VLO Form 10-Q - 3.31.2013
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 March 31, 2013
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 such 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 April 30, 2013 was 545,365,570.
 
 
 
 
 


VALERO ENERGY CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 





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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)

 
March 31,
2013
 
December 31,
2012
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and temporary cash investments
$
1,857

 
$
1,723

Receivables, net
7,658

 
8,167

Inventories
6,937

 
5,973

Income taxes receivable
90

 
169

Deferred income taxes
280

 
274

Prepaid expenses and other
384

 
154

Total current assets
17,206

 
16,460

Property, plant and equipment, at cost
34,470

 
34,132

Accumulated depreciation
(8,072
)
 
(7,832
)
Property, plant and equipment, net
26,398

 
26,300

Intangible assets, net
203

 
213

Deferred charges and other assets, net
1,694

 
1,504

Total assets
$
45,501

 
$
44,477

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of debt and capital lease obligations
$
406

 
$
586

Accounts payable
9,821

 
9,348

Accrued expenses
761

 
590

Taxes other than income taxes
1,314

 
1,026

Income taxes payable
15

 
1

Deferred income taxes
388

 
378

Total current liabilities
12,705

 
11,929

Debt and capital lease obligations, less current portion
6,463

 
6,463

Deferred income taxes
6,131

 
5,860

Other long-term liabilities
1,784

 
2,130

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
7,245

 
7,322

Treasury stock, at cost; 125,469,048 and 121,406,520 common shares
(6,605
)
 
(6,437
)
Retained earnings
17,575

 
17,032

Accumulated other comprehensive income
121

 
108

Total Valero Energy Corporation stockholders’ equity
18,343

 
18,032

Noncontrolling interests
75

 
63

Total equity
18,418

 
18,095

Total liabilities and equity
$
45,501

 
$
44,477

See Condensed Notes to Consolidated Financial Statements.



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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Millions of Dollars, Except Per Share Amounts)
(Unaudited)
 
Three Months Ended
March 31,
 
2013
 
2012
Operating revenues (a)
$
33,474

 
$
35,167

Costs and expenses:
 
 
 
Cost of sales
30,685

 
33,035

Operating expenses:
 
 
 
Refining
876

 
964

Retail
169

 
166

Ethanol
77

 
87

General and administrative expenses
176

 
164

Depreciation and amortization expense
430

 
384

Asset impairment losses
—

 
611

Total costs and expenses
32,413

 
35,411

Operating income (loss)
1,061

 
(244
)
Other income, net
14

 
6

Interest and debt expense, net of capitalized interest
(83
)
 
(99
)
Income (loss) before income tax expense
992

 
(337
)
Income tax expense
340

 
95

Net income (loss)
652

 
(432
)
Less: Net loss attributable to noncontrolling interests
(2
)
 
—

Net income (loss) attributable to Valero Energy Corporation stockholders
$
654

 
$
(432
)
 
 
 
 
Earnings per common share
$
1.18

 
$
(0.78
)
Weighted-average common shares outstanding (in millions)
550

 
551

 
 
 
 
Earnings per common share – assuming dilution
$
1.18

 
$
(0.78
)
Weighted-average common shares outstanding –
assuming dilution (in millions)
556

 
551

 
 
 
 
Dividends per common share
$
0.20

 
$
0.15

____________________________________
 
 
 
Supplemental information:
 
 
 
(a) Includes excise taxes on sales by our U.S. retail system
$
236

 
$
234

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
March 31,
 
2013
 
2012
Net income (loss)
$
652

 
$
(432
)
 
 
 
 
Other comprehensive income (loss):
 
 
 
Foreign currency translation adjustment
(204
)
 
123

 
 
 
 
Pension and other postretirement benefits:
 
 
 
Gain arising during the period related to
remeasurement due to plan amendments
328

 
—

(Gain) loss reclassified into income related to:
 
 
 
Net actuarial loss
14

 
8

Prior service credit
(6
)
 
(4
)
Net gain on pension
and other postretirement benefits
336

 
4

 
 
 
 
Derivative instruments designated
and qualifying as cash flow hedges:
 
 
 
Net gain arising during the period
1

 
47

Net gain reclassified into income
(3
)
 
(48
)
Net loss on cash flow hedges
(2
)
 
(1
)
 
 
 
 
Other comprehensive income,
before income tax expense
130

 
126

Income tax expense related to items of other
comprehensive income
117

 
1

Other comprehensive income
13

 
125

 
 
 
 
Comprehensive income (loss)
665

 
(307
)
Less: Comprehensive loss attributable to
noncontrolling interests
(2
)
 
—

Comprehensive income (loss) attributable to
Valero Energy Corporation stockholders
$
667

 
$
(307
)
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)

 
Three Months Ended
March 31,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income (loss)
$
652

 
$
(432
)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
 
 
 
Depreciation and amortization expense
430

 
384

Asset impairment losses
—

 
611

Noncash interest expense and other income, net
1

 
7

Stock-based compensation expense
12

 
10

Deferred income tax expense
173

 
61

Changes in current assets and current liabilities
255

 
903

Changes in deferred charges and credits and other operating activities, net
26

 
—

Net cash provided by operating activities
1,549

 
1,544

Cash flows from investing activities:
 
 
 
Capital expenditures
(577
)
 
(726
)
Deferred turnaround and catalyst costs
(287
)
 
(158
)
Proceeds from the sale of the Paulsboro Refinery
—

 
160

Other investing activities, net
4

 
10

Net cash used in investing activities
(860
)
 
(714
)
Cash flows from financing activities:
 
 
 
Non-bank debt:
 
 
 
Repayments
(180
)
 
—

Accounts receivable sales program:
 
 
 
Repayments
—

 
(150
)
Purchase of common stock for treasury
(304
)
 
(106
)
Proceeds from the exercise of stock options
38

 
9

Common stock dividends
(111
)
 
(83
)
Contributions from noncontrolling interest
13

 
11

Other financing activities, net
22

 
—

Net cash used in financing activities
(522
)
 
(319
)
Effect of foreign exchange rate changes on cash
(33
)
 
24

Net increase in cash and temporary cash investments
134

 
535

Cash and temporary cash investments at beginning of period
1,723

 
1,024

Cash and temporary cash investments at end of period
$
1,857

 
$
1,559


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
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 financial statements have been prepared in accordance with United States (U.S.) 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 U.S. GAAP for complete 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 months ended March 31, 2013 and 2012 included in these Condensed Notes to Consolidated Financial Statements is derived from our unaudited financial statements. Operating results for the three months ended March 31, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013.

The balance sheet as of December 31, 2012 has been derived from our audited financial statements as of that date. For further information, refer to our financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2012.
Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions that affect the amounts reported in the 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.

Comprehensive Income
In February 2013, the provisions of Accounting Standards Codification (ASC) ASC Topic 220, “Comprehensive Income,” were amended to require an entity to disclose information about the amounts reclassified out of accumulated other comprehensive income by component. For amounts required to be reclassified out of accumulated other comprehensive income in their entirety in the same reporting period, the guidance requires entities to present significant amounts by the respective line items of net income, either on the face of the income statement or in the notes to the financial statements. For other amounts that are not required to be reclassified to net income in their entirety, a cross-reference is required to other disclosures that provide additional details about those amounts. These provisions are effective for interim and annual reporting periods beginning after December 15, 2012. The adoption of this guidance effective January 1, 2013 did not affect our financial position or results of operations, but did result in additional disclosures, which are included in Note 7.

Balance Sheet Offsetting Arrangements
In December 2011, the provisions of ASC Topic 210, “Balance Sheet,” were amended to require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of these arrangements on its financial position. In January 2013, the provisions of ASC Topic 210 were further amended to clarify that the scope of the previous amendment only applies to



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

derivative instruments, including bifurcated derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either eligible for offset in the balance sheet or are subject to an agreement similar to a master netting agreement. The guidance requires entities to disclose both gross information and net information about assets and liabilities within the scope of the amendment. These provisions are effective for interim and annual reporting periods beginning on or after January 1, 2013. The adoption of this guidance effective January 1, 2013 did not affect our financial position or results of operations, but did result in additional disclosures, which are included in Note 12.

Other
The statement of cash flows for the three months ended March 31, 2012, which was included in our Form 10-Q for the quarterly period ended March 31, 2012, reflected an incorrect classification of $160 million in proceeds on a note receivable related to the sale of our Paulsboro Refinery in December 2010. We previously reflected such proceeds as a component of cash flows from operating activities rather than as a component of cash flows from investing activities. The statement of cash flows for the three months ended March 31, 2012 included in this Form 10-Q for the quarterly period ended March 31, 2013 has been corrected to properly reflect the classification of those proceeds.

2.
SEPARATION OF RETAIL BUSINESS

On May 1, 2013, we completed the separation of our retail business, creating an independent public company named CST Brands, Inc. (CST). In accordance with a separation and distribution agreement, the separation occurred by way of a pro rata distribution of 80 percent of the outstanding shares of CST common stock to our stockholders on May 1, 2013. Each Valero stockholder received one share of CST common stock for every nine shares of Valero common stock held at the close of business on the record date of April 19, 2013. Fractional shares of CST common stock were not distributed, but instead were aggregated and sold in the open market at prevailing rates with net cash proceeds then distributed pro rata to each Valero stockholder who was entitled to receive fractional shares.

In connection with the separation, we received an aggregate of $1.05 billion in cash, consisting of $550 million from the issuance of short-term debt to a third-party financial institution on April 16, 2013 and $500 million distributed to us by CST on May 1, 2013. The cash distributed to us by CST was borrowed by CST on May 1, 2013 under its senior secured credit facility. See Note 5 for further discussion of that credit facility. Also on May 1, 2013, CST issued $550 million of its senior unsecured bonds to us, and we exchanged those bonds with the third-party financial institution in satisfaction of our short-term debt. Immediately prior to May 1, 2013, subsidiaries of CST held $315 million of cash, and CST retained that cash following the distribution on May 1, 2013. Approximately $265 million of the cash retained by CST resulted from a change in the payment terms from “due upon receipt” to “net 10” days on motor fuel purchased from us, and this change in payment terms was effective prior to May 1, 2013. The new payment terms are consistent with those offered by us to our other creditworthy retail distributors. Also in connection with the separation, we incurred a tax liability of approximately $220 million primarily related to the manner in which the transaction is treated for tax purposes in Canada, and most of these taxes will not be paid until the first half of 2014. Therefore the net cash we will receive as a result of the separation will be approximately $500 million. We expect to liquidate the remaining 20 percent of the outstanding shares of CST common stock that we own within 18 months.




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

In order to effect the separation and provide a framework for our relationship with CST after the separation, we entered into various agreements with CST, including fuel supply agreements in the U.S. and Canada. The nature and significance of our post-separation participation in the supply of motor fuel to CST represents a continuation of activities with CST for accounting purposes. As such, the historical results of operations related to CST will not be reported by us as discontinued operations in our consolidated statements of income.

3.
IMPAIRMENTS

Aruba Refinery
In March 2012, we suspended the operations of the Aruba Refinery because of its inability to generate positive cash flows on a sustained basis subsequent to its restart in January 2011 and the sensitivity of its profitability to sour crude oil differentials, which had narrowed significantly in the fourth quarter of 2011. Shortly thereafter, we received a non-binding offer to purchase the refinery for $350 million, plus working capital as of the closing date. Because of our decision to suspend the operations and the possibility of selling the refinery, we evaluated the refinery for potential impairment as of March 31, 2012 and concluded that it was impaired. We recognized an asset impairment loss of $595 million in March 2012. We did not, however, classify the Aruba Refinery as “held for sale” in our balance sheet because all of the accounting criteria required for that classification had not been met.

In September 2012, we decided to reorganize the Aruba Refinery into a crude oil and refined products terminal in response to the withdrawal of the non-binding offer to purchase the refinery. We bifurcated the idled crude oil processing units and related infrastructure (refining assets) from the terminal assets and evaluated the refining assets for potential impairment as of September 30, 2012. We concluded that the refining assets were impaired and recognized an asset impairment loss of $308 million in September 2012. We also recognized an asset impairment loss of $25 million related to materials and supplies inventories that supported the refining operations, resulting in a total asset impairment loss of $333 million that was recognized in September 2012 related to the Aruba Refinery. The terminal assets were not impaired.

We have continued to maintain the refining assets to allow them to be restarted and do not consider them to be abandoned. Therefore, we have not reflected the Aruba Refinery as a discontinued operation in our financial statements. It is possible, however, that we may abandon these assets in the future. Should we ultimately decide to abandon these assets, we may be required under our land lease agreement with the Government of Aruba to dismantle and remove the abandoned assets, which would require us to recognize an asset retirement obligation, that would be immediately charged to expense. We do not expect these amounts to be material to our financial position or results of operations.

The variation in the customary relationship between income tax expense and income before income tax expense for the three months ended March 31, 2012 was primarily due to not recognizing a tax benefit associated with the asset impairment loss of $595 million related to the Aruba Refinery as we do not expect to realize this tax benefit.

Cancelled Capital Project
In March 2012, we wrote down the carrying value of equipment associated with a permanently cancelled capital project at one of our refineries, resulting in an asset impairment loss of $16 million.




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

4.
INVENTORIES

Inventories consisted of the following (in millions):
 
March 31,
2013
 
December 31,
2012
Refinery feedstocks
$
2,580

 
$
2,458

Refined products and blendstocks
3,832

 
2,995

Ethanol feedstocks and products
190

 
191

Convenience store merchandise
111

 
112

Materials and supplies
224

 
217

Inventories
$
6,937

 
$
5,973


As of March 31, 2013 and December 31, 2012, the replacement cost (market value) of last in, first out (LIFO) inventories exceeded their LIFO carrying amounts by approximately $7.5 billion and $6.7 billion, respectively.

5.
DEBT

Bank Debt and Credit Facilities
We have a $3 billion revolving credit facility (the Revolver) that has a maturity date of December 2016. The Revolver has certain restrictive covenants, including a maximum debt-to-capitalization ratio of 60 percent. As of March 31, 2013 and December 31, 2012, our debt-to-capitalization ratios, calculated in accordance with the terms of the Revolver, were 21 percent and 23 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$50 million.

During the three months ended March 31, 2013 and 2012, we had no borrowings or repayments under our Revolver or the Canadian revolving credit facility. As of March 31, 2013 and December 31, 2012, we had no borrowings outstanding under the Revolver or the Canadian revolving credit facility.

On March 20, 2013, in anticipation of the separation of our retail business as described in Note 2, CST entered into a credit agreement providing for $800 million of senior secured credit facilities (consisting of a $500 million term loan and a revolving credit facility with a borrowing capacity of up to $300 million). Borrowings under the term loan and revolving credit facility will bear interest at a base rate or the London Interbank Offered Rate, as prescribed in the agreement. The credit agreement matures on May 1, 2018 and has certain restrictive covenants. As of March 31, 2013, no amounts were outstanding under these credit facilities. This credit facility was retained by CST after the separation from us.

On April 16, 2013, also in anticipation of the separation of our retail business, we borrowed $550 million under a short-term debt agreement with a third-party financial institution. On May 1, 2013, CST issued $550 million of its senior unsecured bonds to us, and we exchanged those bonds with the third-party financial institution in satisfaction of our short-term debt.



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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
 
March 31,
2013
 
December 31,
2012
Letter of credit facilities
 
$
550

 
June 2013
 
$
550

 
$
418

Revolver
 
$
3,000

 
December 2016
 
$
59

 
$
59

Canadian revolving credit facility
 
C$
50

 
November 2013
 
C$
10

 
C$
10


As of March 31, 2013 and December 31, 2012, we had $441 million and $275 million, respectively, of letters of credit outstanding under our uncommitted short-term bank credit facilities.

Non-Bank Debt
In January 2013, we made a scheduled debt repayment of $180 million related to our 6.7% senior notes. In March 2012, we exercised the call provisions on our Series 1997 5.6%, Series 1998 5.6%, Series 1999 5.7%, Series 2001 6.65%, and Series 1997A 5.45% industrial revenue bonds, which were redeemed on May 3, 2012 for $108 million, or 100 percent of their outstanding stated values.

Accounts Receivable Sales Facility
We have an accounts receivable sales facility with a group of third-party entities and financial institutions to sell up to $1.5 billion of eligible trade receivables on a revolving basis. This facility matures in July 2013. Proceeds from the sale of receivables under this facility are reflected as debt. Under this program, one of our marketing subsidiaries (Valero Marketing) sells eligible receivables, without recourse, to another of our subsidiaries (Valero Capital), whereupon the receivables are no longer owned by Valero Marketing. Valero Capital, in turn, sells an undivided percentage ownership interest in the eligible receivables, without recourse, to the third-party entities and financial institutions. To the extent that Valero Capital retains an ownership interest in the receivables it has purchased from Valero Marketing, such interest is included in our financial statements solely as a result of the consolidation of the financial statements of Valero Capital with those of Valero Energy Corporation; the receivables are not available to satisfy the claims of the creditors of Valero Marketing or Valero Energy Corporation.

Changes in the amounts outstanding under our accounts receivable sales facility were as follows (in millions):

 
Three Months Ended
March 31,
 
2013
 
2012
Balance as of beginning of period
$
100

 
$
250

Repayments
—

 
(150
)
Balance as of end of period
$
100

 
$
100


Capitalized Interest
Capitalized interest was $40 million and $52 million for the three months ended March 31, 2013 and 2012, respectively.



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

6.
COMMITMENTS AND CONTINGENCIES

Environmental Matter
We are involved, together with several other companies, in an environmental cleanup in the Village of Hartford, Illinois (the Village) and the adjacent shutdown refinery site, which we acquired as part of a prior acquisition. In cooperation with some of the other companies, we have been conducting initial mitigation and cleanup response pursuant to an administrative order issued by the U.S. Environmental Protection Agency (EPA). The EPA is seeking further cleanup obligations from us and other potentially responsible parties for the Village. In parallel with the Village cleanup, we are also in litigation with the State of Illinois Environmental Protection Agency and other potentially responsible parties relating to the remediation of the shutdown refinery site. In each of these matters, we have various defenses and rights for contribution from the other potentially responsible parties. We have accrued for our own expected contribution obligations. However, because of the unpredictable nature of these cleanups and the methodology for allocation of liabilities, it is reasonably possible that we could incur a loss in a range of $0 to $250 million in excess of the amount of our accrual to ultimately resolve these matters. Factors underlying this estimated range are expected to change from time to time, and actual results may vary significantly from this estimate.

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.

One-Time Severance Benefits
As described in Note 3, we decided to reorganize the Aruba Refinery into a crude oil and refined products terminal in September 2012 resulting in a decrease in required personnel for our operations in Aruba. We notified 495 employees in September 2012 of the termination of their employment effective November 15, 2012. Benefits to each terminated employee consisted primarily of a cash payment based on a formula that considers the employee’s current compensation and years of service, among other factors. We recognized a severance liability of $41 million in September 2012, which approximated fair value. We paid $31 million of these benefits in the fourth quarter of 2012 and we paid the remaining termination benefits of $10 million during the three months ended March 31, 2013.




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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 the noncontrolling interests, and total equity for the three months ended March 31, 2013 and 2012:
 
 
2013
 
2012
 
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests
 
Total
Equity
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interest
 
Total
Equity
Balance as of
beginning of period
 
$
18,032

 
$
63

 
$
18,095

 
$
16,423

 
$
22

 
$
16,445

Net income (loss)
 
654

 
(2
)
 
652

 
(432
)
 
—

 
(432
)
Dividends
 
(111
)
 
—

 
(111
)
 
(83
)
 
—

 
(83
)
Stock-based
   compensation expense
 
11

 
—

 
11

 
10

 
—

 
10

Tax deduction in excess
   of stock-based
   compensation expense
 
24

 
—

 
24

 
2

 
—

 
2

Transactions
   in connection with
   stock-based
   compensation plans
 
 
 
 
 
 
 
 
 
 
 
 
Stock issuances
 
38

 
—

 
38

 
9

 
—

 
9

Stock repurchases
 
(24
)
 
—

 
(24
)
 
(95
)
 
—

 
(95
)
Stock repurchases under
   buyback program
 
(294
)
 
—

 
(294
)
 
—

 
—

 
—

Contributions from
   noncontrolling interests
 
—

 
14

 
14

 
—

 
11

 
11

Other comprehensive
   income
 
13

 
—

 
13

 
125

 
—

 
125

Balance as of end of period
 
$
18,343

 
$
75

 
$
18,418

 
$
15,959

 
$
33

 
$
15,992


The noncontrolling interests relate to third-party ownership interests in two joint venture companies, whose financial statements we consolidate due to our controlling interests.




11
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Share Activity
Activity in the number of shares of common stock and treasury stock was as follows (in millions) for the three months ended March 31, 2013 and 2012:
 
2013
 
2012
 
Common
Stock
 
Treasury
Stock
 
Common
Stock
 
Treasury
Stock
Balance as of beginning of period
673

 
(121
)
 
673

 
(117
)
Transactions in connection with
  stock-based compensation plans:
 
 
 
 
 
 
 
Stock issuances
—

 
3

 
—

 
1

Stock purchases
—

 
—

 
—

 
(5
)
Stock repurchases under buyback program
—

 
(7
)
 
—

 
—

Balance as of end of period
673

 
(125
)
 
673

 
(121
)

Common Stock Dividends
On May 1, 2013, our board of directors declared a quarterly cash dividend of $0.20 per common share payable on June 19, 2013 to holders of record at the close of business on May 22, 2013.
Accumulated Other Comprehensive Income
Changes in accumulated other comprehensive income by component, net of tax, were as follows for the three months ended March 31, 2013 (in millions):

Foreign
Currency
Translation
Adjustment
 
Defined
Benefit
Pension
Items
 
Gains and
(Losses) on
Cash Flow
Hedges
 
Total
Balance as of December 31, 2012
$
665

 
$
(558
)
 
$
1

 
$
108

Other comprehensive income (loss)
before reclassifications
(204
)
 
213

 
1

 
10

Amounts reclassified from
  accumulated other comprehensive income
—

 
5

 
(2
)
 
3

Net other comprehensive income (loss)
(204
)
 
218

 
(1
)
 
13

Balance as of March 31, 2013
$
461

 
$
(340
)
 
$
—

 
$
121





12
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Reclassifications into income out of accumulated other comprehensive income were as follows for the three months ended March 31, 2013 (in millions):
Details about Accumulated Other
Comprehensive Income Components
 
Gain (Loss)
Reclassified
from
Accumulated
Other
Comprehensive
Income
 
Affected Line
Item in the
Statement of
 Income
Amortization of items related to
defined benefit pension plans:
 
 
 
 
Net actuarial loss
 
$
(14
)
 
(a)
Prior service credit
 
6

 
(a)
 
 
(8
)
 
Total before tax
 
 
3

 
Tax benefit
 
 
$
(5
)
 
Net of tax
 
 
 
 
 
Gains on cash flow hedges:
 
 
 
 
Commodity contracts
 
$
3

 
Cost of sales
 
 
3

 
Total before tax
 
 
(1
)
 
Tax expense
 
 
$
2

 
Net of tax
 
 
 
 
 
Total reclassifications for the period
 
$
(3
)
 
Net of tax
_________________________
(a) These accumulated other comprehensive income components are included in the computation of net periodic benefit cost, as further discussed in Note 8. Net periodic benefit cost is reflected in operating expenses and general and administrative expenses.




13
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8.
EMPLOYEE BENEFIT PLANS

The components of net periodic benefit cost related to our defined benefit plans were as follows (in millions) :
 
Pension Plans
 
Other Postretirement
Benefit Plans
 
2013
 
2012
 
2013
 
2012
Three months ended March 31:
 
 
 
 
 
 
 
Service cost
$
36

 
$
35

 
$
3

 
$
3

Interest cost
22

 
23

 
4

 
5

Expected return on plan assets
(32
)
 
(31
)
 
—

 
—

Amortization of:
 
 
 
 
 
 
 
Prior service cost (credit)
(3
)
 
1

 
(3
)
 
(5
)
Net actuarial loss
14

 
8

 
—

 
—

Net periodic benefit cost
$
37

 
$
36

 
$
4

 
$
3


On February 15, 2013, we announced changes to certain of our U.S. qualified pension plans that cover the majority of our U.S. employees who work in our refining segment and corporate operations. Benefits under our primary pension plan will change from a final average pay formula to a cash balance formula with staged effective dates that commence either on July 1, 2013 or January 1, 2015 depending on the age and service of the affected employees. All final average pay benefits will be frozen as of December 31, 2014, with all future benefits to be earned under the new cash balance formula. These plan amendments resulted in a $328 million decrease to pension liabilities and a related increase to other comprehensive income during the three months ended March 31, 2013. The benefit of this remeasurement will be amortized into income through 2025.

As a result of these plan amendments, management has decided to reduce its discretionary contributions to our pension plans by $100 million, resulting in expected contributions to our pension plans of $45 million for 2013. During the three months ended March 31, 2013 and 2012, we contributed $8 million and $10 million, respectively, to our pension plans and $4 million and $4 million, respectively, to our other postretirement benefit plans.




14
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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 were computed as follows (dollars and shares in millions, except per share amounts):
 
Three Months Ended March 31,
 
2013
 
2012
 
Restricted 
Stock
 
Common
Stock 
 
Restricted
Stock 
 
 Common
Stock
Earnings per common share:
 
 
 
 
 
 
 
Net income (loss) attributable to Valero stockholders
 
 
$
654

 
 
 
$
(432
)
Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
110

 

 
83

Nonvested restricted stock
 
 
1

 

 
—

Undistributed earnings (loss)
 
 
$
543

 

 
$
(515
)
Weighted-average common shares outstanding
3

 
550

 
3

 
551

Earnings per common share:
 
 
 
 
 
 
 
Distributed earnings
$
0.20

 
$
0.20

 
$
0.15

 
$
0.15

Undistributed earnings (loss)
0.98

 
0.98

 
—

 
(0.93
)
Total earnings per common share
$
1.18

 
$
1.18

 
$
0.15

 
$
(0.78
)
 
 
 
 
 
 
 
 
Earnings per common share – assuming dilution:
 
 
 
 
 
 
 
Net income (loss) attributable to Valero stockholders
 
 
$
654

 
 
 
$
(432
)
Weighted-average common shares outstanding
 
 
550

 
 
 
551

Common equivalent shares:
 
 

 
 
 
 
Stock options
 
 
4

 
 
 
—

Performance awards and
nonvested restricted stock
 
 
2

 
 
 
—

Weighted-average common shares outstanding –
assuming dilution
 
 
556

 
 
 
551

Earnings per common share – assuming dilution
 
 
$
1.18

 
 
 
$
(0.78
)
 
 
 
 
 
 
 
 




15
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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 – assuming dilution” as the effect of including such securities would have been antidilutive.

 
Three Months Ended
March 31,
 
2013
 
2012
Common equivalent shares (a)
—

 
6

Stock options (b)
3

 
6


_______________________
(a)
Common equivalent shares (primarily stock options) were excluded from weighted-average common shares outstanding – assuming dilution due to the net loss for the three months ended March 31, 2012.
(b)
Stock options were excluded from weighted-average common shares outstanding – assuming dilution because the exercise price of the stock option was greater than the average market price of our common shares during each reporting period.

10.
SEGMENT INFORMATION

The following table reflects activity related to our reportable segments (in millions):
 
 
Refining
 
Retail
 
Ethanol
 
Corporate
 
Total
Three months ended March 31, 2013:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
customers
 
$
29,553

 
$
2,917

 
$
1,004

 
$
—

 
$
33,474

Intersegment revenues
 
2,205

 
—

 
55

 
—

 
2,260

Operating income (loss)
 
1,212

 
42

 
14

 
(207
)
 
1,061

 
 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2012:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
customers
 
31,150

 
2,935

 
1,082

 
—

 
35,167

Intersegment revenues
 
2,255

 
—

 
14

 
—

 
2,269

Operating income (loss)
 
(119
)
 
40

 
9

 
(174
)
 
(244
)

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

 
March 31,
2013
 
December 31,
2012
Refining
$
40,185

 
$
39,490

Retail
2,125

 
2,043

Ethanol
924

 
929

Corporate
2,267

 
2,015

Total assets
$
45,501

 
$
44,477




16
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11.
SUPPLEMENTAL CASH FLOW INFORMATION

In order to determine net cash provided by operating activities, net income (loss) is adjusted by, among other things, changes in current assets and current liabilities as follows (in millions):
 
Three Months Ended
March 31,
 
2013
 
2012
Decrease (increase) in current assets:
 
 
 
Receivables, net
$
409

 
$
1,159

Inventories
(1,074
)
 
(471
)
Income taxes receivable
79

 
(14
)
Prepaid expenses and other
(233
)
 
6

Increase (decrease) in current liabilities:
 
 
 
Accounts payable
561

 
410

Accrued expenses
181

 
(100
)
Taxes other than income taxes
318

 
9

Income taxes payable
14

 
(96
)
Changes in current assets and current liabilities
$
255

 
$
903


The above changes in current assets and current liabilities differ from changes between amounts reflected in the applicable 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;
•
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
•
certain differences between 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.

There were no significant noncash investing or financing activities for the three months ended March 31, 2013 and 2012.

Cash flows related to interest and income taxes were as follows (in millions):

 
Three Months Ended
March 31,
 
2013
 
2012
Interest paid in excess of amount capitalized
$
56

 
$
45

Income taxes paid, net
48

 
142




17
Table of Contents



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

12.
FAIR VALUE MEASUREMENTS

General
GAAP requires that certain financial instruments, such as derivative instruments, be recognized at their fair values in our 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 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 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 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.




18
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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 balance sheets categorized according to the fair value hierarchy of the inputs utilized by us to determine the fair values as of March 31, 2013 and December 31, 2012.

We have elected to offset the fair value amounts recognized for multiple similar derivative contracts executed with the same counterparty, including any related cash collateral assets or obligations as shown below; however, fair value amounts by hierarchy level are presented on a gross basis in the tables below. We have no derivative contracts that are subject to master netting arrangements that are reflected gross on the balance sheet.
 
March 31, 2013
 
Fair Value Hierarchy
 
 Total
Gross
Fair
Value
 
Effect of
Counter-
party
Netting
 
Effect of
Collateral
Netting
 
Net
Carrying
Value
on
Balance
Sheet
 

Cash
Collateral
Paid or
Received
Not Offset

 
Level 1
 
Level 2
 
Level 3
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
1,036

 
$
30

 
$
—

 
$
1,066

 
$
(989
)
 
$
—

 
$
77

 
$
—

Physical purchase contracts
—

 
8

 
—

 
8

 
N/A

 
N/A

 
8

 
N/A

RINs fixed-price contracts
—

 
(12
)
 
—

 
(12
)
 
N/A

 
N/A

 
(12
)
 
N/A

Investments of certain benefit plans
91

 
—

 
11

 
102

 
N/A

 
N/A

 
102

 
N/A

Total
$
1,127

 
$
26

 
$
11

 
$
1,164

 
$
(989
)
 
$
—

 
$
175

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 

 
 
 
 
 

 
 
Commodity derivative
contracts
$
983

 
$
30

 
$
—

 
$
1,013

 
$
(989
)
 
$
(17
)
 
$
7

 
$
(82
)
Foreign currency contracts
3

 
—

 
—

 
3

 
N/A

 
N/A

 
3

 
N/A

Total
$
986

 
$
30

 
$
—

 
$
1,016

 
$
(989
)
 
$
(17
)
 
$
10

 
 




19
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VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

 
December 31, 2012
 
Fair Value Hierarchy
 
Total
Gross
Fair
Value
 
Effect of
Counter-
party
Netting
 
Effect of
Collateral
Netting
 
Net
Carrying
Value
on
Balance
Sheet
 
Cash
Collateral
Paid or
Received
Not Offset
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
1,143

 
$
60

 
$
—

 
$
1,203

 
$
(1,189
)
 
$
—

 
$
14

 
$
—

Physical purchase contracts
—

 
11

 
—

 
11

 
N/A

 
N/A

 
11

 
N/A

Investments of certain benefit plans
87

 
—

 
11

 
98

 
N/A

 
N/A

 
98

 
N/A

Foreign currency contracts
1

 
—

 
—

 
1

 
N/A

 
N/A

 
1

 
N/A

Total
$
1,231

 
$
71

 
$
11

 
$
1,313

 
$
(1,189
)
 
$
—

 
$
124

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
1,138

 
$
70

 
$
—

 
$
1,208

 
$
(1,189
)
 
$
(13
)
 
$
6

 
$
(114
)
Biofuels blending obligation
—

 
10

 
—

 
10

 
N/A

 
N/A

 
10

 
N/A

Foreign currency contracts
1

 
—

 
—

 
1

 
N/A

 
N/A

 
1

 
N/A

Total
$
1,139

 
$
80

 
$
—

 
$
1,219

 
$
(1,189
)
 
$
(13
)
 
$
17

 
 

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 or an independent pricing service and are categorized in Level 2 of the fair value hierarchy.
•
RINs fixed-price contracts represent the fair value of fixed-price purchase and sale contracts of RINs. (RINs are defined and described in Note 13 under “Compliance Program Price Risk.”) The fair values of these contracts are measured using a market approach based on quoted prices from an independent pricing service and are categorized in Level 2 of the fair value hierarchy.



20
Table of Contents



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

•
Investments of certain benefit plans consist of investment securities held by trusts for the purpose of satisfying a portion of our obligations under certain U.S. nonqualified benefit plans. The assets categorized in Level 1 of the fair value hierarchy are measured at fair value using a market approach based on quoted prices from national securities exchanges. The assets categorized in Level 3 of the fair value hierarchy represent insurance contracts, the fair value of which is provided by the insurer.
•
Foreign currency contracts consist of foreign currency exchange and purchase contracts entered into by our international operations to manage our exposure to exchange rate fluctuations on transactions denominated in currencies other than the local (functional) currencies of those operations. These contracts are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy.
•
Our biofuels blending obligation represents a liability for the purchase of RINs and RTFCs, as defined and described in Note 13 under “Compliance Program Price Risk,” to satisfy our obligation to blend biofuels into the products we produce. Our obligation is based on our deficiency in RINs and RTFCs and the price of these instruments as of the balance sheet date. Our obligation is categorized in Level 2 of the fair value hierarchy and is measured at fair value using the market approach based on quoted prices from an independent pricing service.

During the three months ended March 31, 2013 and 2012, there were no transfers between assets classified as Level 1 and Level 2.
The following is a reconciliation of the beginning and ending balances (in millions) for fair value measurements developed using significant unobservable inputs (Level 3).
 
2013
 
2012
 
Investments
of Certain
Benefit
Plans
 
Investments
of Certain
Benefit
Plans
Three months ended March 31:
 
 
 
Balance as of beginning of period
$
11

 
$
11

Purchases
—

 
—

Total gains (losses) included in
refining operating expenses
—

 
—

Transfers in and/or out of Level 3
—

 
—

Balance as of end of period
$
11

 
$
11

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

 
$
—







21
Table of Contents



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

Nonrecurring Fair Value Measurements
There were no assets or liabilities that were measured at fair value on a nonrecurring basis during the three months ended March 31, 2013.

The table below presents the fair value (in millions) of our nonfinancial assets measured on a nonrecurring basis during the three months ended March 31, 2012 and categorized according to the fair value hierarchy of the inputs utilized by us to determine the fair values as of March 31, 2012.

 
Fair Value Measurements Using
 
 
 
Total Loss
Recognized
During the
Three Months Ended
March 31,
2012
 
Level 1
 
Level 2
 
Level 3
 
Total
Fair Value
as of
March 31,
2012
 
Assets:
 
 
 
 
 
 
 
 
 
Long-lived assets of
  the Aruba Refinery
$
—

 
$
—

 
$
350

 
$
350

 
$
595

Cancelled capital project
—

 
—

 
2

 
2

 
16


There were no liabilities that were measured at fair value on a nonrecurring basis during the three months ended March 31, 2012.

Aruba Refinery
As discussed in Note 3, we concluded that the Aruba Refinery was impaired as of March 31, 2012. As a result, we were required to determine the fair value of the Aruba Refinery and to write down its carrying value to that amount. We determined that the best measure of the refinery’s fair value at that time was the $350 million offer received and accepted. The fair value of the Aruba Refinery was measured using the market approach and was categorized in Level 3 within the fair value hierarchy. The carrying value of the Aruba Refinery’s long-lived assets as of March 31, 2012 was $945 million; therefore, we recognized an asset impairment loss of $595 million in March 2012.

Cancelled Capital Project
In March 2012, we wrote down the carrying value of equipment associated with a permanently cancelled capital project at one of our refineries and recognized an asset impairment loss of $16 million.



22
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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 balance sheets at their carrying amounts are shown in the table below (in millions):

 
March 31, 2013
 
December 31, 2012
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount

 
Fair
Value

Financial assets:
 
 
 
 
 
 
 
Cash and temporary cash investments
$
1,857

 
$
1,857

 
$
1,723

 
$
1,723

Financial liabilities:
 
 
 
 
 
 
 
Debt (excluding capital leases)
6,821

 
8,414

 
7,000

 
8,621


The methods and significant assumptions used to estimate the fair value of these financial instruments are as follows:
•
The fair value of cash and temporary cash investments approximates the carrying value due to the low level of credit risk of these assets combined with their short maturities and market interest rates (Level 1).
•
The fair value of debt is determined primarily using the market approach based on quoted prices provided by third-party brokers and vendor pricing services, but are not exchange-traded (Level 2).

13.
PRICE RISK MANAGEMENT ACTIVITIES
We are exposed to market risks related to the volatility in the price of commodities, the price of financial instruments associated with governmental and regulatory compliance programs, interest rates, and foreign currency exchange rates, and we enter into derivative instruments to manage some of these 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, financial instruments we must purchase to maintain compliance with various governmental and regulatory programs, 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, is 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 our 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 volatility in 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 futures, swaps, 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.




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

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 March 31, 2013, 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
 
2013
Crude oil and refined products:
 
 
Futures – long
 
369

Futures – short
 
3,256

Physical contracts - long
 
2,887

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, refined product, or natural gas purchases or refined product sales at existing market prices that we deem favorable.

As of March 31, 2013, 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
 
2013
Crude oil and refined products:
 
 
Futures – long
 
1,829

Futures – short
 
347

Physical contracts – short
 
1,482





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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 for 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 March 31, 2013, we had the following outstanding commodity derivative instruments that were used 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
 
2013
 
2014
Crude oil and refined products:
 
 
 
 
Swaps – long
 
2,267

 
—

Swaps – short
 
1,550

 
—

Futures – long
 
50,113

 
17

Futures – short
 
69,216

 
—

Options – long
 
2

 
—

Natural gas:
 
 
 
 
Options – long
 
12,250

 
—

Options – short
 
3,000

 
—

Corn:
 
 
 
 
Futures – long
 
19,320

 
5

Futures – short
 
39,620

 
420

Physical contracts – long
 
17,358

 
447




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

Trading Derivatives
Our objective in entering into commodity derivative instruments for trading purposes is to take advantage of existing market conditions related to future results of operations and cash flows.

As of March 31, 2013, we had the following outstanding commodity derivative instruments that were entered into for trading purposes. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes represent thousands of barrels, except those identified as natural gas contracts that are presented in billions of British thermal units, corn contracts that are presented in thousands of bushels, and RINs contracts that are presented in thousands of gallons).

 
 
Notional Contract Volumes by
Year of Maturity
Derivative Instrument
 
2013
 
2014
Crude oil and refined products:
 
 
 
 
Swaps – long
 
43,972

 
16,915

Swaps – short
 
43,972

 
16,915

Futures – long
 
106,227

 
22,518

Futures – short
 
105,432

 
22,793

Options – long
 
18,660

 
—

Options – short
 
17,310

 
—

Natural gas:
 
 
 
 
Futures – long
 
3,500

 
—

Futures – short
 
1,500

 
—

Options – long
 
1,250

 
—

Options – short
 
250

 
—

Corn:
 
 
 
 
Swaps – long
 
1,125

 
—

Swaps – short
 
500

 
—

Futures – long
 
2,555

 
—

Futures – short
 
2,555

 
—

RINs:
 
 
 
 
Fixed-price contracts – long
 
15,600

 
—

Fixed-price contracts – short
 
33,038

 
—


Compliance Program Price Risk
We are exposed to market risks related to the volatility in the price of financial instruments associated with various governmental and regulatory compliance programs that we must purchase in the open market to comply with these programs. These programs are described below.




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

Obligation to Blend Biofuels
We are obligated to blend biofuels into the products we produce in most of the countries in which we operate, and these countries set annual quotas for the percentage of biofuels that must be blended into the motor fuels consumed in these countries. 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 applicable quota. To the degree we are unable to blend at the applicable rate in the U.S. and the United Kingdom (U.K.), we must purchase Renewable Identification Numbers (RINs) in the U.S. and Renewable Transport Fuel Certificates (RTFCs) in the U.K., and as such, we are exposed to the volatility in the market price of these financial instruments. We have not entered into derivative instruments to manage this risk, but we purchase RINs and RTFCs when the price of these instruments is deemed favorable. During the three months ended March 31, 2013, we purchased a portion of our expected obligation for 2013 due to rising RINs prices. The cost of meeting our obligations under this compliance program was $130 million and $67 million for the three months ended March 31, 2013 and 2012, respectively. These amounts are reflected in cost of sales.

Maintaining Minimum Inventory Quantities
In the U.K., we are required to maintain a minimum quantity of crude oil and refined products as a reserve against shortages or interruptions in the supply of these products. To the degree we decide not to physically hold the minimum quantity of crude oil and refined products, we must purchase Compulsory Stock Obligation (CSO) tickets from other suppliers of refined products in the U.K. or other European Union (EU) member countries, and we make economic decisions as to the cost of maintaining certain quantities of crude oil and refined products versus the cost of purchasing CSO tickets. We have not entered into derivative instruments to manage the price volatility of CSO tickets. For the three months ended March 31, 2013, costs incurred to meet our obligations under this compliance program were immaterial. For the three months ended March 31, 2012, the cost of purchasing CSO tickets to help meet our obligations under this compliance program was $2 million, which was reflected in cost of sales.

Emission Allowances
Our Pembroke Refinery is subject to a maximum amount of carbon dioxide that it can emit each year under the EU Emissions Trading Scheme. Under this cap-and-trade program, we purchase emission allowances on the open market for the difference between the amount of carbon dioxide emitted and the maximum amount allowed under the program. Therefore, we are exposed to the volatility in the market price of these allowances. For the three months ended March 31, 2013, no costs were incurred to meet our obligation under this compliance program. For the three months ended March 31, 2012, the cost of meeting our obligation under this compliance program was $1 million, which was reflected in refining operating expenses.

We enter into derivative instruments (futures) to reduce the impact of this risk on our results of operations and cash flows. Our positions in these 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. As of March 31, 2013 and December 31, 2012, we had no futures contracts outstanding related to this compliance program. For the three months ended March 31, 2012, the loss recognized in income on these derivative instruments designated as economic hedges was immaterial and therefore not separately presented in the table below under “Effect of Derivative Instruments on Income and Other Comprehensive Income.”



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

Interest Rate Risk
Our primary market risk exposure for changes in interest rates relates to our debt obligations. We manage our exposure to changing interest rates through the use of a combination of fixed-rate and floating-rate debt. In addition, at times we have used interest rate swap agreements to manage our fixed to floating interest rate position by converting certain fixed-rate debt to floating-rate debt. We had no interest rate derivative instruments outstanding as of March 31, 2013 or December 31, 2012, or during the three months ended March 31, 2013 and 2012.

Foreign Currency Risk
We are exposed to exchange rate fluctuations on transactions entered into by our international operations that are denominated in currencies other than the local (functional) currencies of those operations. To manage our exposure to these exchange rate fluctuations, we use foreign currency exchange and purchase contracts. These contracts are not designated as hedging instruments for accounting purposes, and therefore they are classified as economic hedges. As of March 31, 2013, we had commitments to purchase $576 million of U.S. dollars. These commitments matured on or before April 30, 2013, resulting in an immaterial loss in the second quarter of 2013.




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

Fair Values of Derivative Instruments
The following tables provide information about the fair values of our derivative instruments as of March 31, 2013 and December 31, 2012 (in millions) and the line items in the balance sheets in which the fair values are reflected. See Note 12 for additional information related to the fair values of our derivative instruments.

As indicated in Note 12, we net fair value amounts recognized for multiple similar derivative contracts executed with the same counterparty under master netting arrangements, including cash collateral assets and obligations. The tables below, however, are presented on a gross asset and gross liability basis, which results in the reflection of certain assets in liability accounts and certain liabilities in asset accounts.

 
Balance Sheet
Location
 
March 31, 2013
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
14

 
$
28

 
 
 
 
 
 
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
1,022

 
$
953

Swaps
Receivables, net
 
17

 
15

Swaps
Prepaid expenses and other
 
1

 
1

Swaps
Accrued expenses
 
5

 
11

Options
Receivables, net
 
5

 
3

Options
Prepaid expenses and other
 
2

 
1

Options
Accrued expenses
 
—

 
1

Physical purchase contracts
Inventories
 
13

 
5

RINs fixed-price contracts
Prepaid expenses and other
 
7

 
19

Foreign currency contracts
Accrued expenses
 
—

 
3

Total
 
 
$
1,072

 
$
1,012

Total derivatives
 
 
$
1,086

 
$
1,040




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

 
Balance Sheet
Location
 
December 31, 2012
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
77

 
$
64

Swaps
Receivables, net
 
15

 
13

Swaps
Prepaid expenses and other
 
2

 
2

Total
 
 
$
94

 
$
79

 
 
 
 
 
 
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
1,066

 
$
1,073

Swaps
Receivables, net
 
9

 
6

Swaps
Accrued expenses
 
32

 
46

Options
Receivables, net
 
1

 
4

Options
Accrued expenses
 
1

 
—

Physical purchase contracts
Inventories
 
11

 
—

Foreign currency contracts
Receivables, net
 
1

 
—

Foreign currency contracts
Accrued expenses
 
—

 
1

Total
 
 
$
1,121

 
$
1,130

Total derivatives
 
 
$
1,215

 
$
1,209

Market and Counterparty Risk
Our price risk management activities involve the receipt or payment of fixed price commitments into the future. These transactions give rise to market risk, which is the risk that future changes in market conditions may make an instrument less valuable. We closely monitor and manage our exposure to market risk on a daily basis in accordance with policies approved by our board of directors. Market risks are monitored by a risk control group to ensure compliance with our stated risk management policy. Concentrations of customers in the refining industry may impact our overall exposure to counterparty risk because these customers may be similarly affected by changes in economic or other conditions. In addition, financial services companies are the counterparties in certain of our price risk management activities, and such financial services companies may be adversely affected by periods of uncertainty and illiquidity in the credit and capital markets.
There were no material amounts due from counterparties in the refining or financial services industry as of March 31, 2013 or December 31, 2012. These amounts represent the aggregate amount payable to us by companies in those industries, reduced by payables from us to those companies under master netting arrangements that allow for the setoff of amounts receivable from and payable to the same party. We do not require any collateral or other security to support derivative instruments into which we enter. We also do not have any derivative instruments that require us to maintain a minimum investment-grade credit rating.



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

Effect of Derivative Instruments on Income and Other Comprehensive Income
The following tables provide information about the gain or loss recognized in income and other comprehensive income on our derivative instruments and the line items in the financial statements in which such gains and losses are reflected (in millions).

Derivatives in Fair Value
Hedging Relationships
 
Location of Gain (Loss)
Recognized in Income
on Derivatives
 
Three Months Ended
March 31,
 
 
2013
 
2012
Commodity contracts:
 
 
 
 
 
 
Loss recognized in
income on derivatives
 
Cost of sales
 
$
(1
)
 
$
(267
)
Gain recognized in
income on hedged item
 
Cost of sales
 
—

 
228

Loss recognized in
income on derivatives
(ineffective portion)
 
Cost of sales
 
(1
)
 
(39