the first question. We don't typically provide specific comments about our turnaround activities for the quarter. The volumes can serve as an indication for that, and you can interpret what that means. Additionally, we refrain from commenting on our competitors regarding their turnaround efforts, which is part of our policy.

Gary, you want to talk about Russia?

Yes. So obviously, we don't really until any kind of sanctions are announced, we don't really know what they would entail. What I can tell you is that when we've seen things like this happen in the past in other locations, it simply results in a change in trade flows. So what we would expect to happen here is some of those intermediates that we're running today will be run somewhere else throughout the world. And wherever those end up going, they'll kick out feedstocks that make it available for us to run. So certainly, as a commercial team, we're looking at what those are today and making sure we have them approved in our system and are ready to run them if we need to in the future.

Maybe sticking with major exporters. I was wondering what you guys made of the discussion around Pemex potentially ending crude exports? And what do you see as the implications? Do you think it's likely to occur? And what do you think the implications on particularly the Gulf Coast refining industry would be?

Yes. So this is Gary. I think Lane has been pretty public on our views on being able to meaningfully change refinery reliability and utilization. He's kind of said 2 turnaround cycles and a lot of capital. So it looks like their goals are pretty aggressive. But if they're able to increase refinery utilization, if it does focus refinery starts up, certainly, it would decrease the amount of crude for export. Our view is that the first destinations to be cut will really be European destinations and Asian destinations for export from Mexico. Our experience has been that as they increase refinery runs in Mexico, they increase the export of high-sulfur fuel oil, and that's a good feedstock for our high complexity U.S. Gulf Coast system that actually serves as a nice complement to a lot of the light sweet grades we run in our U.S. Gulf Coast system. We've had a long-standing great relationship with Pemex, and we expect that to continue long into the future.

Understood. That's helpful context. Returning to the capacity question on a global scale, there has been a net decline in certain areas, but in theory, you are transitioning back to growth globally over the next few years. Are you worried about that? Do you think it will significantly impact product flows or crude flows? How do you perceive that affecting your margins?

This is Lane. We follow the same journals and trade magazines as you and have people monitoring refinery closures and new openings. The Middle East and China both have some refineries starting up. We believe that China has a long-term plan to operate larger refineries rather than the smaller teapot refineries. However, it's challenging to have a definitive outlook on the overall direction. I recall when the Indian refinery alliance was emerging, and we were initially concerned. Based on our experience, we assessed those refineries and calculated their import parity in our marketing strategies. Ultimately, most of the oil remained in the region. These matters can be complex. We focus on managing our assets to ensure their competitiveness globally, not just in the U.S. We are confident that as long as there is demand in this industry, we will secure our share of it.

Great. Thanks, Donna. Thanks, everyone, for joining us today. Obviously, if there's anything you want to follow up on, feel free to ping the IR team. Thank you, and have a great week.