VLO 9.30.11 10Q
Table of Contents

 
 
 
 
 
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2011
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _______________ to _______________
Commission file number 1-13175
VALERO ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
74-1828067
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
One Valero Way
San Antonio, Texas
(Address of principal executive offices)
78249
(Zip Code)
(210) 345-2000
(Registrant’s telephone number, including area code) 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes R No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer R
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No R
The number of shares of the registrant’s only class of common stock, $0.01 par value, outstanding as of October 31, 2011 was 559,726,988.
 
 
 
 
 
VALERO ENERGY CORPORATION AND SUBSIDIARIES
INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 





2
Table of Contents

PART I – FINANCIAL INFORMATION
Item 1. Financial Statements

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Millions of Dollars, Except Par Value)
 
 
September 30,
2011
 
December 31,
2010
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and temporary cash investments
$
2,829

 
$
3,334

Receivables, net
7,509

 
4,583

Inventories
5,164

 
4,947

Income taxes receivable
5

 
343

Deferred income taxes
254

 
190

Prepaid expenses and other
109

 
121

Total current assets
15,870

 
13,518

Property, plant and equipment, at cost
31,066

 
28,921

Accumulated depreciation
(6,847
)
 
(6,252
)
Property, plant and equipment, net
24,219

 
22,669

Intangible assets, net
251

 
224

Deferred charges and other assets, net
1,343

 
1,210

Total assets
$
41,683

 
$
37,621

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of debt and capital lease obligations
$
867

 
$
822

Accounts payable
8,520

 
6,441

Accrued expenses
785

 
590

Taxes other than income taxes
1,053

 
671

Income taxes payable
136

 
3

Deferred income taxes
322

 
257

Total current liabilities
11,683

 
8,784

Debt and capital lease obligations, less current portion
6,781

 
7,515

Deferred income taxes
4,942

 
4,530

Other long-term liabilities
1,607

 
1,767

Commitments and contingencies

 

Equity:
 
 
 
Valero Energy Corporation stockholders’ equity:
 
 
 
Common stock, $0.01 par value; 1,200,000,000 shares authorized;
   673,501,593 and 673,501,593 shares issued
7

 
7

Additional paid-in capital
7,559

 
7,704

Treasury stock, at cost; 114,855,199 and 105,113,545 common shares
(6,491
)
 
(6,462
)
Retained earnings
15,347

 
13,388

Accumulated other comprehensive income
232

 
388

Total Valero Energy Corporation stockholders’ equity
16,654

 
15,025

Noncontrolling interests
16

 
—

Total equity
16,670

 
15,025

Total liabilities and equity
$
41,683

 
$
37,621

See Condensed Notes to Consolidated Financial Statements.



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Table of Contents

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Operating revenues (a)
$
33,713

 
$
21,015

 
$
91,314

 
$
60,069

Costs and expenses:
 
 
 
 
 
 
 
Cost of sales
30,033

 
18,915

 
82,981

 
54,198

Operating expenses:
 
 
 
 
 
 
 
Refining
870

 
753

 
2,427

 
2,210

Retail
177

 
169

 
508

 
484

Ethanol
103

 
96

 
302

 
267

General and administrative expenses
161

 
139

 
442

 
367

Depreciation and amortization expense
390

 
353

 
1,141

 
1,043

Asset impairment loss
—

 
—

 
—

 
2

Total costs and expenses
31,734

 
20,425

 
87,801

 
58,571

Operating income
1,979

 
590

 
3,513

 
1,498

Other income, net
1

 
17

 
28

 
29

Interest and debt expense, net of capitalized interest
(88
)
 
(119
)
 
(312
)
 
(363
)
Income from continuing operations before income tax expense
1,892

 
488

 
3,229

 
1,164

Income tax expense
689

 
185

 
1,178

 
421

Income from continuing operations
1,203

 
303

 
2,051

 
743

Income (loss) from discontinued operations, net of income taxes
—

 
(11
)
 
(7
)
 
19

Net income
1,203

 
292

 
2,044

 
762

Less: Net loss attributable to noncontrolling interests
—

 
—

 
(1
)
 
—

Net income attributable to Valero Energy Corporation stockholders
$
1,203

 
$
292

 
$
2,045

 
$
762

Net income attributable to Valero Energy Corporation stockholders:
 
 
 
 
 
 
 
Continuing operations
$
1,203

 
$
303

 
$
2,052

 
$
743

Discontinued operations
—

 
(11
)
 
(7
)
 
19

Total
$
1,203

 
$
292

 
$
2,045

 
$
762

Earnings per common share:
 
 
 
 
 
 
 
Continuing operations
$
2.12

 
$
0.54

 
$
3.61

 
$
1.31

Discontinued operations
—

 
(0.02
)
 
(0.01
)
 
0.03

Total
$
2.12

 
$
0.52

 
$
3.60

 
$
1.34

Weighted-average common shares outstanding (in millions)
564

 
564

 
566

 
563

Earnings per common share – assuming dilution:
 
 
 
 
 
 
 
Continuing operations
$
2.11

 
$
0.53

 
$
3.59

 
$
1.31

Discontinued operations
—

 
(0.02
)
 
(0.01
)
 
0.03

Total
$
2.11

 
$
0.51

 
$
3.58

 
$
1.34

Weighted-average common shares outstanding –
  assuming dilution (in millions)
569

 
568

 
572

 
567

Dividends per common share
$
0.05

 
$
0.05

 
$
0.15

 
$
0.15

Supplemental information:
 
 
 
 
 
 
 
(a) Includes excise taxes on sales by our U.S. retail system
$
229

 
$
234

 
$
670

 
$
667

See Condensed Notes to Consolidated Financial Statements.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Millions of Dollars)
(Unaudited)
 
Nine Months Ended
September 30,
 
2011
 
2010
Cash flows from operating activities:
 
 
 
Net income
$
2,044

 
$
762

Adjustments to reconcile net income to net cash provided by
  operating activities:
 
 
 
Depreciation and amortization expense
1,141

 
1,096

Noncash interest expense and other income, net
20

 
8

Asset impairment loss
—

 
2

Gain on sale of Delaware City Refinery assets
—

 
(92
)
Stock-based compensation expense
34

 
32

Deferred income tax expense
393

 
285

Changes in current assets and current liabilities
840

 
592

Changes in deferred charges and credits and other operating activities, net
(144
)
 
(63
)
Net cash provided by operating activities
4,328

 
2,622

Cash flows from investing activities:
 
 
 
Capital expenditures
(1,584
)
 
(1,226
)
Deferred turnaround and catalyst costs
(501
)
 
(410
)
Acquisition of Pembroke Refinery, net of cash acquired
(1,675
)
 
—

Acquisition of pipeline and terminal facilities
(37
)
 
—

Acquisitions of ethanol plants
—

 
(260
)
Proceeds from sale of the Delaware City Refinery assets and
  associated terminal and pipeline assets
—

 
220

Other investing activities, net
(24
)
 
15

Net cash used in investing activities
(3,821
)
 
(1,661
)
Cash flows from financing activities:
 
 
 
Non-bank debt:
 
 
 
Borrowings
—

 
1,244

Repayments
(718
)
 
(517
)
Accounts receivable sales program:
 
 
 
Proceeds from the sale of receivables
—

 
1,225

Repayments
—

 
(1,325
)
Purchase of common stock for treasury
(270
)
 
(2
)
Issuance of common stock in connection with stock-based compensation plans
42

 
12

Common stock dividends
(85
)
 
(85
)
Debt issuance costs
—

 
(10
)
Contributions from noncontrolling interests
12

 
—

Other financing activities, net
17

 
5

Net cash provided by (used in) financing activities
(1,002
)
 
547

Effect of foreign exchange rate changes on cash
(10
)
 
19

Net increase (decrease) in cash and temporary cash investments
(505
)
 
1,527

Cash and temporary cash investments at beginning of period
3,334

 
825

Cash and temporary cash investments at end of period
$
2,829

 
$
2,352

 
See Condensed Notes to Consolidated Financial Statements.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Millions of Dollars)
(Unaudited)

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Net income
$
1,203

 
$
292

 
$
2,044

 
$
762

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
(278
)
 
100

 
(166
)
 
63

Pension and other postretirement benefits:
 
 
 
 
 
 
 
Net loss arising during the period,
  net of income tax benefit of $-, $-, $-, and $-
—

 
—

 
—

 
(21
)
Net gain reclassified into income,
  net of income tax expense of $1, $2, $2, and $2
(1
)
 
(2
)
 
(3
)
 
(4
)
Net loss on pension and other
  postretirement benefits
(1
)
 
(2
)
 
(3
)
 
(25
)
 
 
 
 
 
 
 
 
Derivative instruments designated and
  qualifying as cash flow hedges:
 
 
 
 
 
 
 
Net gain (loss) arising during the period,
  net of income tax (expense) benefit of
  $(7), $-, $(7), and $1
13

 
—

 
13

 
(1
)
Net gain reclassified into income,
  net of income tax expense of $-, $13, $-, and $47
—

 
(24
)
 
—

 
(88
)
Net gain (loss) on cash flow hedges
13

 
(24
)
 
13

 
(89
)
Other comprehensive income (loss)
(266
)
 
74

 
(156
)
 
(51
)
Comprehensive income
937

 
366

 
1,888

 
711

Less: Comprehensive loss attributable to
  noncontrolling interests
—

 
—

 
(1
)
 
—

Comprehensive income attributable to
  Valero Energy Corporation stockholders
$
937

 
$
366

 
$
1,889

 
$
711

See Condensed Notes to Consolidated Financial Statements.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.
BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
General
As used in this report, the terms “Valero,” “we,” “us,” or “our” may refer to Valero Energy Corporation, one or more of its consolidated subsidiaries, or all of them taken as a whole.
These unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature unless disclosed otherwise. Financial information for the three and nine months ended September 30, 2011 and 2010 included in these Condensed Notes to Consolidated Financial Statements is derived from our unaudited consolidated financial statements. Operating results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.

The consolidated balance sheet as of December 31, 2010 has been derived from our audited financial statements as of that date. For further information, refer to our consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2010.
We have evaluated subsequent events that occurred after September 30, 2011 through the filing of this Form 10-Q. Any material subsequent events that occurred during this time have been properly recognized or disclosed in these financial statements.

Noncontrolling Interests
In connection with the acquisition of the Pembroke Refinery (see further discussion in Note 2), we acquired an 85 percent interest in Mainline Pipelines Limited (MLP). MLP owns a pipeline that distributes refined products from the Pembroke Refinery to terminals in the United Kingdom.

On January 21, 2011, we entered into a joint venture agreement with Darling Green Energy LLC, a subsidiary of Darling International, Inc., to form Diamond Green Diesel Holdings LLC (DGD Holdings). DGD Holdings, through its wholly owned subsidiary, Diamond Green Diesel LLC (DGD), will construct and operate a biomass-based diesel plant having a design feed capacity of 10,000 barrels per day that will process animal fats, used cooking oils, and other vegetable oils into renewable green diesel. The plant will be located next to our St. Charles Refinery. The aggregate cost of this facility is estimated to be approximately $368 million and the construction is expected to be completed in late 2012. The joint venture agreement requires that contributions be made to DGD Holdings based on the percentage of units held by each member, which is currently on a 50/50 basis. In addition, on May 31, 2011, we agreed to lend DGD up to $221 million in order to finance 60 percent of the construction costs of the plant.

Because of our controlling financial interests in MLP and DGD Holdings, we have included the financial statements of MLP and DGD Holdings in these consolidated financial statements and have separately disclosed the related noncontrolling interests.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Significant Accounting Policies
Reclassifications
As discussed in Note 2, we sold our Paulsboro Refinery in December 2010. As a result, the results of operations of the Paulsboro Refinery have been reclassified to discontinued operations for the three and nine months ended September 30, 2010.

In addition, credit card fees previously recognized in 2010 in retail operating expenses have been reclassified to cost of sales as such fees are directly and jointly related to the sale transaction. This reclassification resulted in an increase in cost of sales and a decrease in retail operating expenses of $23 million and $68 million for the three and nine months ended September 30, 2010, respectively.

Use of Estimates
The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. On an ongoing basis, we review our estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.

New Accounting Pronouncements
In June 2011, the provisions of Accounting Standards Codification (ASC) Topic 220, “Comprehensive Income,” were amended to allow an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. In both choices, the entity is required to present reclassification adjustments on the face of the financial statements for items that are reclassified from other comprehensive income to net income in the statement where those components are presented. These provisions are effective for the first interim or annual period beginning after December 15, 2011, and are to be applied retrospectively, with early adoption permitted. The adoption of this guidance effective January 1, 2012 will not affect our financial position or results of operations because these requirements only affect disclosures.

In May 2011, the provisions of ASC Topic 820, “Fair Value Measurement,” were amended to clarify the application of existing fair value measurement requirements and to change certain fair value measurement and disclosure requirements. Amendments that change measurement and disclosure requirements relate to (i) fair value measurement of financial instruments that are managed within a portfolio, (ii) application of premiums and discounts in a fair value measurement, and (iii) additional disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy. These provisions are effective for the first interim or annual period beginning after December 15, 2011. The adoption of this guidance effective January 1, 2012 will not affect our financial position or results of operations, but may result in additional disclosures.

In January 2011, the provisions of ASC Topic 310, “Receivables,” were amended to delay temporarily the effective date of disclosures relating to troubled debt restructurings, which were previously amended in July 2010, in order to allow the Financial Accounting Standards Board time to complete its deliberations on what constitutes a troubled debt restructuring. In April 2011, the provisions of ASC Topic 310 were amended to clarify the guidance on a creditor’s evaluations of whether it has granted a concession to the debtor and whether the debtor is experiencing financial difficulties. These provisions are effective for the first interim



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

or annual period beginning on or after June 15, 2011. The new guidance should be applied retrospectively to restructurings occurring on or after the beginning of the annual period of adoption, with early adoption permitted. The adoption of this guidance effective July 1, 2011 did not affect our financial position or results of operations.

2.
ACQUISITIONS AND DISPOSITIONS

Meraux Acquisition
On October 1, 2011, we acquired the Meraux Refinery and related logistics assets for an initial payment of $586 million, including inventories of $261 million, from Murphy Oil Corporation, with the total purchase price funded from available cash. We expect to receive a favorable adjustment related to inventories in the fourth quarter of 2011 that will reduce the purchase price by approximately $40 million. The Meraux Refinery has a total throughput capacity of 135,000 barrels per day and is located in Meraux, Louisiana. This acquisition is referred to as the Meraux Acquisition.

The Meraux Acquisition is consistent with our general business strategy and complements our existing refining and marketing network.

A determination of the acquisition-date fair values of the assets acquired and the liabilities assumed in the Meraux Acquisition is pending the completion of an independent appraisal and other evaluations. Disclosure of pro forma information for the Meraux Acquisition for the three and nine months ended September 30, 2011 and 2010 is impracticable as historical financial information is not readily available at this time.

Pembroke Acquisition
On August 1, 2011, we acquired 100 percent of the outstanding shares of Chevron Limited from a subsidiary of Chevron Corporation (Chevron), and we subsequently changed the name of Chevron Limited to Valero Energy Ltd. Valero Energy Ltd owns and operates the Pembroke Refinery, which has a total throughput capacity of approximately 270,000 barrels per day and is located in Wales, United Kingdom. Valero Energy Ltd also owns, directly and through various subsidiaries, an extensive network of marketing and logistics assets throughout the United Kingdom and Ireland. On the acquisition date, we initially paid $1.8 billion from available cash, of which $1.1 billion was for working capital. Subsequent to the acquisition date, the amounts paid have been favorably adjusted for working capital true-up adjustments (primarily inventory), with an adjusted purchase price of $1.675 billion, as outlined below. We expect final settlement by year end. This acquisition is referred to as the Pembroke Acquisition.

The Pembroke Acquisition is consistent with our general business strategy and broadens the geographic diversity of our refining and marketing network.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The purchase price for the Pembroke Acquisition has been preliminarily allocated based on estimated fair values of the assets acquired and liabilities assumed at the acquisition date, pending the completion of an independent appraisal and other evaluations. The preliminary purchase price allocation as of September 30, 2011 was as follows (in millions):

Current assets, net of cash acquired
$
2,217

Property, plant and equipment
777

Deferred charges and other assets
17

Intangible assets
50

Current liabilities, less current portion of debt
and capital lease obligations
(1,294
)
Debt and capital leases assumed, including current portion
(12
)
Other long-term liabilities
(77
)
Noncontrolling interest
(3
)
Purchase price, net of cash acquired
$
1,675


The acquired intangible assets are subject to amortization and have preliminary estimated useful lives of 15 years. These acquired intangible assets have been preliminarily assigned to the major intangible asset classes of royalties and licenses and wholesale dealer agreements.

During the three and nine months ended September 30, 2011, we recognized $18 million and $23 million, respectively, of costs related to the Pembroke Acquisition. These costs were expensed and are included in general and administrative expenses.

Our consolidated statements of income include the results of operations of the Pembroke Acquisition commencing on August 1, 2011. The operating revenues and income from continuing operations associated with the Pembroke Acquisition included in our consolidated statements of income for the three and nine months ended September 30, 2011, were as follows (in millions):

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Operating revenues
$
3,028

 
N/A
 
$
3,028

 
N/A
Income from continuing operations
19

 
N/A
 
19

 
N/A




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following pro forma financial information (in millions, except per share amounts) presents our consolidated results assuming the Pembroke Acquisition occurred on January 1, 2010. The pro forma financial information is not necessarily indicative of the results of future operations.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Operating revenues
$
35,491

 
$
24,594

 
$
103,030

 
$
70,638

Income from continuing operations
  attributable to Valero stockholders
1,196

 
306

 
1,941

 
767

Earnings per common share from
  continuing operations – basic
2.11

 
0.54

 
3.41

 
1.36

Earnings per common share from
  continuing operations – assuming dilution
2.10

 
0.54

 
3.39

 
1.35


Acquisition of Pipeline and Terminal Facilities
In June 2011, we acquired two product terminal facilities in Louisville and Lexington, Kentucky and a minority interest in the LouLex Pipeline system, which connects the terminal facilities, from a subsidiary of Chevron for cash consideration of $37 million. These assets provide storage and distribution facilities for our wholesale marketing business in eastern Kentucky, which is supplied primarily by our Memphis Refinery.

Because this acquisition was not material to our results of operations, we have not presented actual results of operations for this acquisition from the acquisition date through September 30, 2011 or pro forma results of operations for the three and nine months ended September 30, 2011 and 2010. The consolidated statements of income for the three and nine months ended September 30, 2011 include the results of this acquisition from its acquisition date.

Acquisitions of Ethanol Plants
In December 2009, we signed an agreement with ASA Ethanol Holdings, LLC to buy two ethanol plants located in Linden, Indiana and Bloomingburg, Ohio and made a $20 million advance payment towards the acquisition of these plants. In January 2010, we completed the acquisition of these plants, including certain inventories, for total consideration of $202 million.

Also in December 2009, we received approval from a bankruptcy court to acquire an ethanol plant located near Jefferson, Wisconsin from Renew Energy LLC and made a $1 million advance payment towards the acquisition of this plant. We completed the acquisition of this plant, including certain receivables and inventories, in February 2010 for total consideration of $79 million.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Disposition of Paulsboro Refinery
In December 2010, we sold our Paulsboro Refinery to PBF Holding Company LLC (PBF Holding) for total proceeds of $707 million, including $361 million from the sale of working capital, resulting in a pre-tax loss of $980 million ($610 million after taxes). The sale proceeds consisted of $547 million of cash and a $160 million note secured by the Paulsboro Refinery. The note matures in December 2011 and bears interest at LIBOR plus 700 basis points. PBF Holding has the option to extend the note for six months; however, the interest rate for the additional six months will be LIBOR plus 900 basis points.

The results of operations of the Paulsboro Refinery are reflected in discontinued operations, and selected results prior to its sale are shown below (in millions).

 
 
Three Months Ended
September 30, 2010
 
Nine Months Ended
September 30, 2010
Operating revenues
 
$
1,195

 
$
3,559

Loss before income taxes
 
(18
)
 
(36
)

Disposition of Delaware City Refinery Assets and Associated Terminal and Pipeline Assets
In June 2010, we sold our shutdown Delaware City Refinery assets and associated terminal and pipeline assets to wholly owned subsidiaries of PBF Energy Partners LP (PBF) for $220 million of cash proceeds. The sale resulted in a gain of $92 million ($58 million after taxes) related to the shutdown refinery assets and a gain of $3 million related to the terminal and pipeline assets. The gain on the sale of the shutdown refinery assets resulted from the proceeds we received for the scrap value of the assets and the reversal of certain liabilities recorded in the fourth quarter of 2009 associated with the shutdown of the refinery, which we did not incur because of the sale, and this gain is presented in discontinued operations for the nine months ended September 30, 2010.

Results of operations of the Delaware City Refinery are reflected in discontinued operations, and selected results prior to its sale, excluding the gain on the sale, are shown below (in millions):

 
Three Months Ended
September 30, 2010
 
Nine Months Ended
September 30, 2010
Operating revenues
$
—

 
$
—

Loss before income taxes
—

 
(33
)




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3.
IMPAIRMENT ANALYSIS

In late 2008, the U.S. and worldwide economies experienced severe disruptions in their capital and commodities markets resulting in a significant slowdown that persisted throughout 2009. This slowdown negatively impacted refining industry fundamentals and the demand and price for our refined products. Because of this negative impact, we decided to shut down our Aruba Refinery temporarily in July 2009, and it remained shut until January 2011. We restarted our Aruba Refinery due to improvements in the U.S. and worldwide economies and the resulting improvement in refining industry fundamentals; however, we analyzed our Aruba Refinery for potential impairment as of September 30, 2011 because of its recent temporary shutdown, its negative operating cash flows subsequent to its restart, the sensitivity of its profitability to sour crude oil differentials, and our decision in July 2011 to renew our exploration of strategic alternatives for the refinery, which may include the sale of the refinery. We considered these matters in our impairment analysis and concluded that our Aruba Refinery was not impaired as of September 30, 2011. Our future cash flow estimates for the refinery are based on our expectation that refining industry fundamentals will continue to improve in connection with an increase in the demand for refined products. Should refining industry fundamentals fail to continue to improve or should we decide to sell the refinery, our future cash flow estimates may be negatively impacted and we could ultimately determine that the refinery is impaired. The Aruba Refinery had a net book value of $950 million as of September 30, 2011; therefore, an impairment loss could be material to our results of operations.

4.
INVENTORIES

Inventories consisted of the following (in millions):

 
September 30,
2011
 
December 31,
2010
Refinery feedstocks
$
2,502

 
$
2,225

Refined products and blendstocks
2,217

 
2,233

Ethanol feedstocks and products
130

 
201

Convenience store merchandise
102

 
101

Materials and supplies
213

 
187

Inventories
$
5,164

 
$
4,947


As of September 30, 2011 and December 31, 2010, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by approximately $7.1 billion and $6.1 billion, respectively.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

5.
DEBT
Non-Bank Debt
During the nine months ended September 30, 2011, the following activity occurred related to our non-bank debt:
•
in May 2011, we made a scheduled debt repayment of $200 million related to our 6.125% senior notes;
•
in April 2011, we made scheduled debt repayments of $8 million related to our Series A 5.45%, Series B 5.40%, and Series C 5.40% industrial revenue bonds;
•
in February 2011, we made a scheduled debt repayment of $210 million related to our 6.75% senior notes; and
•
in February 2011, we paid $300 million to acquire the Gulf Opportunity Zone Revenue Bonds Series 2010 (GO Zone Bonds), which were subject to mandatory tender. We expect to hold the GO Zone Bonds for our own account until conditions permit the remarketing of these bonds at an interest rate acceptable to us.

During the nine months ended September 30, 2010, the following activity occurred related to our non-bank debt:
•
in June 2010, we made a scheduled debt repayment of $25 million related to our 7.25% debentures;
•
in May 2010, we redeemed our 6.75% senior notes with a maturity date of May 1, 2014 for $190 million, or 102.25% of stated value;
•
in April 2010, we made scheduled debt repayments of $8 million related to our Series A 5.45%, Series B 5.40%, and Series C 5.40% industrial revenue bonds;
•
in March 2010, we redeemed our 7.50% senior notes with a maturity date of June 15, 2015 for $294 million, or 102.5% of stated value; and
•
in February 2010, we issued $400 million of 4.50% notes due in February 2015 and $850 million of 6.125% notes due in February 2020 for total net proceeds of $1.2 billion.

Bank Debt and Credit Facilities
We have a $2.4 billion revolving credit facility (the Revolver) that has a maturity date of November 2012. The Revolver has certain restrictive covenants, including a maximum debt-to-capitalization ratio of 60 percent. As of September 30, 2011 and December 31, 2010, our debt-to-capitalization ratio, calculated in accordance with the terms of the Revolver, was 22 percent and 25 percent, respectively. We believe that we will remain in compliance with this covenant.

In addition to the Revolver, one of our Canadian subsidiaries has a committed revolving credit facility under which it may borrow and obtain letters of credit up to C$115 million.

During the nine months ended September 30, 2011 and 2010, we had no borrowings or repayments under our Revolver or the Canadian revolving credit facility. As of September 30, 2011 and December 31, 2010, we had no borrowings outstanding under the Revolver or the Canadian revolving credit facility.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

We had outstanding letters of credit under our committed lines of credit as follows (in millions):
 
 
 
 
 
 
Amounts Outstanding
 
 
Borrowing Capacity
 
Expiration
 
September 30, 2011
 
December 31, 2010
 Letter of credit facility
 
$200
 
June 2012
 
$—
 
$—
 Letter of credit facility
 
$300
 
June 2012
 
$300
 
$100
 Revolver
 
$2,400
 
November 2012
 
$74
 
$399
 Canadian revolving credit facility
 
C$115
 
December 2012
 
C$20
 
C$20

As of September 30, 2011 and December 31, 2010, we had $346 million and $176 million, respectively, of letters of credit outstanding under our uncommitted short-term bank credit facilities.

In connection with the Pembroke Acquisition, we assumed a €2.8 million short-term demand loan, which bears interest at EURIBOR plus a margin. We expect to repay the loan on or before February 2012.

Accounts Receivable Sales Facility
We have an accounts receivable sales facility with a group of third-party entities and financial institutions to sell on a revolving basis up to $1 billion of eligible trade receivables. We amended our agreement in June 2011 to extend the maturity date to June 2012. As of September 30, 2011 and December 31, 2010, the amount of eligible receivables sold was $100 million. There were no sales or repayments of eligible receivables during the nine months ended September 30, 2011. During the nine months ended September 30, 2010, we sold $1.2 billion of eligible receivables and repaid $1.3 billion to the third-party entities and financial institutions. Proceeds from the sale of receivables under this facility are reflected as debt.

Capitalized Interest
Capitalized interest was $41 million and $25 million for the three months ended September 30, 2011 and 2010, respectively, and $101 million and $67 million for the nine months ended September 30, 2011 and 2010, respectively.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

6.
COMMITMENTS AND CONTINGENCIES

Environmental Matters
The U.S. Environmental Protection Agency (EPA) began regulating greenhouse gases on January 2, 2011, under the Clean Air Act Amendments of 1990 (Clean Air Act). According to statements by the EPA, any new construction or material expansions will require that, among other things, a greenhouse gas permit be issued at either or both the state or federal level in accordance with the Clean Air Act and regulations, and we will be required to undertake a technology review to determine appropriate controls to be implemented with the project in order to reduce greenhouse gas emissions. The determination will be on a case by case basis, and the EPA has provided only general guidance on which controls will be required. Any such controls, however, could result in material increased compliance costs, additional operating restrictions for our business, and an increase in the cost of the products we produce, which could have a material adverse effect on our financial position, results of operations, and liquidity.

In addition, certain states and foreign governments have pursued independent regulation of greenhouse gases. For example, the California Global Warming Solutions Act, also known as AB 32, directs the California Air Resources Board (CARB) to develop and issue regulations to reduce greenhouse gas emissions in California to 1990 levels by 2020. The CARB has issued a variety of regulations aimed at reaching this goal, including a Low Carbon Fuel Standard (LCFS) as well as a statewide cap-and-trade program. The LCFS is effective in 2011, with small reductions in the carbon intensity of transportation fuels sold in California. The mandated reductions in carbon intensity are scheduled to increase through 2020, after which another step-change in reductions is anticipated. The LCFS is designed to encourage substitution of traditional petroleum fuels, and, over time, it is anticipated that the LCFS will lead to a greater use of electric cars and alternative fuels, such as E85, as companies seek to generate more credits to offset petroleum fuels. The statewide cap-and-trade program will begin in 2013. Initially, the program will apply only to stationary sources of greenhouse gases (e.g., refinery and power plant greenhouse gas emissions). Greenhouse gas emissions from fuels that we sell in California will be covered by the program beginning in 2015. We anticipate that free allocations of credits will be available in the early years of the program, but we expect that compliance costs will increase significantly beginning in 2015, when fuels are included in the program. Complying with AB 32, including the LCFS and the cap-and-trade program, could result in material increased compliance costs for us, increased capital expenditures, increased operating costs, and additional operating restrictions for our business, resulting in an increase in the cost of, and decreases in the demand for, the products we produce. To the degree we are unable to recover these increased costs, these matters could have a material adverse effect on our financial position, results of operations, and liquidity.

On June 30, 2010, the EPA formally disapproved the flexible permits program submitted by the Texas Commission on Environmental Quality (TCEQ) in 1994 for inclusion in its clean-air implementation plan.  The EPA determined that Texas’ flexible permit program did not meet several requirements under the federal Clean Air Act.  Our Port Arthur, Texas City, Three Rivers, McKee, and Corpus Christi East and West Refineries formerly operated under flexible permits administered by the TCEQ.  In the fourth quarter of 2010, we completed the conversion of our flexible permits into federally enforceable conventional state NSR permits (“de-flexed permits”). We are now in the process of incorporating these de-flexed permits into our Title V permits. Continued discussions with the TCEQ and the EPA regarding this matter are likely.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Meanwhile, the EPA has formally disapproved other TCEQ permitting programs that historically have streamlined the environmental permitting process in Texas. For example, the EPA has disapproved the TCEQ pollution control standard permit, thus requiring conventional permitting for future pollution control equipment. Litigation is pending from industry groups and others against the EPA for each of these actions. The EPA has also objected to numerous Title V permits in Texas and other states, including permits at our Port Arthur, Corpus Christi East, and McKee Refineries. Environmental activist groups have filed a notice of intent to sue the EPA, seeking to require the EPA to assume control of these permits from the TCEQ. All of these developments have created substantial uncertainty regarding existing and future permitting. Because of this uncertainty, we are unable to determine the costs or effects of the EPA’s actions on our permitting activity. But the EPA’s disruption of the Texas permitting system could result in material increased compliance costs for us, increased capital expenditures, increased operating costs, and additional operating restrictions for our business, resulting in an increase in the cost of, and decreases in the demand for, the products we produce, which could have a material adverse effect on our financial position, results of operations, and liquidity.

Tax Matters
We are subject to extensive tax liabilities, including federal, state, and foreign income taxes and transactional taxes such as excise, sales/use, payroll, franchise, withholding, and ad valorem taxes. New tax laws and regulations and changes in existing tax laws and regulations are continuously being enacted or proposed that could result in increased expenditures for tax liabilities in the future. Many of these liabilities are subject to periodic audits by the respective taxing authority. Subsequent changes to our tax liabilities as a result of these audits may subject us to interest and penalties.

Litigation Matters
We are party to claims and legal proceedings arising in the ordinary course of business. We have not recorded a loss contingency liability with respect to some of these matters because we have determined that it is remote that a loss has been incurred.  For other matters, we have recorded a loss contingency liability where we have determined that it is probable that a loss has been incurred and that the loss is reasonably estimable.  These loss contingency liabilities are not material to our financial position. We re-evaluate and update our loss contingency liabilities as matters progress over time, and we believe that any changes to the recorded liabilities will not be material to our financial position or results of operations.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

7.
EQUITY

The following is a reconciliation of the beginning and ending balances (in millions) of equity attributable to our stockholders, equity attributable to noncontrolling interests, and total equity for the nine months ended September 30, 2011 and 2010:
 
 
2011
 
2010
 
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests
 
Total
Equity
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests
 
Total
Equity
Balance at beginning of period
 
$
15,025

 
$
—

 
$
15,025

 
$
14,725

 
$
—

 
$
14,725

Net income (loss)
 
2,045

 
(1
)
 
2,044

 
762

 
—

 
762

Dividends
 
(85
)
 
—

 
(85
)
 
(85
)
 
—

 
(85
)
Stock-based compensation expense
 
34

 
—

 
34

 
32

 
—

 
32

Tax deduction in excess of stock-based compensation expense
 
19

 
—

 
19

 
7

 
—

 
7

Transactions in connection with stock-based compensation plans:
 
 
 
 
 
 
 
 
 
 
 
 
Stock issuances
 
42

 
—

 
42

 
12

 
—

 
12

Stock repurchases
 
(270
)
 
—

 
(270
)
 
(2
)
 
—

 
(2
)
Contributions from noncontrolling interest
 
—

 
14

 
14

 
—

 
—

 
—

Recognition of noncontrolling interest in connection with Pembroke Acquisition
 
—

 
3

 
3

 
—

 
—

 
—

Other comprehensive income (loss)
 
(156
)
 
—

 
(156
)
 
(51
)
 
—

 
(51
)
Balance at end of period
 
$
16,654

 
$
16

 
$
16,670

 
$
15,400

 
$
—

 
$
15,400


The noncontrolling interests relate to the ownership interests in MLP and DGD Holdings that are owned by parties unrelated to us, as discussed in Note 1.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Treasury Stock
During the nine months ended September 30, 2011 and 2010, we purchased 13.6 million shares and 1.6 million shares, respectively, of our common stock in connection with the administration of our stock-based compensation plans. During the nine months ended September 30, 2011 and 2010, we issued 3.9 million and 1.6 million shares from treasury, respectively, for our stock-based compensation plans.

Common Stock Dividends
On October 27, 2011, our board of directors declared a regular quarterly cash dividend of $0.15 per common share payable on December 14, 2011 to holders of record at the close of business on November 16, 2011.

8.
EMPLOYEE BENEFIT PLANS

The components of net periodic benefit cost related to our defined benefit plans were as follows for the three and nine months ended September 30, 2011 and 2010 (in millions):

 
Pension Plans
 
Other Postretirement
Benefit Plans
 
2011
 
2010
 
2011
 
2010
Three months ended September 30:
 
 
 
 
 
 
 
Service cost
$
28

 
$
22

 
$
4

 
$
3

Interest cost
21

 
21

 
5

 
6

Expected return on plan assets
(28
)
 
(28
)
 
—

 
—

Amortization of:

 
 
 
 
 
 
Prior service cost (credit)
1

 
1

 
(6
)
 
(5
)
Net loss
3

 
—

 
—

 
1

Net periodic benefit cost
$
25

 
$
16

 
$
3

 
$
5

 
 
 
 
 
 
 
 
Nine months ended September 30:
 
 
 
 
 
 
 
Service cost
$
73

 
$
65

 
$
9

 
$
8

Interest cost
64

 
62

 
16

 
19

Expected return on plan assets
(84
)
 
(84
)
 
—

 
—

Amortization of:
 
 
 
 
 
 
 
Prior service cost (credit)
2

 
2

 
(17
)
 
(15
)
Net loss
9

 
1

 
1

 
3

Net periodic benefit cost
$
64

 
$
46

 
$
9

 
$
15


During the nine months ended September 30, 2011 and 2010, we contributed $207 million and $54 million, respectively, to our pension plans.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

9.
EARNINGS PER COMMON SHARE

Earnings per common share from continuing operations were computed as follows (dollars and shares in millions, except per share amounts):

 
Three Months Ended September 30,
 
2011
 
2010
 
Restricted 
Stock
 
Common
Stock 
 
Restricted
Stock 
 
 Common
Stock
Earnings per common share from
  continuing operations:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
1,203

 
 
 
$
303

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
28

 
 
 
28

Nonvested restricted stock
 
 
—

 
 
 
—

Undistributed earnings
 
 
$
1,175

 
 
 
$
275

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
3

 
564

 
3

 
564

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations:
 
 
 
 
 
 
 
Distributed earnings
$
0.05

 
$
0.05

 
$
0.05

 
$
0.05

Undistributed earnings
2.07

 
2.07

 
0.49

 
0.49

Total earnings per common share from
  continuing operations
$
2.12

 
$
2.12

 
$
0.54

 
$
0.54

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations – assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
1,203

 
 
 
$
303

Weighted-average common shares outstanding
 
 
564

 
 
 
564

Common equivalent shares:
 
 

 
 
 
 
Stock options
 
 
3

 
 
 
3

Performance awards and unvested restricted
  stock
 
 
2

 
 
 
1

Weighted-average common shares outstanding –
  assuming dilution
 
 
569

 
 
 
568

Earnings per common share from
  continuing operations – assuming dilution
 
 
$
2.11

 
 
 
$
0.53




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
Nine Months Ended September 30,
 
2011
 
2010
 
Restricted 
Stock
 
Common
Stock 
 
Restricted
Stock 
 
 Common
Stock
Earnings per common share from
  continuing operations:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
2,052

 
 
 
$
743

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
85

 
 
 
85

Nonvested restricted stock
 
 
—

 
 
 
—

Undistributed earnings
 
 
$
1,967

 
 
 
$
658

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
3

 
566

 
3

 
563

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations:
 
 
 
 
 
 
 
Distributed earnings
$
0.15

 
$
0.15

 
$
0.15

 
$
0.15

Undistributed earnings
3.46

 
3.46

 
1.16

 
1.16

Total earnings per common share from
  continuing operations
$
3.61

 
$
3.61

 
$
1.31

 
$
1.31

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations – assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
2,052

 
 
 
$
743

Weighted-average common shares outstanding
 
 
566

 
 
 
563

Common equivalent shares:
 
 
 
 
 
 
 
Stock options
 
 
4

 
 
 
3

Performance awards and unvested restricted
  stock
 
 
2

 
 
 
1

Weighted-average common shares outstanding –
  assuming dilution
 
 
572

 
 
 
567

Earnings per common share from
  continuing operations – assuming dilution
 
 
$
3.59

 
 
 
$
1.31




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table reflects potentially dilutive securities (in millions) that were excluded from the calculation of “earnings per common share from continuing operations – assuming dilution” as the effect of including such securities would have been antidilutive. These potentially dilutive securities included common stock options for which the exercise prices were greater than the average market price of our common stock during each respective reporting period.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2011
 
2010
 
2011
 
2010
Stock options
6

 
17

 
6

 
14


10.
SEGMENT INFORMATION
The following table reflects segment activity related to continuing operations (in millions):

 
 
Refining
 
Retail
 
Ethanol
 
Corporate
 
Total
Three months ended September 30, 2011:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
$
29,177

 
$
3,053

 
$
1,483

 
$
—

 
$
33,713

Intersegment revenues
 
2,258

 
—

 
25

 
—

 
2,283

Operating income (loss)
 
1,947

 
97

 
107

 
(172
)
 
1,979

 
 
 
 
 
 
 
 
 
 
 
Three months ended September 30, 2010:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
17,811

 
2,360

 
844

 
—

 
21,015

Intersegment revenues
 
1,576

 
—

 
73

 
—

 
1,649

Operating income (loss)
 
590

 
105

 
47

 
(152
)
 
590

 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2011:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
78,660

 
8,865

 
3,789

 
—

 
91,314

Intersegment revenues
 
6,566

 
—

 
125

 
—

 
6,691

Operating income (loss)
 
3,476

 
298

 
215

 
(476
)
 
3,513

 
 
 
 
 
 
 
 
 
 
 
Nine months ended September 30, 2010:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
51,104

 
6,893

 
2,072

 
—

 
60,069

Intersegment revenues
 
4,675

 
—

 
184

 
—

 
4,859

Operating income (loss)
 
1,479

 
285

 
139

 
(405
)
 
1,498





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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Total assets by reportable segment were as follows (in millions):

 
September 30,
2011
 
December 31, 2010
Refining
$
35,541

 
$
30,363

Retail
1,933

 
1,925

Ethanol
879

 
953

Corporate
3,330

 
4,380

Total consolidated assets
$
41,683

 
$
37,621


11.
SUPPLEMENTAL CASH FLOW INFORMATION
In order to determine net cash provided by operating activities, net income is adjusted by, among other things, changes in current assets and current liabilities as follows (in millions):

 
Nine Months Ended
September 30,
 
2011
 
2010
Decrease (increase) in current assets:
 
 
 
Receivables, net
$
(1,963
)
 
$
(516
)
Inventories
891

 
79

Income taxes receivable
333

 
787

Prepaid expenses and other
12

 
111

Increase (decrease) in current liabilities:
 
 
 
Accounts payable
1,191

 
358

Accrued expenses
137

 
(51
)
Taxes other than income taxes
99

 
(168
)
Income taxes payable
140

 
(8
)
Changes in current assets and current liabilities
$
840

 
$
592


The above changes in current assets and current liabilities differ from changes between amounts reflected in the applicable consolidated balance sheets for the respective periods for the following reasons:
•
the amounts shown above exclude changes in cash and temporary cash investments, deferred income taxes, and current portion of debt and capital lease obligations, as well as the effect of certain noncash investing and financing activities discussed below;
•
the amounts shown above exclude the current assets and current liabilities acquired in connection with the the Pembroke Acquisition in August 2011 and the acquisitions of three ethanol plants in the first quarter of 2010;
•
amounts accrued for capital expenditures and deferred turnaround and catalyst costs are reflected in investing activities when such amounts are paid;
•
amounts accrued for common stock purchases in the open market that are not settled as of the balance sheet date are reflected in financing activities when the purchases are settled and paid; and



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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•
certain differences between consolidated balance sheet changes and the changes reflected above result from translating foreign currency denominated balances at the applicable exchange rates as of each balance sheet date.
During the nine months ended September 30, 2011, we received a noncash contribution of $2 million from the noncontrolling interest for property, plant and equipment related to DGD Holdings. There were no significant noncash investing or financing activities for the nine months ended September 30, 2010.

Cash flows related to interest and income taxes were as follows (in millions):
 
Nine Months Ended
September 30,
 
2011
 
2010
Interest paid in excess of amount capitalized
$
276

 
$
302

Income taxes paid (received), net
289

 
(645
)
Cash flows related to the discontinued operations of the Paulsboro and Delaware City Refineries have been combined with the cash flows from continuing operations within each category in the consolidated statement of cash flows for the nine months ended September 30, 2010 and are summarized as follows (in millions):

Cash provided by (used in) operating activities:
 
Paulsboro Refinery
$
42

Delaware City Refinery
(76
)
Cash used in investing activities:
 
Paulsboro Refinery
(32
)
Delaware City Refinery
—


12.
FAIR VALUE MEASUREMENTS
General
GAAP requires that certain financial instruments, such as derivative instruments, be recognized at their fair values in our consolidated balance sheets. However, other financial instruments, such as debt obligations, are not required to be recognized at their fair values, but GAAP provides an option to elect fair value accounting for these instruments. GAAP requires the disclosure of the fair values of all financial instruments, regardless of whether they are recognized at their fair values or carrying amounts in our consolidated balance sheets. For financial instruments recognized at fair value, GAAP requires the disclosure of their fair values by type of instrument, along with other information, including changes in the fair values of certain financial instruments recognized in income or other comprehensive income, and this information is provided below under “Recurring Fair Value Measurements.” For financial instruments not recognized at fair value, the disclosure of their fair values is provided below under “Other Financial Instruments.”

Nonfinancial assets, such as property, plant and equipment, and nonfinancial liabilities are recognized at their carrying amounts in our consolidated balance sheets. GAAP does not permit nonfinancial assets and liabilities to be remeasured at their fair values. However, GAAP requires the remeasurement of such assets



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CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

and liabilities to their fair values upon the occurrence of certain events, such as the impairment of property, plant and equipment. In addition, if such an event occurs, GAAP requires the disclosure of the fair value of the asset or liability along with other information, including the gain or loss recognized in income in the period the remeasurement occurred. This information is provided below under “Nonrecurring Fair Value Measurements.”

GAAP provides a framework for measuring fair value and establishes a three-level fair value hierarchy that prioritizes inputs to valuation techniques based on the degree to which objective prices in external active markets are available to measure fair value. Following is a description of each of the levels of the fair value hierarchy.
•
Level 1 - Observable inputs, such as unadjusted quoted prices in active markets for identical assets or liabilities.
•
Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.
•
Level 3 - Unobservable inputs for the asset or liability for which there is little, if any, market activity at the measurement date. Unobservable inputs reflect our own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include occasional market quotes or sales of similar instruments or our own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant judgment.

The financial instruments and nonfinancial assets and liabilities included in our disclosure of recurring and nonrecurring fair value measurements are categorized according to the fair value hierarchy based on the inputs used to measure their fair values.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Recurring Fair Value Measurements
The tables below present information (in millions) about our financial instruments recognized at their fair values in our consolidated balance sheets categorized according to the fair value hierarchy of the inputs utilized by us to determine the fair values as of September 30, 2011 and December 31, 2010.

 
Fair Value Measurements Using
 
 
 
 
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
 
 
Total as of
September 30,
2011
 
 
 
 
Netting
Adjustments
 
Assets:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
$
6,764

 
$
238

 
$
—

 
$
(6,734
)
 
$
268

Physical purchase contracts
—

 
(81
)
 
—

 
—

 
(81
)
Investments of nonqualified benefit plans
81

 
—

 
11

 
—

 
92

Other investments
—

 
—

 
—

 
—

 
—

Liabilities:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
6,503

 
338

 
—

 
(6,734
)
 
107

Nonqualified benefit plan obligations
34

 
—

 
—

 
—

 
34

RINs obligation
137

 
—

 
—

 
—

 
137


 
Fair Value Measurements Using
 
 
 
 
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
 
 
Total as of
December 31,
2010
 
 
 
 
Netting
Adjustments
 
Assets:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
$
3,240

 
$
489

 
$
—

 
$
(3,560
)
 
$
169

Physical purchase contracts
—

 
17

 
—

 
—

 
17

Investments of nonqualified benefit plans
104

 
—

 
10

 
—

 
114

Other investments
—

 
—

 
—

 
—

 
—

Liabilities:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
3,097

 
502

 
—

 
(3,560
)
 
39

Nonqualified benefit plan obligations
36

 
—

 
—

 
—

 
36

RINs obligation
51

 
—

 
—

 
—

 
51




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

A description of our financial instruments and the valuation methods used to measure those instruments at fair value are as follows:
•
Commodity derivative contracts consist primarily of exchange-traded futures and swaps, and as disclosed in Note 13, some of these contracts are designated as hedging instruments. These contracts are measured at fair value using the market approach. Exchange-traded futures are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Swaps are priced using third-party broker quotes, industry pricing services, and exchange-traded curves, with appropriate consideration of counterparty credit risk, but because they have contractual terms that are not identical to exchange-traded futures instruments with a comparable market price, these financial instruments are categorized in Level 2 of the fair value hierarchy.
•
Physical purchase contracts to purchase inventories represent the fair value of firm commitments to purchase crude oil feedstocks and the fair value of fixed-price corn purchase contracts, and as disclosed in Note 13, some of these contracts are designated as hedging instruments. The fair values of these firm commitments and purchase contracts are measured using a market approach based on quoted prices from the commodity exchange, but because these commitments have contractual terms that are not identical to exchange-traded futures instruments with a comparable market price, they are categorized in Level 2 of the fair value hierarchy.
•
Nonqualified benefit plan assets consist of investment securities held by our nonqualified defined benefit and nonqualified defined contribution plans. The nonqualified benefit plan obligations relate to our nonqualified defined contribution plans under which our obligations to eligible employees are equal to the fair value of the assets held by those plans. The nonqualified benefit plan assets categorized in Level 1 of the fair value hierarchy are measured at fair value using a market approach based on quotations from national securities exchanges. The nonqualified benefit plan assets categorized in Level 3 of the fair value hierarchy represent insurance contracts, the fair value of which is provided by the insurer.
•
Other investments consist of (i) equity securities of private companies over which we do not exercise significant influence nor whose financial statements are consolidated into our financial statements and (ii) debt securities of a private company whose financial statements are not consolidated into our financial statements. We have elected to account for these investments at their fair values. These investments are categorized in Level 3 of the fair value hierarchy as the fair values of these investments are determined using the income approach based on internally developed analyses.
•
Our RINs obligation represents a liability for the purchase of Renewable Identification Numbers (RINs) to satisfy our obligation to blend biofuels into the products we produce. A RIN represents a serial number assigned to each gallon of biofuel produced or imported into the U.S. as required by the EPA’s Renewable Fuel Standard, which was implemented in accordance with the Energy Policy Act of 2005. The EPA sets annual quotas for the percentage of biofuels that must be blended into motor fuels consumed in the U.S., and as a producer of motor fuels from petroleum, we are obligated to blend biofuels into the products we produce at a rate that is at least equal to the EPA’s quota. To the degree we are unable to blend at that rate, we must purchase RINs in the open market to satisfy our obligation. Our RINs obligation is based on our RINs deficiency and the price of those RINs as of the balance sheet date. Our RINs obligation is categorized in Level 1 of the fair value hierarchy and is measured at fair value using the market approach based on quoted prices from an independent pricing service.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Cash collateral deposits of $228 million and $403 million with brokers under master netting arrangements are included in the fair value of the commodity derivatives reflected in Level 1 as of September 30, 2011 and December 31, 2010, respectively. Certain of our commodity derivative contracts under master netting arrangements include both asset and liability positions. We have elected to offset the fair value amounts recognized for multiple similar derivative instruments executed with the same counterparty, including any related cash collateral asset or obligation; however, fair value amounts by hierarchy level are presented on a gross basis in the tables above.
The following is a reconciliation of the beginning and ending balances (in millions) for fair value measurements developed using significant unobservable inputs (Level 3).

 
2011
 
2010
 
Investments of Nonqualified
Benefit
Plans
 
Other
Investments
 
Investments of
Nonqualified
Benefit
Plans
 
Other
Investments
Three months ended September 30:
 
 
 
 
 
 
 
Balance at beginning of period
$
11

 
$
—

 
$
10

 
$
—

Purchases
—

 
5

 
—

 
—

Total losses included in earnings
—

 
(5
)
 
—

 
—

Transfers in and/or out of Level 3
—

 
—

 
—

 
—

Balance at end of period
$
11

 
$
—

 
$
10

 
$
—

The amount of total losses included
  in earnings attributable to the change in
  unrealized losses relating to assets still
  held at end of period
$
—

 
$
(5
)
 
$
—

 
$
—

 
 
 
 
 
 
 
 
Nine months ended September 30:
 
 
 
 
 
 
 
Balance at beginning of period
$
10

 
$
—

 
$
10

 
$
—

Purchases
—

 
21

 
—

 
1

Total gains (losses) included in
  earnings
1

 
(21
)
 
—

 
(1
)
Transfers in and/or out of Level 3
—

 
—

 
—

 
—

Balance at end of period
$
11

 
$
—

 
$
10

 
$
—

The amount of total gains (losses)
  included in earnings attributable to the
  change in unrealized gains (losses)
  relating to assets still held
  at end of period
$
1

 
$
(21
)
 
$
—

 
$
(1
)
    
Nonrecurring Fair Value Measurements
As of September 30, 2011 and December 31, 2010, there were no assets or liabilities that were measured at fair value on a nonrecurring basis.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Other Financial Instruments
Financial instruments that we recognize in our consolidated balance sheets at their carrying amounts include cash and temporary cash investments, receivables, payables, debt and capital lease obligations. The fair values of these financial instruments approximate their carrying amounts, except for debt as shown in the table below (in millions):

 
September 30,
2011
 
December 31,
2010
Carrying amount (excluding capital leases)
$
7,595

 
$
8,300

Fair value
9,169

 
9,492


The fair value of our debt is determined using the market approach based on quoted prices in active markets (Level 1).

13.
PRICE RISK MANAGEMENT ACTIVITIES
We are exposed to market risks related to the volatility in the price of commodities, interest rates and foreign currency exchange rates, and we enter into derivative instruments to manage those risks. We also enter into derivative instruments to manage the price risk on other contractual derivatives into which we have entered. The only types of derivative instruments we enter into are those related to the various commodities we purchase or produce, interest rate swaps, and foreign currency exchange and purchase contracts, as described below. All derivative instruments are recorded as either assets or liabilities measured at their fair values (See Note 12).
When we enter into a derivative instrument, it is designated as a fair value hedge, a cash flow hedge, an economic hedge, or a trading derivative. The gain or loss on a derivative instrument designated and qualifying as a fair value hedge, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized currently in income in the same period. The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge is initially reported as a component of other comprehensive income and is then recorded in income in the period or periods during which the hedged forecasted transaction affects income. The ineffective portion of the gain or loss on the cash flow derivative instrument, if any, is recognized in income as incurred. For our economic hedges (derivative instruments not designated as fair value or cash flow hedges) and for derivative instruments entered into by us for trading purposes, the derivative instrument is recorded at fair value and changes in the fair value of the derivative instrument are recognized currently in income. The cash flow effects of all of our derivative instruments are reflected in operating activities in the consolidated statements of cash flows for all periods presented.




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Commodity Price Risk
We are exposed to market risks related to the price of crude oil, refined products (primarily gasoline and distillate), grain (primarily corn), and natural gas used in our operations. To reduce the impact of price volatility on our results of operations and cash flows, we use commodity derivative instruments, including swaps, futures, and options. We use the futures markets for the available liquidity, which provides greater flexibility in transacting our hedging and trading operations. We use swaps primarily to manage our price exposure. Our positions in commodity derivative instruments are monitored and managed on a daily basis by a risk control group to ensure compliance with our stated risk management policy that has been approved by our board of directors.

For risk management purposes, we use fair value hedges, cash flow hedges, and economic hedges. In addition to the use of derivative instruments to manage commodity price risk, we also enter into certain commodity derivative instruments for trading purposes. Our objective for entering into each type of hedge or trading derivative is described below.

Fair Value Hedges
Fair value hedges are used to hedge price volatility in certain refining inventories and firm commitments to purchase inventories. The level of activity for our fair value hedges is based on the level of our operating inventories, and generally represents the amount by which our inventories differ from our previous year-end LIFO inventory levels.
As of September 30, 2011, we had the following outstanding commodity derivative instruments that were entered into to hedge crude oil and refined product inventories and commodity derivative instruments related to the physical purchase of crude oil and refined products at a fixed price. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels).

 
 
Notional
Contract
Volumes by
Year of
Maturity
Derivative Instrument
 
2011
Crude oil and refined products:
 
 
Futures – long
 
3,025

Futures – short
 
16,453

Physical purchase contracts – long
 
13,428




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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Cash Flow Hedges
Cash flow hedges are used to hedge price volatility in certain forecasted feedstock and refined product purchases, refined product sales, and natural gas purchases. The objective of our cash flow hedges is to lock in the price of forecasted feedstock, product or natural gas purchases or refined product sales at existing market prices that we deem favorable.

As of September 30, 2011, we had the following outstanding commodity derivative instruments that were entered into to hedge forecasted purchases or sales of crude oil and refined products. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels).

 
 
Notional Contract Volumes by Year of Maturity
Derivative Instrument
 
2012
Crude oil and refined products:
 
 
Swaps – long
 
5,241

Swaps – short
 
5,241





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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Economic Hedges
Economic hedges represent commodity derivative instruments that are not designated as fair value or cash flow hedges and are used to manage price volatility in certain (i) refinery feedstock, refined product, and corn inventories, (ii) forecasted refinery feedstock, refined product, and corn purchases, and refined product sales, and (iii) fixed-price corn purchase contracts. Our objective in entering into economic hedges is consistent with the objectives discussed above for fair value hedges and cash flow hedges. However, the economic hedges are not designated as a fair value hedge or a cash flow hedge for accounting purposes, usually due to the difficulty of establishing the required documentation at the date that the derivative instrument is entered into that would allow us to achieve “hedge deferral accounting.”
As of September 30, 2011, we had the following outstanding commodity derivative instruments that were entered into as economic hedges and commodity derivative instruments related to the physical purchase of corn at a fixed price. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels, except those identified as corn contracts that are presented in thousands of bushels).

 
 
Notional Contract Volumes by
Year of Maturity
Derivative Instrument
 
2011
 
2012
 
2013
Crude oil and refined products:
 
 
 
 
 
 
Swaps – long
 
34,708

 
65,040

 
—

Swaps – short
 
33,890

 
65,040

 
—

Futures – long
 
200,076

 
40,388

 
—

Futures – short
 
192,292

 
41,219

 
—

Options – long
 
606

 
10

 
—

Options – short
 
600

 
—

 
—

Corn:
 
 
 
 
 
 
Futures – long
 
22,325

 
8,405

 
—

Futures – short
 
41,300

 
23,980

 
260

Physical purchase contracts – long
 
12,166

 
10,991