VLO 6.30.11 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 June 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 July 29, 2011 was 572,133,317.
 
 
 
 
 
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)
 
 
June 30,
2011
 
December 31,
2010
 
(Unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and temporary cash investments
$
4,107

 
$
3,334

Receivables, net
6,027

 
4,583

Inventories
3,988

 
4,947

Income taxes receivable
118

 
343

Deferred income taxes
285

 
190

Prepaid expenses and other
162

 
121

Total current assets
14,687

 
13,518

Property, plant and equipment, at cost
29,866

 
28,921

Accumulated depreciation
(6,660
)
 
(6,252
)
Property, plant and equipment, net
23,206

 
22,669

Intangible assets, net
222

 
224

Deferred charges and other assets, net
1,411

 
1,210

Total assets
$
39,526

 
$
37,621

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of debt and capital lease obligations
$
861

 
$
822

Accounts payable
7,642

 
6,441

Accrued expenses
765

 
590

Taxes other than income taxes
627

 
671

Income taxes payable
82

 
3

Deferred income taxes
254

 
257

Total current liabilities
10,231

 
8,784

Debt and capital lease obligations, less current portion
6,762

 
7,515

Deferred income taxes
4,801

 
4,530

Other long-term liabilities
1,740

 
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
7,616

 
7,704

Treasury stock, at cost; 102,738,591 and 105,113,545 common shares
(6,312
)
 
(6,462
)
Retained earnings
14,173

 
13,388

Accumulated other comprehensive income
498

 
388

Total Valero Energy Corporation stockholders’ equity
15,982

 
15,025

Noncontrolling interest
10

 
—

Total equity
15,992

 
15,025

Total liabilities and equity
$
39,526

 
$
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 June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
Operating revenues (a)
$
31,293

 
$
20,561

 
$
57,601

 
$
39,054

Costs and expenses:
 
 
 
 
 
 
 
Cost of sales
28,380

 
18,227

 
52,948

 
35,283

Operating expenses:
 
 
 
 
 
 
 
Refining
813

 
693

 
1,557

 
1,457

Retail
169

 
163

 
331

 
315

Ethanol
104

 
91

 
199

 
171

General and administrative expenses
151

 
131

 
281

 
228

Depreciation and amortization expense
386

 
350

 
751

 
690

Asset impairment loss
—

 
2

 
—

 
2

Total costs and expenses
30,003

 
19,657

 
56,067

 
38,146

Operating income
1,290

 
904

 
1,534

 
908

Other income, net
10

 
1

 
27

 
12

Interest and debt expense, net of capitalized interest
(107
)
 
(117
)
 
(224
)
 
(244
)
Income from continuing operations before income tax expense
1,193

 
788

 
1,337

 
676

Income tax expense
449

 
268

 
489

 
236

Income from continuing operations
744

 
520

 
848

 
440

Income (loss) from discontinued operations, net of income taxes
(1
)
 
63

 
(7
)
 
30

Net income
743

 
583

 
841

 
470

Less: Net loss attributable to noncontrolling interest
(1
)
 
—

 
(1
)
 
—

Net income attributable to Valero Energy Corporation stockholders
$
744

 
$
583

 
$
842

 
$
470

Net income attributable to Valero Energy Corporation stockholders:
 
 
 
 
 
 
 
Continuing operations
$
745

 
$
520

 
$
849

 
$
440

Discontinued operations
(1
)
 
63

 
(7
)
 
30

Total
$
744

 
$
583

 
$
842

 
$
470

Earnings per common share:
 
 
 
 
 
 
 
Continuing operations
$
1.31

 
$
0.92

 
$
1.49

 
$
0.78

Discontinued operations
—

 
0.11

 
(0.01
)
 
0.05

Total
$
1.31

 
$
1.03

 
$
1.48

 
$
0.83

Weighted-average common shares outstanding (in millions)
567

 
563

 
567

 
563

Earnings per common share – assuming dilution:
 
 
 
 
 
 
 
Continuing operations
$
1.30

 
$
0.92

 
$
1.48

 
$
0.78

Discontinued operations
—

 
0.11

 
(0.01
)
 
0.05

Total
$
1.30

 
$
1.03

 
$
1.47

 
$
0.83

Weighted-average common shares outstanding –
  assuming dilution (in millions)
574

 
567

 
573

 
567

Dividends per common share
$
0.05

 
$
0.05

 
$
0.10

 
$
0.10

Supplemental information:
 
 
 
 
 
 
 
(a) Includes excise taxes on sales by our U.S. retail system
$
227

 
$
225

 
$
441

 
$
433

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)
 
Six Months Ended June 30,
 
2011
 
2010
Cash flows from operating activities:
 
 
 
Net income
$
841

 
$
470

Adjustments to reconcile net income to net cash provided by
  operating activities:
 
 
 
Depreciation and amortization expense
751

 
724

Noncash interest expense and other income, net
21

 
4

Asset impairment loss
—

 
2

Gain on sale of Delaware City Refinery assets
—

 
(92
)
Stock-based compensation expense
23

 
22

Deferred income tax expense
166

 
83

Changes in current assets and current liabilities
1,147

 
613

Changes in deferred charges and credits and other operating activities, net
5

 
(56
)
Net cash provided by operating activities
2,954

 
1,770

Cash flows from investing activities:
 
 
 
Capital expenditures
(969
)
 
(785
)
Deferred turnaround and catalyst costs
(432
)
 
(343
)
Acquisition of pipeline and terminal facilities
(37
)
 
—

Advance payment related to the Pembroke Acquisition
(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
(19
)
 
11

Net cash used in investing activities
(1,494
)
 
(1,157
)
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
)
Issuance of common stock in connection with stock-based compensation plans
30

 
11

Common stock dividends
(57
)
 
(57
)
Debt issuance costs
—

 
(10
)
Contributions from noncontrolling interest
9

 
—

Other financing activities, net
7

 
4

Net cash provided by (used in) financing activities
(729
)
 
575

Effect of foreign exchange rate changes on cash
42

 
(12
)
Net increase in cash and temporary cash investments
773

 
1,176

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

 
825

Cash and temporary cash investments at end of period
$
4,107

 
$
2,001

 
See Condensed Notes to Consolidated Financial Statements.



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Table of Contents

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

 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
Net income
$
743

 
$
583

 
$
841

 
$
470

Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustment
20

 
(138
)
 
112

 
(37
)
Pension and other postretirement benefits:
 
 
 
 
 
 
 
Net loss arising during the period,
  net of income tax benefit of $-, $-, $-, and $-
—

 
(21
)
 
—

 
(21
)
Net gain reclassified into income,
  net of income tax expense of $-, $-, $1, and $-
(1
)
 
(1
)
 
(2
)
 
(2
)
Net loss on pension and other
  postretirement benefits
(1
)
 
(22
)
 
(2
)
 
(23
)
 
 
 
 
 
 
 
 
Derivative instruments designated and
  qualifying as cash flow hedges:
 
 
 
 
 
 
 
Net loss arising during the period,
  net of income tax benefit of $-, $-, $-, and $1
—

 
—

 
—

 
(1
)
Net gain reclassified into income,
  net of income tax expense of $-, $17, $-, and $34
—

 
(32
)
 
—

 
(64
)
Net loss on cash flow hedges
—

 
(32
)
 
—

 
(65
)
Other comprehensive income (loss)
19

 
(192
)
 
110

 
(125
)
Comprehensive income
762

 
391

 
951

 
345

Less: Comprehensive loss attributable to
  noncontrolling interest
(1
)
 
—

 
(1
)
 
—

Comprehensive income attributable to
  Valero Energy Corporation stockholders
$
763

 
$
391

 
$
952

 
$
345

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 six months ended June 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 six months ended June 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 June 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.

Consolidation of Joint Venture
On January 21, 2011, we entered into a joint venture agreement with Darling Green Energy LLC, a subsidiary of Darling International, Inc. (collectively, Darling), 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 or early 2013.

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 interest in DGD Holdings, we have consolidated the consolidated financial statements of DGD Holdings in these financial statements and have separately disclosed Darling’s noncontrolling interest.



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

Significant Accounting Policies
Reclassifications
In December 2010, we sold our Paulsboro Refinery to PBF Holding Company LLC. The results of operations of the Paulsboro Refinery for the three and six months ended June 30, 2010, therefore, have been presented as discontinued operations in the consolidated statements of income and are shown below (in millions):
 
 
 
Three Months
Ended
June 30, 2010
 
Six Months
Ended
June 30, 2010
Operating revenues
 
$
1,214

 
$
2,364

Income (loss) before income taxes
 
18

 
(18
)

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 $24 million and $45 million for the three and six months ended June 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.




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

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 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 DISPOSITION

Pembroke Acquisition
On August 1, 2011, we acquired 100 percent of the outstanding shares of Chevron Limited from a subsidiary of Chevron Corporation (Chevron). Chevron Limited 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. Chevron Limited also owns, directly and through various subsidiaries, an extensive network of marketing and logistics assets throughout the United Kingdom and Ireland. On the closing date, we paid $1.8 billion from available cash, of which $1.1 billion was for working capital based on estimated amounts at closing that are subject to adjustment. 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.

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

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 June 30, 2011 or pro forma results of operations for the three and six months ended June 30, 2011 and 2010. The consolidated statements of income for the three and six months ended June 30, 2011 include the results of this acquisition from its acquisition date.




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

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 it is presented in discontinued operations for the three and six months ended June 30, 2010.

Results of operations for the Delaware City Refinery prior to its sale, excluding the gain on the sale, are shown below (in millions):

 
Three Months
Ended
June 30, 2010
 
Six Months
Ended
June 30, 2010
Operating revenues
$
—

 
$
—

Loss before income taxes
(7
)
 
(33
)

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.

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 decided to restart our Aruba Refinery due to improvements in the U.S. and worldwide economies during 2010 and the resulting improvement in refining industry fundamentals, both of which continued to improve during the first six months of 2011. Despite these improvements and the restart of the refinery, we analyzed our Aruba Refinery for potential impairment as of June 30, 2011 because of its recent temporary shutdown, its negative operating cash flows subsequent to its restart, and the sensitivity of its profitability to sour crude oil differentials. The price of sour crude oil is generally less than the price of sweet crude oil, and that price difference is referred to as the sour crude oil differential. Sour crude oil differentials have improved along with other refining industry fundamentals. We considered these positive developments in our impairment analysis and concluded that our Aruba Refinery was not



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

impaired as of June 30, 2011. Our cash flow estimates for the refinery are based on our expectation that sour crude oil differentials will continue to improve in connection with an increase in the demand for refined products and the increased production of sour crude oils. Should differentials fail to widen or fail to widen to amounts experienced in prior years, our 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 $953 million as of June 30, 2011; therefore, an impairment loss could be material to our results of operations.

In July 2011, we renewed our exploration of strategic alternatives related to our Aruba Refinery. We are continuing to pursue potential transactions for this refinery, which may include the sale of the refinery.

4.
INVENTORIES

Inventories consisted of the following (in millions):

 
June 30,
2011
 
December 31,
2010
Refinery feedstocks
$
2,188

 
$
2,225

Refined products and blendstocks
1,314

 
2,233

Ethanol feedstocks and products
182

 
201

Convenience store merchandise
109

 
101

Materials and supplies
195

 
187

Inventories
$
3,988

 
$
4,947


As of June 30, 2011 and December 31, 2010, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by approximately $7.9 billion and $6.1 billion, respectively.
 
5.
DEBT
Non-Bank Debt
During the six months ended June 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
•
also 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.




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

During the six months ended June 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 $1.244 billion.

Bank 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 June 30, 2011 and December 31, 2010, our debt-to-capitalization ratio, calculated in accordance with the terms of the Revolver, was 18 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 six months ended June 30, 2011 and 2010, we had no borrowings or repayments under our Revolver or the Canadian revolving credit facility. As of June 30, 2011 and December 31, 2010, we had no borrowings outstanding under the Revolver or the Canadian revolving credit facility.

We had outstanding letters of credit under our committed lines of credit as follows (in millions):
 
 
Borrowing Capacity
 
Expiration
 
June 30, 2011
 
December 31, 2010
 Letter of credit facility
 
$200
 
June 2012
 
$200
 
$—
 Letter of credit facility
 
$300
 
June 2012
 
$230
 
$100
 Revolver
 
$2,400
 
November 2012
 
$123
 
$399
 Canadian revolving credit facility
 
C$115
 
December 2012
 
C$20
 
C$20

As of June 30, 2011 and December 31, 2010, we had $223 million and $176 million, respectively, of letters of credit outstanding under our uncommitted short-term bank credit facilities.
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 June 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 six months ended June 30, 2011. During the six months ended June 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.



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

Capitalized Interest
Capitalized interest was $33 million and $22 million for the three months ended June 30, 2011 and 2010, respectively, and $60 million and $42 million for the six months ended June 30, 2011 and 2010, respectively.

6.
COMMITMENTS AND CONTINGENCIES

Environmental Matters
The regulation of greenhouse gases at the federal level has now shifted from the U.S. Congress to the U.S. Environmental Protection Agency (EPA), which 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 state-wide 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 state-wide cap-and-trade program will begin in 2012 (although the CARB has proposed to delay the implementation until 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.




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

Litigation Matters
Retail Fuel Temperature Litigation
In 2006, a class action complaint was filed against us and several other defendants engaged in the retail and wholesale petroleum marketing business. The complaint alleges that because fuel volume increases with fuel temperature, the defendants violated state consumer protection laws by failing to adjust the volume or price of fuel when the fuel temperature exceeded 60 degrees Fahrenheit. The complaints seek to certify classes of retail consumers who purchased fuel in various locations. The complaints seek an order compelling the installation of temperature correction devices as well as monetary relief. Following the 2006 complaint, numerous other federal complaints were filed, and there are now a total of 46 lawsuits of which 21 involve us. (We are named in classes involving several states where we have no retail presence.)  The lawsuits are consolidated into a multi-district litigation case in the U.S. District Court for the District of Kansas (Kansas City) (Multi-District Litigation Docket No. 1840, In re: Motor Fuel Temperature Sales Practices Litigation). In May 2010, the court issued an order in response to the plaintiffs’ motion for class certification of the Kansas cases. The court certified an “injunction class” covering nonmonetary relief but deferred ruling on a “damages class.”  The court has scheduled trial in the Kansas cases for May 2012. We anticipate that the non-Kansas cases will be remanded in late 2011 or early 2012 with no additional rulings on the merits or class certification. We are a party to the Kansas cases, but we have no company-owned retail locations in Kansas. We believe that we have several strong defenses to these lawsuits, which we intend to contest. We have not recorded a loss contingency liability with respect to this matter. While we believe that it is reasonably possible that we may suffer a loss with respect to one or more of the lawsuits, we do not believe that such an outcome in any one or more of these lawsuits would have a material adverse effect on our financial position or results of operations.

Other Litigation
We are also a party to additional 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

On July 28, 2011, our board of directors declared a regular quarterly cash dividend of $0.05 per common share payable on September 14, 2011 to holders of record at the close of business on August 17, 2011.

The following is a reconciliation of the beginning and ending balances (in millions) of equity attributable to our stockholders, equity attributable to the noncontrolling interest, and total equity for the six months ended June 30, 2011 and 2010:

 
 
2011
 
2010
 
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interest
 
Total
Equity
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interest
 
Total
Equity
Balance at beginning of period
 
$
15,025

 
$
—

 
$
15,025

 
$
14,725

 
$
—

 
$
14,725

Net income (loss)
 
842

 
(1
)
 
841

 
470

 
—

 
470

Dividends
 
(57
)
 
—

 
(57
)
 
(57
)
 
—

 
(57
)
Stock-based
  compensation expense
 
23

 
—

 
23

 
22

 
—

 
22

Tax deduction in excess of
  stock-based compensation
  expense
 
11

 
—

 
11

 
7

 
—

 
7

Transactions in connection
  with stock-based
  compensation plans:
 
 
 
 
 
 
 
 
 
 
 
 
Stock issuances
 
30

 
—

 
30

 
11

 
—

 
11

Stock repurchases
 
(2
)
 
—

 
(2
)
 
(2
)
 
—

 
(2
)
Contributions from
  noncontrolling interest
 
—

 
11

 
11

 
—

 
—

 
—

Other comprehensive
  income (loss)
 
110

 
—

 
110

 
(125
)
 
—

 
(125
)
Balance at end of period
 
$
15,982

 
$
10

 
$
15,992

 
$
15,051

 
$
—

 
$
15,051


The noncontrolling interest relates to the DGD Holdings joint venture as discussed in Note 1.



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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 for the three and six months ended June 30, 2011 and 2010 (in millions):

 
Pension Plans
 
Other Postretirement
Benefit Plans
 
2011
 
2010
 
2011
 
2010
Three months ended June 30:
 
 
 
 
 
 
 
Service cost
$
22

 
$
21

 
$
2

 
$
2

Interest cost
22

 
21

 
5

 
7

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

 
—

Amortization of:

 
 
 
 
 
 
Prior service cost (credit)
—

 
—

 
(5
)
 
(5
)
Net loss
3

 
1

 
1

 
1

Net periodic benefit cost
$
19

 
$
15

 
$
3

 
$
5

 
 
 
 
 
 
 
 
Six months ended June 30:
 
 
 
 
 
 
 
Service cost
$
45

 
$
43

 
$
5

 
$
5

Interest cost
43

 
41

 
11

 
13

Expected return on plan assets
(56
)
 
(56
)
 
—

 
—

Amortization of:
 
 
 
 
 
 
 
Prior service cost (credit)
1

 
1

 
(11
)
 
(10
)
Net loss
6

 
1

 
1

 
2

Net periodic benefit cost
$
39

 
$
30

 
$
6

 
$
10


Our anticipated contributions to our pension plans during 2011 have not changed from amounts previously disclosed in our consolidated financial statements for the year ended December 31, 2010. There were no significant contributions made to our pension plans during the six months ended June 30, 2011. We contributed $25 million to our pension plans in July 2011, and we expect to contribute an additional $75 million later in the third quarter of 2011. During the six months ended June 30, 2010, we contributed $53 million 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 June 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
 
 
$
745

 
 
 
$
520

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
29

 
 
 
29

Nonvested restricted stock
 
 
—

 
 
 
—

Undistributed earnings
 
 
$
716

 
 
 
$
491

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
3

 
567

 
3

 
563

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

 
$
0.05

 
$
0.05

 
$
0.05

Undistributed earnings
1.26

 
1.26

 
0.87

 
0.87

Total earnings per common share from
  continuing operations
$
1.31

 
$
1.31

 
$
0.92

 
$
0.92

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations – assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
745

 
 
 
$
520

Weighted-average common shares outstanding
 
 
567

 
 
 
563

Common equivalent shares:
 
 

 
 
 
 
Stock options
 
 
5

 
 
 
3

Performance awards and unvested restricted
  stock
 
 
2

 
 
 
1

Weighted-average common shares outstanding –
  assuming dilution
 
 
574

 
 
 
567

Earnings per common share from
  continuing operations – assuming dilution
 
 
$
1.30

 
 
 
$
0.92




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

 
Six Months Ended June 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
 
 
$
849

 
 
 
$
440

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
57

 
 
 
57

Nonvested restricted stock
 
 
—

 
 
 
—

Undistributed earnings
 
 
$
792

 
 
 
$
383

 
 
 
 
 
 
 
 
Weighted-average common shares outstanding
3

 
567

 
3

 
563

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations:
 
 
 
 
 
 
 
Distributed earnings
$
0.10

 
$
0.10

 
$
0.10

 
$
0.10

Undistributed earnings
1.39

 
1.39

 
0.68

 
0.68

Total earnings per common share from
  continuing operations
$
1.49

 
$
1.49

 
$
0.78

 
$
0.78

 
 
 
 
 
 
 
 
Earnings per common share from
  continuing operations – assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
  from continuing operations
 
 
$
849

 
 
 
$
440

Weighted-average common shares outstanding
 
 
567

 
 
 
563

Common equivalent shares:
 
 
 
 
 
 
 
Stock options
 
 
5

 
 
 
3

Performance awards and unvested restricted
  stock
 
 
1

 
 
 
1

Weighted-average common shares outstanding –
  assuming dilution
 
 
573

 
 
 
567

Earnings per common share from
  continuing operations – assuming dilution
 
 
$
1.48

 
 
 
$
0.78




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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 June 30,
 
Six Months Ended June 30,
 
2011
 
2010
 
2011
 
2010
Stock options
6

 
11

 
6

 
11

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

 
 
Refining
 
Retail
 
Ethanol
 
Corporate
 
Total
Three months ended June 30, 2011:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
$
26,921

 
$
3,128

 
$
1,244

 
$
—

 
$
31,293

Intersegment revenues
 
2,311

 
—

 
52

 
—

 
2,363

Operating income (loss)
 
1,253

 
135

 
64

 
(162
)
 
1,290

 
 
 
 
 
 
 
 
 
 
 
Three months ended June 30, 2010:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
17,546

 
2,357

 
658

 
—

 
20,561

Intersegment revenues
 
1,591

 
—

 
56

 
—

 
1,647

Operating income (loss)
 
904

 
109

 
35

 
(144
)
 
904

 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2011:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
49,483

 
5,812

 
2,306

 
—

 
57,601

Intersegment revenues
 
4,308

 
—

 
100

 
—

 
4,408

Operating income (loss)
 
1,529

 
201

 
108

 
(304
)
 
1,534

 
 
 
 
 
 
 
 
 
 
 
Six months ended June 30, 2010:
 
 
 
 
 
 
 
 
 
 
Operating revenues from external
  customers
 
33,293

 
4,533

 
1,228

 
—

 
39,054

Intersegment revenues
 
3,099

 
—

 
111

 
—

 
3,210

Operating income (loss)
 
889

 
180

 
92

 
(253
)
 
908






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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):

 
June 30,
2011
 
December 31, 2010
Refining
$
31,798

 
$
30,363

Retail
1,999

 
1,925

Ethanol
927

 
953

Corporate
4,802

 
4,380

Total consolidated assets
$
39,526

 
$
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):

 
Six Months Ended June 30,
 
2011
 
2010
Decrease (increase) in current assets:
 
 
 
Receivables, net
$
(1,422
)
 
$
(394
)
Inventories
978

 
102

Income taxes receivable
175

 
808

Prepaid expenses and other
(3
)
 
124

Increase (decrease) in current liabilities:
 
 
 
Accounts payable
1,147

 
122

Accrued expenses
202

 
(145
)
Taxes other than income taxes
(52
)
 
(151
)
Income taxes payable
122

 
147

Changes in current assets and current liabilities
$
1,147

 
$
613

 
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 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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VALERO ENERGY CORPORATION AND SUBSIDIARIES
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 rate as of each balance sheet date.
During the six months ended June 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 six months ended June 30, 2010.

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

 
Six Months Ended June 30,
 
2011
 
2010
Interest paid in excess of amount capitalized
$
221

 
$
225

Income taxes paid, net
(10
)
 
(797
)
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 six months ended June 30, 2010 and are summarized as follows (in millions):

Cash provided by (used in) operating activities:
 
Paulsboro Refinery
$
32

Delaware City Refinery
(76
)
Cash used in investing activities:
 
Paulsboro Refinery
(28
)
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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VALERO ENERGY CORPORATION AND SUBSIDIARIES
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 June 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
June 30,
2011
 
 
 
 
Netting
Adjustments
 
Assets:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
$
5,018

 
$
227

 
$
—

 
$
(4,815
)
 
$
430

Investments of nonqualified
    benefit plans
92

 
—

 
11

 
—

 
103

Other investments
—

 
—

 
—

 
—

 
—

Liabilities:
 
 
 
 
 
 
 
 
 
Commodity derivative contracts
4,592

 
378

 
—

 
(4,815
)
 
155

Firm commitments to purchase
    inventories
—

 
31

 
—

 
—

 
31

Nonqualified benefit plan
  obligations
39

 
—

 
—

 
—

 
39

RINs obligation
135

 
—

 
—

 
—

 
135


 
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

Firm commitments to purchase
    inventories
—

 
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.
•
Firm commitments 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 in connection with hedging activity as more fully described in Note 13. 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. 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 $376 million and $403 million with brokers under master netting arrangements is included in the fair value of the commodity derivatives reflected in Level 1 as of June 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 June 30:
 
 
 
 
 
 
 
Balance at beginning of period
$
11

 
$
—

 
$
10

 
$
—

Purchases
—

 
10

 
—

 
1

Total losses included in earnings
—

 
(10
)
 
—

 
(1
)
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
$
—

 
$
(10
)
 
$
—

 
$
(1
)
 
 
 
 
 
 
 
 
Six months ended June 30:
 
 
 
 
 
 
 
Balance at beginning of period
$
10

 
$
—

 
$
10

 
$
—

Purchases
—

 
16

 
—

 
1

Total gains (losses) included in
  earnings
1

 
(16
)
 
—

 
(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

 
$
(16
)
 
$
—

 
$
(1
)
    
Nonrecurring Fair Value Measurements
As of June 30, 2011 and December 31, 2010, there were no assets or liabilities that were measured and recorded 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):

 
June 30,
2011
 
December 31,
2010
Carrying amount (excluding capital leases)
$
7,588

 
$
8,300

Fair value
8,835

 
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 activity. 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 hedging relationships (hedges 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 contracts 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 refining 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 activity is described below.

Fair Value Hedges
Fair value hedges are used to hedge 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 June 30, 2011, we had the following outstanding commodity derivative instruments that were entered into to hedge crude oil and refined product inventories. 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
 
5,878

Futures – short
 
18,734

Cash Flow Hedges
Cash flow hedges are used to hedge 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 June 30, 2011, we had no outstanding commodity derivative instruments that were designated as cash flow hedges.




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

Economic Hedges
Economic hedges are hedges 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 June 30, 2011, we had the following outstanding commodity derivative instruments that were entered into as economic hedges. 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
Crude oil and refined products:
 
 
 
 
Swaps – long
 
74,882

 
51,750

Swaps – short
 
73,791

 
51,750

Futures – long
 
203,662

 
10,584

Futures – short
 
198,509

 
9,326

Options – long
 
1,200

 
—

Options – short
 
1,200

 
—

Corn:
 
 
 
 
Futures – long
 
78,065

 
8,405

Futures – short
 
109,420

 
19,155





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

Trading Activities
Derivatives entered into for trading purposes represent commodity derivative instruments held or issued for trading purposes. Our objective in entering into commodity derivative instruments for trading purposes is to take advantage of existing market conditions related to commodities that we perceive as opportunities to benefit our results of operations and cash flows, but for which there are no related physical transactions.

As of June 30, 2011, 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 and corn contracts that are presented in thousands of bushels).

 
 
Notional Contract Volumes by
Year of Maturity
Derivative Instrument
 
2011
 
2012
Crude oil and refined products:
 
 
 
 
Swaps – long
 
12,167

 
1,500

Swaps – short
 
12,167

 
1,500

Futures – long
 
71,114

 
13,089

Futures – short
 
71,159

 
13,054

Options – long
 
1,545

 
—

Options – short
 
1,545

 
—

Natural gas:
 
 
 
 
Futures – long
 
4,850

 
—

Futures – short
 
4,600

 
—

Corn:
 
 
 
 
Futures – long
 
4,925

 
60

Futures – short
 
4,525

 
60

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.

Foreign Currency Risk
We are exposed to exchange rate fluctuations on transactions entered into by our Canadian operations that are denominated in currencies other than the Canadian dollar, which is the functional currency 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 June 30, 2011, we had commitments to purchase $480 million of U.S. dollars. These commitments matured on or before July 28, 2011.



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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 June 30, 2011 and December 31, 2010 (in millions) and the line items in the balance sheet 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 instruments executed with the same counterparty under master netting arrangements. 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. In addition, in Note 12, we included cash collateral on deposit with or received from brokers in the fair value of the commodity derivatives; these cash amounts are not reflected in the tables below.

 
 
 
Fair Value as of
June 30, 2011
 
Balance Sheet
Location
 
Asset
Derivatives  
 
Liability
Derivatives  
Derivatives designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
939

 
$
815

Total
 
 
$
939

 
$
815

 
 
 
 
 
 
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
3,700

 
$
3,777

Swaps
Prepaid expenses and other
 
39

 
35

Swaps
Accrued expenses
 
188

 
320

Options
Receivables, net
 
3

 
—

Options
Accrued expenses
 
—

 
23

Total
 
 
$
3,930

 
$
4,155

Total derivatives
 
 
$
4,869

 
$
4,970





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

 
 
 
Fair Value as of
December 31, 2010
 
Balance Sheet
Location
 
Asset
Derivatives  
 
Liability
Derivatives  
Derivatives designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
120

 
$
183

Swaps
Prepaid expenses and other