Document
 
 
 
 
 
 
 
 
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2018
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 þ 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 þ No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer þ Accelerated filer o Non-accelerated filer o
Smaller reporting company o Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 þ
The number of shares of the registrant’s only class of common stock, $0.01 par value, outstanding as of April 30, 2018 was 431,023,418.
 
 
 
 
 


VALERO ENERGY CORPORATION
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 





i

Table of Contents

PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VALERO ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(millions of dollars, except par value)
 
March 31,
2018
 
December 31,
2017
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and temporary cash investments
$
4,658

 
$
5,850

Receivables, net
6,814

 
6,922

Inventories
6,555

 
6,384

Prepaid expenses and other
233

 
156

Total current assets
18,260

 
19,312

Property, plant, and equipment, at cost
40,543

 
40,010

Accumulated depreciation
(12,812
)
 
(12,530
)
Property, plant, and equipment, net
27,731

 
27,480

Deferred charges and other assets, net
3,385

 
3,366

Total assets
$
49,376

 
$
50,158

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of debt and capital lease obligations
$
871

 
$
122

Accounts payable
7,966

 
8,348

Accrued expenses
590

 
712

Taxes other than income taxes payable
1,226

 
1,321

Income taxes payable
99

 
568

Total current liabilities
10,752

 
11,071

Debt and capital lease obligations, less current portion
8,086

 
8,750

Deferred income tax liabilities
4,711

 
4,708

Other long-term liabilities
2,902

 
2,729

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
7,026

 
7,039

Treasury stock, at cost;
242,573,833 and 239,603,534 common shares
(13,588
)
 
(13,315
)
Retained earnings
29,415

 
29,200

Accumulated other comprehensive loss
(983
)
 
(940
)
Total Valero Energy Corporation stockholders’ equity
21,877


21,991

Noncontrolling interests
1,048

 
909

Total equity
22,925

 
22,900

Total liabilities and equity
$
49,376

 
$
50,158

See Condensed Notes to Consolidated Financial Statements.



1

Table of Contents

VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(millions of dollars, except per share amounts)
(unaudited)
 
Three Months Ended
March 31,
 
2018
 
2017
Revenues (a)
$
26,439

 
$
21,772

Cost of sales:
 
 
 
Cost of materials and other
23,756

 
19,428

Operating expenses (excluding depreciation and amortization
expense reflected below)
1,136

 
1,124

Depreciation and amortization expense
485

 
488

Total cost of sales
25,377

 
21,040

Other operating expenses
10

 
—

General and administrative expenses (excluding depreciation and
amortization expense reflected below)
238

 
192

Depreciation and amortization expense
13

 
12

Operating income
801

 
528

Other income, net
51

 
26

Interest and debt expense, net of capitalized interest
(121
)
 
(121
)
Income before income tax expense
731

 
433

Income tax expense
149

 
112

Net income
582

 
321

Less: Net income attributable to noncontrolling interests
113

 
16

Net income attributable to Valero Energy Corporation stockholders
$
469

 
$
305

 
 
 
 
Earnings per common share
$
1.09

 
$
0.68

Weighted-average common shares outstanding (in millions)
431

 
448

Earnings per common share – assuming dilution
$
1.09

 
$
0.68

Weighted-average common shares outstanding –
assuming dilution (in millions)
432

 
451

Dividends per common share
$
0.80

 
$
0.70

_______________________________________________
 
 
 
Supplemental information:
 
 
 
(a)    Includes excise taxes on sales by certain of our international
operations
$
1,464

 
$
1,272


See Condensed Notes to Consolidated Financial Statements.



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Table of Contents

VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(millions of dollars)
(unaudited)
 
Three Months Ended
March 31,
 
2018
 
2017
Net income
$
582

 
$
321

Other comprehensive income:
 
 
 
Foreign currency translation adjustment
45

 
74

Net gain on pension and other postretirement
benefits
8

 
3

Other comprehensive income before
income tax expense
53

 
77

Income tax expense related to items of
other comprehensive income
2

 
1

Other comprehensive income
51

 
76

Comprehensive income
633

 
397

Less: Comprehensive income attributable
to noncontrolling interests
116

 
16

Comprehensive income attributable to
Valero Energy Corporation stockholders
$
517

 
$
381


See Condensed Notes to Consolidated Financial Statements.



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Table of Contents

VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(millions of dollars)
(unaudited)
 
Three Months Ended
March 31,
 
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
582

 
$
321

Adjustments to reconcile net income to net cash provided by
operating activities:
 
 
 
Depreciation and amortization expense
498

 
500

Deferred income tax expense (benefit)
2

 
(4
)
Changes in current assets and current liabilities
(1,026
)
 
151

Changes in deferred charges and credits and
other operating activities, net
82

 
20

Net cash provided by operating activities
138

 
988

Cash flows from investing activities:
 
 
 
Capital expenditures
(356
)
 
(279
)
Deferred turnaround and catalyst costs
(220
)
 
(245
)
Investments in joint ventures
(55
)
 
(117
)
Acquisition of undivided interests
(85
)
 
(72
)
Capital expenditures of certain variable interest entities
(28
)
 
—

Other investing activities, net
(8
)
 
(1
)
Net cash used in investing activities
(752
)
 
(714
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of Valero Energy Partners LP debt
498

 
—

Repayments of debt and capital lease obligations
(415
)
 
(5
)
Purchase of common stock for treasury
(320
)
 
(314
)
Common stock dividends
(345
)
 
(315
)
Proceeds from issuance of Valero Energy Partners LP common units
—

 
35

Contribution from noncontrolling interest
32

 
—

Distributions to noncontrolling interests
(11
)
 
(34
)
Other financing activities, net
(12
)
 
(19
)
Net cash used in financing activities
(573
)
 
(652
)
Effect of foreign exchange rate changes on cash
(5
)
 
25

Net decrease in cash and temporary cash investments
(1,192
)
 
(353
)
Cash and temporary cash investments at beginning of period
5,850

 
4,816

Cash and temporary cash investments at end of period
$
4,658

 
$
4,463


See Condensed Notes to Consolidated Financial Statements.



4
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VALERO ENERGY CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.
BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation
General
As used in this report, the terms “Valero,” “we,” “us,” or “our” 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. Operating results for the three months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

The balance sheet as of December 31, 2017 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, 2017.

Reclassifications
Certain amounts reported for the three months ended March 31, 2017 have been reclassified in order to conform to the 2018 presentation.

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.

Revenue Recognition
We adopted the provisions of Financial Accounting Standards Board (FASB) Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers,” (Topic 606) on January 1, 2018, as described below in “Accounting Pronouncements Adopted On January 1, 2018.” Accordingly, our revenue recognition accounting policy has been revised to reflect the adoption of this standard.

Our revenues are primarily generated from contracts with customers. We generate revenue from contracts with customers from the sale of products by our refining and ethanol segments. Our VLP segment generates intersegment revenues from transportation and terminaling activities provided to our refining segment that are eliminated in consolidation. Revenues are recognized when we satisfy our performance obligation to transfer products to our customers, which typically occurs at a point in time upon shipment or delivery of the products, and for an amount that reflects the transaction price that is allocated to the performance obligation.




5

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

The customer is able to direct the use of, and obtain substantially all of the benefits from, the products at the point of shipment or delivery. As a result, we consider control to have transferred upon shipment or delivery because we have a present right to payment at that time, the customer has legal title to the asset, we have transferred physical possession of the asset, and the customer has significant risks and rewards of ownership of the asset.

Our contracts with customers state the final terms of the sale, including the description, quantity, and price for goods sold. Payment is typically due in full within two to ten days of delivery. In the normal course of business, we generally do not accept product returns.

The transaction price is the consideration that we expect to be entitled to in exchange for our products. The transaction price for substantially all of our contracts is generally based on commodity market pricing (i.e., variable consideration). As such, this market pricing may be constrained (i.e., not estimable) at the inception of the contract but will be recognized based on the applicable market pricing, which will be known upon transfer of the goods to the customer. Some of our contracts also contain variable consideration in the form of sales incentives to our customers, such as discounts and rebates. For contracts that include variable consideration, we estimate the factors that determine the variable consideration in order to establish the transaction price.

We have elected to exclude from the measurement of the transaction price all taxes assessed by governmental authorities that are both imposed on and concurrent with a specific revenue-producing transaction and collected by us from a customer (e.g., sales tax, use tax, value-added tax, etc.). We continue to include in the transaction price excise taxes that are imposed on certain inventories in our international operations. The amount of such taxes is provided in supplemental information in a footnote on the statements of income.

There are instances where we provide shipping services in relation to the goods sold to our customer. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be fulfillment activities and are included in cost of materials and other. We have elected to account for shipping and handling activities that occur after the customer has obtained control of a good as fulfillment activities rather than as a promised service and we have included these activities in cost of materials and other.

Accounting Pronouncements Adopted On January 1, 2018
Topic 606
Effective January 1, 2018, we adopted the provisions of Topic 606, which clarifies the principles for recognizing revenue and supersedes previous revenue recognition requirements under “Revenue Recognition (Topic 605),” using the modified retrospective method of adoption as permitted by the standard. Under this method, the cumulative effect of initially applying the standard is recognized as an adjustment to the opening balance of retained earnings, and revenues reported in the periods prior to the date of adoption are not changed. We elected to apply the transition guidance only to contracts that were not completed as of the date of adoption. There was no material impact to our financial position as a result of adopting Topic 606; therefore, there was no cumulative-effect adjustment to retained earnings as of January 1, 2018. Additionally, there was no material impact to our financial position or results of operations as of and for the three months ended March 31, 2018. See “Revenue Recognition” above for a discussion of our accounting policy affected by our adoption of Topic 606. Also see Note 10 for further information on our revenues. We implemented new processes in order to monitor ongoing compliance with accounting and disclosure requirements.



6

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

ASU No. 2016-01
In January 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10),” (ASU No. 2016-01) to enhance the reporting model for financial instruments regarding certain aspects of recognition, measurement, presentation, and disclosure. Effective January 1, 2018, we adopted the provisions of ASU No. 2016-01 using the cumulative-effect method of adoption as required by the ASU. The adoption of this ASU did not affect our financial position or our results of operations as of or for the three months ended March 31, 2018, but it resulted in reduced disclosures as it eliminated the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments.

ASU No. 2017-07
In March 2017, the FASB issued ASU No. 2017-07, “Compensation—Retirement Benefits (Topic 715),” (ASU No. 2017-07) which requires employers to report the service cost component of net periodic pension cost and net periodic postretirement benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost (non-service cost components) to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. Effective January 1, 2018, we retrospectively adopted the provisions of ASU No. 2017-07. The adoption of this ASU did not affect our financial position or results of operations. However, for the three months ended March 31, 2017, we reclassified the non-service cost components out of operating expenses (excluding depreciation and amortization expense) and general and administrative expenses (excluding depreciation and amortization expense) of $7 million and $2 million, respectively, and into other income, net.

ASU No. 2017-09
In May 2017, the FASB issued ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718),” (ASU No. 2017-09) to reduce diversity in practice, as well as reduce cost and complexity regarding a change to the terms or conditions of a share-based payment award. Effective January 1, 2018, we adopted ASU No. 2017-09. The adoption of this ASU did not have an immediate effect on our financial position or results of operations as it is applied prospectively to an award modified on or after adoption.

ASU No. 2018-02
In February 2018, the FASB issued ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220),” (ASU No. 2018-02) which allows for the stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (Tax Reform) to be reclassified from accumulated other comprehensive income to retained earnings. The provisions of ASU No. 2018-02 are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual periods, with early adoption permitted. This ASU shall be applied either at the beginning of the annual or interim period of adoption or retrospectively to each period in which the income tax effects of Tax Reform affects the items remaining in accumulated other comprehensive income (loss). We elected to reclassify the stranded income tax effects of Tax Reform from accumulated other comprehensive loss to retained earnings as of the beginning of the interim period of adoption. Effective January 1, 2018, we adopted ASU No. 2018-02 and such adoption did not affect our financial position or results of operations but resulted in the reclassification of $91 million of income tax benefits related to Tax Reform from accumulated other comprehensive loss to retained earnings as presented in Note 5 under “Accumulated Other Comprehensive Loss.” We release stranded income tax



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

effects from accumulated other comprehensive income (loss) to retained earnings on an individual item basis as those items are reclassified into income.

ASU No. 2018-05
In March 2018, the FASB issued ASU No. 2018-05, “Income Taxes (Topic 740)—Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118,” (ASU No. 2018-05) which amends certain Securities and Exchange Commission (SEC) material in Topic 740 for the income tax accounting implications of the recently issued Tax Reform. This guidance clarifies the application of Topic 740 in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting under Topic 740 for certain income tax effects of Tax Reform for the reporting period in which Tax Reform was enacted. See Note 8 for a discussion of the impacts of this ASU.

Accounting Pronouncements Not Yet Adopted
Topic 842
In February 2016, the FASB issued “Leases (Topic 842),” (Topic 842) to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This new standard is effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual periods, with early adoption permitted. We will adopt this new standard on January 1, 2019, and we expect to use the modified retrospective method of adoption. We are enhancing our contracting and lease evaluation systems and related processes, and we are developing a new lease accounting system to capture our leases and support the required disclosures. During 2018, we will continue to monitor the adoption process to ensure compliance with accounting and disclosure requirements. We also continue the integration of our lease accounting system with our general ledger, and we will make modifications to the related procurement and payment processes. We anticipate this standard will have a material impact on our financial position by increasing our assets and liabilities by equal amounts through the recognition of right-of-use assets and lease liabilities for our operating leases. However, we do not expect adoption to have a material impact on our results of operations or liquidity. We expect our accounting for capital leases to remain substantially unchanged.

ASU No. 2017-12
In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815),” (ASU No. 2017-12) to improve and simplify accounting guidance for hedge accounting. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual periods, with early adoption permitted. We use economic hedges to manage commodity price risk; however, we have not designated these hedges as fair value or cash flow hedges. As a result, the adoption of ASU No. 2017-12 effective January 1, 2019 is not expected to affect our financial position or results of operations.




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

2.
INVENTORIES

Inventories consisted of the following (in millions):
 
March 31,
2018

December 31,
2017
Refinery feedstocks
$
2,471

 
$
2,427

Refined petroleum products and blendstocks
3,569

 
3,459

Ethanol feedstocks and products
258

 
242

Materials and supplies
257

 
256

Inventories
$
6,555

 
$
6,384


As of March 31, 2018 and December 31, 2017, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by $3.1 billion and $3.0 billion, respectively, and our non-LIFO inventories accounted for $905 million and $1.0 billion, respectively, of our total inventories.

3.
DEBT AND CAPITAL LEASE OBLIGATIONS

Debt
During the three months ended March 31, 2018, VLP issued in a public offering $500 million aggregate principal amount of its 4.5 percent Senior Notes due March 15, 2028. Gross proceeds from this debt issuance were $498 million before deducting the underwriting discount and other debt issuance costs totaling $5 million. The proceeds are available only to the operations of VLP and were used to repay the outstanding balance of $410 million on VLP’s $750 million senior unsecured revolving credit facility (the VLP Revolver) and $85 million of its notes payable to us, which is eliminated in consolidation.

During the three months ended March 31, 2017, we had no significant debt activity.

We had outstanding borrowings, letters of credit issued, and availability under our credit facilities as follows (amounts in millions and currency in U.S. dollars, except as noted):
 
 
 
 
 
 
March 31, 2018
 
 
Facility
Amount
 
Maturity Date
 
Outstanding
Borrowings
 
Letters of
Credit Issued
 
Availability
Committed facilities:
 
 
 
 
 
 
 
 
 
 
Valero Revolver
 
$
3,000

 
November 2020
 
$
—

 
$
138

 
$
2,862

VLP Revolver
 
750

 
November 2020
 
—

 
—

 
750

Canadian Revolver
 
C$
75

 
November 2018
 
C$
—

 
C$
6

 
C$
69

Accounts receivable
sales facility
 
1,300

 
July 2018
 
100

 
n/a

 
1,200

Letter of credit facility
 
100

 
November 2018
 
n/a

 
—

 
100

Uncommitted facilities:
 
 
 
 
 
 
 
 
 
 
Letter of credit facilities
 
n/a

 
n/a
 
n/a

 
273

 
n/a




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

Letters of credit issued as of March 31, 2018 expire at various times in 2018 through 2020.

As of March 31, 2018 and December 31, 2017, the variable interest rate on the accounts receivable sales facility was 2.3616 percent and 2.0387 percent, respectively.

Other Disclosures
Interest and debt expense, net of capitalized interest is comprised of the following (in millions):
 
Three Months Ended
March 31,
 
2018
 
2017
Interest and debt expense
$
139

 
$
134

Less capitalized interest
18

 
13

Interest and debt expense, net of
capitalized interest
$
121

 
$
121


4.
COMMITMENTS AND CONTINGENCIES

Commitments
MVP Terminal
We have a 50 percent membership interest in MVP Terminalling, LLC (MVP), a Delaware limited liability company formed in September 2017 with a subsidiary of Magellan Midstream Partners LP (Magellan), to construct, own, and operate the Magellan Valero Pasadena marine terminal (MVP Terminal) located adjacent to the Houston Ship Channel in Pasadena, Texas. Construction of phases one and two of the project began in 2017 with a total estimated cost of $840 million of which we have committed to contribute 50 percent (approximately $420 million). The project could expand up to four phases with a total project cost of approximately $1.4 billion if warranted by additional demand and agreed to by Magellan and us. Since inception, we have contributed $123 million to MVP, of which $42 million was contributed during the three months ended March 31, 2018.

Concurrent with the formation of MVP, we entered into a terminaling agreement with MVP to utilize the MVP Terminal upon completion of phase two, which is expected to occur in early 2020. The terminaling agreement has an initial term of 12 years with two five-year automatic renewals, and year-to-year renewals thereafter.

Due to our membership interest in MVP and because the terminaling agreement was determined to be a capital lease, we are the accounting owner of the MVP Terminal during the construction period. Accordingly, as of March 31, 2018, we recorded an asset of $271 million in property, plant, and equipment representing 100 percent of the construction costs incurred by MVP, as well as capitalized interest incurred by us, and a long-term liability of $150 million payable to Magellan. The amounts recorded for the portion of the construction costs associated with the payable to Magellan are noncash investing and financing items, respectively.




10

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

Central Texas Pipeline
We have committed to a 40 percent undivided interest in a project with a subsidiary of Magellan to jointly build an estimated 135-mile, 20-inch refined petroleum products pipeline with a capacity of up to 150,000 barrels per day from Houston to Hearne, Texas. The pipeline is expected to be completed in mid-2019. Our estimated cost to acquire our 40 percent undivided interest in this pipeline is $170 million. Since inception, capital expenditures totaled $24 million, of which $17 million was spent during the three months ended March 31, 2018.

Sunrise Pipeline System
Effective January 31, 2018, we entered into a joint ownership agreement with Sunrise Pipeline LLC, a subsidiary of Plains All American Pipeline, L.P. (Plains), to acquire a 20 percent undivided interest in the expanded Sunrise Pipeline System to be constructed by Plains. The Sunrise Pipeline System is expected to contain (i) an estimated 255-mile, 24-inch crude oil pipeline (the Sunrise Pipeline) to originate at Plains’ terminal in Midland, Texas and end at Plains’ station in Wichita Falls, Texas with throughput capacity of approximately 500,000 barrels per day, and (ii) two 270,000 shell barrel capacity tanks located at the Colorado City, Texas station. The Sunrise Pipeline System expansion is currently under construction and is expected to be placed in service in 2019. The cost to acquire our 20 percent undivided interest in the Sunrise Pipeline System is $135 million. We expect to incur approximately $101 million during 2018. Capital expenditures totaled $68 million for the three months ended March 31, 2018.

Environmental Matters
We are involved, together with several other companies, in an environmental cleanup in the Village of Hartford, Illinois (the Village) and during 2015, one of these companies assumed the ongoing remediation in the Village pursuant to a federal court order. We had previously conducted an initial response in the Village, along with other companies, pursuant to an administrative order issued by the U.S. Environmental Protection Agency (EPA). The parties involved in the initial response may have further claims among themselves for costs already incurred. We also continue to be engaged in site assessment and interim measures at the adjacent shutdown refinery site, which we acquired as part of an acquisition in 2005, and we are in litigation with other potentially responsible parties and the Illinois EPA relating to the remediation of the site. In each of these matters, we have various defenses, limitations, and potential rights for contribution from the other responsible parties. We have recorded a liability for our expected contribution obligations. Progress is being made with the Illinois EPA on remediation standards in certain areas. While we are actively working with the Illinois EPA to identify end points, because of the unpredictable nature of these cleanups, the methodology for allocation of liabilities, and the State of Illinois’ failure to directly sue third parties responsible for historic contamination at the site, it is reasonably possible that we could incur a loss in a range of $0 to $200 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



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

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, results of operations, or liquidity.

Texas City Refinery Fire
In April 2018, our Texas City Refinery experienced a fire in its alkylate fractionator. As of the filing of this quarterly report, the Texas City Refinery is running at reduced rates while efforts are underway to determine the cause of the accident, assess damages, and establish a plan for making repairs. Although we are in the preliminary stages of assessing the extent of damages, we do not believe that this incident will have a material adverse effect on our results of operations.

5.
EQUITY

Reconciliation of Balances
The following is a reconciliation of the beginning and ending balances of equity attributable to our stockholders, equity attributable to noncontrolling interests, and total equity (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests (a)
 
Total
Equity
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests (a)
 
Total
Equity
Balance as of
beginning of period
$
21,991

 
$
909

 
$
22,900

 
$
20,024

 
$
830

 
$
20,854

Net income
469

 
113

 
582

 
305

 
16

 
321

Dividends
(345
)
 
—

 
(345
)
 
(315
)
 
—

 
(315
)
Stock-based
compensation expense
14

 
—

 
14

 
13

 
—

 
13

Transactions in connection
with stock-based
compensation plans
(46
)
 
—

 
(46
)
 
(10
)
 
—

 
(10
)
Stock purchases under
purchase programs
(256
)
 
—

 
(256
)
 
(292
)
 
—

 
(292
)
Contribution from
noncontrolling interest
—

 
30

 
30

 
—

 
—

 
—

Distributions to
noncontrolling interests
—

 
(11
)
 
(11
)
 
—

 
(34
)
 
(34
)
Other
2

 
4

 
6

 
24

 
14

 
38

Other comprehensive
income
48

 
3

 
51

 
76

 
—

 
76

Balance as of end of period
$
21,877

 
$
1,048

 
$
22,925

 
$
19,825

 
$
826

 
$
20,651

___________________________ 
(a)
The noncontrolling interests relate to third-party ownership interests in VIEs for which we are the primary beneficiary and therefore consolidate. See Note 6 for information about our consolidated VIEs.

Share Activity
There was no significant share activity during the three months ended March 31, 2018 and 2017.
 
 
 
 
 
 
 
 



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

Common Stock Dividends
On May 3, 2018, our board of directors declared a quarterly cash dividend of $0.80 per common share payable on June 5, 2018 to holders of record at the close of business on May 17, 2018.

Accumulated Other Comprehensive Loss
Changes in accumulated other comprehensive loss by component, net of tax, were as follows (in millions):
 
Three Months Ended March 31,
 
2018
 
2017
 
Foreign
Currency
Translation
Adjustment
 
Defined
Benefit
Plans
Items
 
Total
 
Foreign
Currency
Translation
Adjustment
 
Defined
Benefit
Plans
Items
 
Total
Balance as of beginning of period
$
(507
)
 
$
(433
)
 
$
(940
)
 
$
(1,021
)
 
$
(389
)
 
$
(1,410
)
Other comprehensive income
before reclassifications
42

 
—

 
42

 
74

 
—

 
74

Amounts reclassified from
accumulated other
comprehensive loss
—

 
6

 
6

 
—

 
2

 
2

Other comprehensive income
42

 
6

 
48

 
74

 
2

 
76

Reclassification of stranded income
tax effects of Tax Reform
to retained earnings per
ASU 2018-02 (see Note 1)
—

 
(91
)
 
(91
)
 
—

 
—

 
—

Balance as of end of period
$
(465
)
 
$
(518
)
 
$
(983
)
 
$
(947
)
 
$
(387
)
 
$
(1,334
)
 
 
 
 
 
 
 
6.
VARIABLE INTEREST ENTITIES

Consolidated VIEs
In the normal course of business, we have financial interests in certain entities that have been determined to be VIEs. Our significant consolidated VIE’s include:

•
VLP, a publicly traded master limited partnership formed to own, operate, develop, and acquire crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets;

•
Diamond Green Diesel Holdings LLC (DGD), a joint venture formed to construct and operate a biodiesel plant that processes animal fats, used cooking oils, and other vegetable oils into renewable green diesel; and

•
terminaling agreements with three subsidiaries of Infraestructura Energetica Nova, S.A.B. de C.V. (IEnova), a Mexican subsidiary of Sempra Energy, a U.S. public company (the three subsidiaries are collectively referred to as VPM Terminals).

The VIEs’ assets can only be used to settle their own obligations and the VIEs’ creditors have no recourse to our assets. We do not provide financial guarantees to our VIEs. Although we have provided credit facilities



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

to some of our VIEs in support of their construction or acquisition activities, these transactions are eliminated in consolidation. Our financial position, results of operations, and cash flows are impacted by our consolidated VIEs’ performance, net of intercompany eliminations, to the extent of our ownership interest in each VIE.

The following tables present summarized balance sheet information for the significant assets and liabilities of our VIEs, which are included in our balance sheets (in millions).
 
March 31, 2018
 
VLP
 
DGD
 
VPM
Terminals
 
Other
 
Total
Assets
 
 
 
 
 
 
 
 
 
Cash and temporary cash investments
$
71

 
$
41

 
$
1

 
$
17

 
$
130

Other current assets
1

 
243

 
9

 
—

 
253

Property, plant, and equipment, net
1,416

 
475

 
57

 
123

 
2,071

Liabilities
 
 
 
 
 
 
 
 
 
Current liabilities
$
26

 
$
34

 
$
3

 
$
9

 
$
72

Debt and capital lease obligations,
less current portion
989

 
—

 
—

 
41

 
1,030

 
December 31, 2017
 
VLP
 
DGD
 
VPM
Terminals
 
Other
 
Total
Assets
 
 
 
 
 
 
 
 
 
Cash and temporary cash investments
$
42

 
$
123

 
$
1

 
$
13

 
$
179

Other current assets
2

 
66

 
4

 
—

 
72

Property, plant, and equipment, net
1,416

 
435

 
51

 
127

 
2,029

Liabilities
 
 
 
 
 
 
 
 
 
Current liabilities
$
27

 
$
33

 
$
26

 
$
9

 
$
95

Debt and capital lease obligations,
less current portion
905

 
—

 
—

 
43

 
948


Non-Consolidated VIEs
We hold variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary. These non-consolidated VIEs are not material to our financial position or results of operations and are primarily accounted for as equity investments. MVP is one of our non-consolidated VIEs and is accounted for under owner accounting as described in Note 4. As of March 31, 2018, our maximum exposure to loss was $122 million, which represents our equity investment in MVP. We have not provided any financial support to MVP other than amounts previously required by our membership interest.




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

7.
EMPLOYEE BENEFIT PLANS

The components of net periodic benefit cost (credit) related to our defined benefit plans were as follows (in millions):
 
Pension Plans
 
Other Postretirement
Benefit Plans
 
2018
 
2017
 
2018
 
2017
Three months ended March 31:
 
 
 
 
 
 
 
Service cost
$
34

 
$
31

 
$
1

 
$
1

Interest cost
23

 
21

 
2

 
3

Expected return on plan assets
(41
)
 
(37
)
 
—

 
—

Amortization of:
 
 
 
 
 
 
 
Net actuarial (gain) loss
16

 
13

 
—

 
(1
)
Prior service credit
(5
)
 
(5
)
 
(3
)
 
(4
)
Special charges
2

 
—

 
—

 
—

Net periodic benefit cost (credit)
$
29

 
$
23

 
$
—

 
$
(1
)

The components of net periodic benefit cost (credit) other than the service cost component (i.e., the non-service cost components) are included in the line item “other income, net” in the statements of income.

Our anticipated contributions to our pension and other postretirement benefit plans during 2018 have not changed from amounts previously disclosed in our financial statements for the year ended December 31, 2017. We contributed $8 million and $7 million, respectively, to our pension plans and $4 million and $5 million, respectively, to our other postretirement benefit plans during the three months ended March 31, 2018 and 2017.

8.
INCOME TAXES

On December 22, 2017, Tax Reform was enacted, which resulted in significant changes to the U.S. Internal Revenue Code of 1986, as amended (the Code), and was effective beginning on January 1, 2018. Tax Reform introduced significant and complex changes to the Code, and regulatory guidance from the Internal Revenue Service (IRS) is needed in order to properly account for many of the changes. In response, the SEC issued Staff Accounting Bulletin No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act,” that was codified through the issuance of ASU No. 2018-05 as described in Note 1, which requires that the effects of Tax Reform be recorded for items where the accounting is complete, as well as for items where a reasonable estimate can be made (referred to as provisional amounts). For items where reasonable estimates cannot be made, provisional amounts should not be recorded and those items would continue to be accounted for under the Code prior to changes from Tax Reform until a reasonable estimate can be made.

We recorded an overall income tax benefit of $1.9 billion associated with the effects of Tax Reform for the year ended December 31, 2017, and in accordance with ASU No. 2018-05, that benefit included provisional amounts associated with the one-time transition tax on the deemed repatriation of previously undistributed



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

accumulated earnings and profits of our international subsidiaries. We also identified items where reasonable estimates could not be made at that time.

We did not revise our initial provisional estimate during the three months ended March 31, 2018, and we have not completed our accounting for the income tax effects of Tax Reform. We continue to gather additional information in order to revise our initial estimates and await regulatory guidance from the IRS. We anticipate this information and guidance will be available in the second half of 2018 and that any adjustments will be recorded at that time.

The lower effective tax rate during the three months ended March 31, 2018 is due to the reduction in the U.S. statutory income tax rate from 35 percent to 21 percent effective January 1, 2018 as a result of Tax Reform.




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VALERO ENERGY CORPORATION
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,
 
2018
 
2017
 
Participating
Securities
 
Common
Stock
 
Participating
Securities
 
Common
Stock
Earnings per common share:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
 
 
$
469

 
 
 
$
305

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
344

 
 
 
314

Participating securities
 
 
1

 
 
 
1

Undistributed earnings (excess distributions
over earnings)
 
 
$
124

 
 
 
$
(10
)
Weighted-average common shares outstanding
1

 
431

 
2

 
448

Earnings per common share:
 
 
 
 
 
 
 
Distributed earnings
$
0.80

 
$
0.80

 
$
0.70

 
$
0.70

Undistributed earnings (excess distributions
over earnings)
0.29

 
0.29

 
—

 
(0.02
)
Total earnings per common share
$
1.09

 
$
1.09

 
$
0.70

 
$
0.68

 
 
 
 
 
 
 
 
Earnings per common share –
assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
 
 
$
469

 
 
 
$
305

Weighted-average common shares outstanding
 
 
431

 
 
 
448

Common equivalent shares
 
 
1

 
 
 
3

Weighted-average common shares outstanding –
assuming dilution
 
 
432

 
 
 
451

Earnings per common share – assuming dilution
 
 
$
1.09

 
 
 
$
0.68


Participating securities include restricted stock and performance awards granted under our 2011 Omnibus Stock Incentive Plan.




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

10.
REVENUES AND SEGMENT INFORMATION

Revenue from Contracts with Customers
Disaggregation of Revenue
Revenue is presented in the table below under “Segment Information” disaggregated by product because this is the level of disaggregation that management has determined to be beneficial to users of the financial statements.

Receivables from Contracts with Customers
Our receivables from contracts with customers are included in “receivables, net.” These balances were $5.1 billion and $5.7 billion as of March 31, 2018 and January 1, 2018, respectively.

Remaining Performance Obligations
The majority of our contracts with customers are spot contracts and therefore have no remaining performance obligations. All of our remaining contracts with customers are primarily term contracts, the majority of which expire by 2020. The transaction price for these term contracts includes an immaterial fixed amount and variable consideration (i.e., a commodity price). The variable consideration is allocated entirely to a wholly unsatisfied promise to transfer a distinct good that forms part of a single performance obligation; therefore, the variable consideration is not included in the remaining performance obligation. As of March 31, 2018, after excluding contracts with an original expected duration of one year or less, the aggregate amount of the transaction price allocated to our remaining performance obligations was immaterial as the transaction price for these contracts includes only an immaterial fixed amount.

Segment Information
We have three reportable segments – refining, ethanol, and VLP. Each segment is a strategic business unit that offers different products and services by employing unique technologies and marketing strategies and whose operations and operating performance are managed and evaluated separately. Operating performance is measured based on the operating income generated by the segment, which includes revenues and expenses that are directly attributable to the management of the respective segment. Intersegment sales are generally derived from transactions made at prevailing market rates. The following is a description of each segment’s business operations.

•
The refining segment includes the operations of our 15 petroleum refineries, the associated marketing activities, and certain logistics assets that support our refining operations that are not owned by VLP. The principal products manufactured by our refineries and sold by this segment include gasolines and blendstocks (e.g., conventional gasolines, premium gasolines, and gasoline meeting the specifications of the California Air Resources Board (CARB)), distillates (e.g., diesel, low-sulfur diesel, ultra-low-sulfur diesel, CARB diesel, jet fuel, and other distillates), and other products (e.g., asphalt, petrochemicals, lubricants, and other refined petroleum products).
•
The ethanol segment includes the operations of our 11 ethanol plants, the associated marketing activities, and logistics assets that support our ethanol operations. The principal products manufactured by our ethanol plants are ethanol and distillers grains. Some ethanol is sold to our refining segment, which is blended into gasoline and sold to that segment’s customers as a finished gasoline product.



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

•
The VLP segment includes the results of VLP. VLP generates revenue from transportation and terminaling activities provided to our refining segment. All of VLP’s revenues are intersegment revenues that are generated under commercial agreements with our refining segment. Revenues generated under these agreements are eliminated in consolidation.

Operations that are not included in any of the reportable segments are included in the corporate category.




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

The following table reflects the components of operating income by reportable segment (in millions):

 
Refining
 
Ethanol
 
VLP
 
Corporate
and
Eliminations
 
Total
Three months ended March 31, 2018:
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
25,561

 
$
877

 
$
—

 
$
1

 
$
26,439

Intersegment revenues
4

 
46

 
132

 
(182
)
 
—

Total revenues
25,565

 
923

 
132

 
(181
)
 
26,439

Cost of sales:
 
 
 
 
 
 
 
 
 
Cost of materials and other
23,188

 
749

 
—

 
(181
)
 
23,756

Operating expenses (excluding depreciation
and amortization expense reflected below)
997

 
111

 
29

 
(1
)
 
1,136

Depreciation and amortization expense
448

 
18

 
19

 
—

 
485

Total cost of sales
24,633

 
878

 
48

 
(182
)
 
25,377

Other operating expenses
10

 
—

 
—

 
—

 
10

General and administrative expenses (excluding
depreciation and amortization expense reflected
below)
—

 
—

 
—

 
238

 
238

Depreciation and amortization expense
—

 
—

 
—

 
13

 
13

Operating income by segment
$
922

 
$
45

 
$
84

 
$
(250
)
 
$
801

 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2017:
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
Revenues from external customers
$
20,887

 
$
885

 
$
—

 
$
—

 
$
21,772

Intersegment revenues
—

 
60

 
106

 
(166
)
 
—

Total revenues
20,887

 
945

 
106

 
(166
)
 
21,772

Cost of sales:
 
 
 
 
 
 
 
 
 
Cost of materials and other
18,807

 
787

 
—

 
(166
)
 
19,428

Operating expenses (excluding depreciation
and amortization expense reflected below)
991

 
109

 
24

 
—

 
1,124

Depreciation and amortization expense
449

 
27

 
12

 
—

 
488

Total cost of sales
20,247

 
923

 
36

 
(166
)
 
21,040

General and administrative expenses (excluding
depreciation and amortization expense reflected
below)
—

 
—

 
—

 
192

 
192

Depreciation and amortization expense
—

 
—

 
—

 
12

 
12

Operating income by segment
$
640

 
$
22

 
$
70

 
$
(204
)
 
$
528




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

The following table provides a disaggregation of revenues by reportable segment (in millions). Refining and ethanol segment revenues are disaggregated for our principal products, and VLP segment revenues are disaggregated by activity type.
 
Three Months Ended
March 31,
 
2018
 
2017
Refining:
 
 
 
Gasolines and blendstocks
$
10,629

 
$
9,335

Distillates
12,658

 
9,696

Other product revenues
2,274

 
1,856

Total refining revenues
25,561

 
20,887

Ethanol:
 
 
 
Ethanol
701

 
750

Distillers grains
176

 
135

Total ethanol revenues
877

 
885

VLP:
 
 
 
Pipeline transportation
31

 
23

Terminaling
99

 
83

Storage and other
2

 
—

Total VLP revenues
132

 
106

Corporate – other revenues
1

 
—

Elimination of intersegment revenues
(132
)
 
(106
)
Revenues
$
26,439

 
$
21,772


Total assets by reportable segment were as follows (in millions):
 
March 31,
2018
 
December 31,
2017
Refining
$
40,699

 
$
40,382

Ethanol
1,355

 
1,344

VLP
1,545

 
1,517

Corporate and eliminations
5,777

 
6,915

Total assets
$
49,376

 
$
50,158





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

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):
 
Three Months Ended
March 31,
 
2018
 
2017
Decrease (increase) in current assets:
 
 
 
Receivables, net
$
145

 
$
817

Inventories
(126
)
 
(291
)
Prepaid expenses and other
(79
)
 
53

Increase (decrease) in current liabilities:
 
 
 
Accounts payable
(322
)
 
(306
)
Accrued expenses
(131
)
 
20

Taxes other than income taxes payable
(111
)
 
(123
)
Income taxes payable
(402
)
 
(19
)
Changes in current assets and current liabilities
$
(1,026
)
 
$
151


Cash flows related to interest and income taxes were as follows (in millions):
 
Three Months Ended
March 31,
 
2018
 
2017
Interest paid in excess of amount capitalized
$
127

 
$
128

Income taxes paid, net
552

 
96


There were no significant noncash investing and financing activities for the three months ended March 31, 2018. Noncash investing and financing activities during the three months ended March 31, 2017 included the recognition of capital lease assets and related obligations totaling approximately $490 million for the lease of storage tanks located at three of our refineries.




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

12.
 FAIR VALUE MEASUREMENTS

Recurring Fair Value Measurements
The following tables present information (in millions) about our assets and liabilities 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, 2018 and December 31, 2017.

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 in the following tables on a gross basis. We have no derivative contracts that are subject to master netting arrangements that are reflected gross on the balance sheet.
 
March 31, 2018
 
 
 
Total
Gross
Fair
Value
 
Effect of
Counter-
party
Netting
 
Effect of
Cash
Collateral
Netting
 
Net
Carrying
Value on
Balance
Sheet
 
Cash
Collateral
Paid or
Received
Not Offset
 
Fair Value Hierarchy
 
 
Level 1
 
Level 2
 
Level 3
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
1,011

 
$
15

 
$
—

 
$
1,026

 
$
(1,013
)
 
$
(1
)
 
$
12

 
$
—

Physical purchase
contracts
—

 
2

 
—

 
2

 
n/a

 
n/a

 
2

 
n/a

Foreign currency
contracts
1

 
—

 
—

 
1

 
n/a

 
n/a

 
1

 
n/a

Investments of certain
benefit plans
63

 
—

 
8

 
71

 
n/a

 
n/a

 
71

 
n/a

Total
$
1,075

 
$
17

 
$
8

 
$
1,100

 
$
(1,013
)
 
$
(1
)
 
$
86

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 

 
 
 
 
 

 
 
Commodity derivative
contracts
$
1,030

 
$
16

 
$
—

 
$
1,046

 
$
(1,013
)
 
$
(33
)
 
$
—

 
$
(97
)
Environmental credit
obligations
—

 
87

 
—

 
87

 
n/a

 
n/a

 
87

 
n/a

Physical purchase
contracts
—

 
2

 
—

 
2

 
n/a

 
n/a

 
2

 
n/a

Total
$
1,030

 
$
105

 
$
—

 
$
1,135

 
$
(1,013
)
 
$
(33
)
 
$
89

 




23

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

 
December 31, 2017
 
 
 
Total
Gross
Fair
Value
 
Effect of
Counter-
party
Netting
 
Effect of
Cash
Collateral
Netting
 
Net
Carrying
Value on
Balance
Sheet
 
Cash
Collateral
Paid or
Received
Not Offset
 
Fair Value Hierarchy
 
 
 
 
 
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
875

 
$
19

 
$
—

 
$
894

 
$
(893
)
 
$
—

 
$
1

 
$
—

Investments of certain
benefit plans
65

 
—

 
8

 
73

 
n/a

 
n/a

 
73

 
n/a

Total
$
940

 
$
19

 
$
8

 
$
967

 
$
(893
)
 
$
—

 
$
74

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
955

 
$
14

 
$
—

 
$
969

 
$
(893
)
 
$
(76
)
 
$
—

 
$
(102
)
Environmental credit
obligations
—

 
104

 
—

 
104

 
n/a

 
n/a

 
104

 
n/a

Physical purchase
contracts
—

 
6

 
—

 
6

 
n/a

 
n/a

 
6

 
n/a

Foreign currency
contracts
7

 
—

 
—

 
7

 
n/a

 
n/a

 
7

 
n/a

Total
$
962

 
$
124

 
$
—

 
$
1,086

 
$
(893
)
 
$
(76
)
 
$
117

 



A description of our assets and liabilities recognized at fair value along with the valuation methods and inputs we used to develop their fair value measurements 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 represent the fair value of fixed-price corn purchase contracts. The fair values of these 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.

•
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.




24

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

•
Foreign currency contracts consist of foreign currency exchange and purchase contracts entered into for 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.

•
Environmental credit obligations represent our liability for the purchase of (i) biofuel credits (primarily Renewable Identification Numbers (RINs) in the U.S.) needed to satisfy our obligation to blend biofuels into the products we produce and (ii) emission credits under the California Global Warming Solutions Act (the California cap-and-trade system, also known as AB 32), Quebec’s Environmental Quality Act (the Quebec cap-and-trade system), and Ontario’s Climate Change Mitigation and Low-Carbon Economy Act (the Ontario cap-and-trade system), (collectively, the cap-and-trade systems). To the degree we are unable to blend biofuels (such as ethanol and biodiesel) at percentages required under the biofuel programs, we must purchase biofuel credits to comply with these programs. Under the cap-and-trade systems, we must purchase emission credits to comply with these systems. These programs are further described in Note 13 under “Environmental Compliance Program Price Risk.” The liability for environmental credits is based on our deficit for such credits as of the balance sheet date, if any, after considering any credits acquired or under contract, and is equal to the product of the credits deficit and the market price of these credits as of the balance sheet date. The environmental credit obligations are categorized in Level 2 of the fair value hierarchy and are measured at fair value using the market approach based on quoted prices from an independent pricing service.

There were no transfers between levels for assets and liabilities held as of March 31, 2018 and December 31, 2017 that were measured at fair value on a recurring basis.

There was no significant activity during the three months ended March 31, 2018 and 2017 related to the fair value amounts categorized in Level 3 as of March 31, 2018 and December 31, 2017.

Nonrecurring Fair Value Measurements
There were no assets or liabilities that were measured at fair value on a nonrecurring basis as of March 31, 2018 and December 31, 2017.

Other Financial Instruments
Financial instruments that we recognize in our balance sheets at their carrying amounts are shown in the following table along with their associated fair values (in millions):
 
 
 
March 31, 2018
 
December 31, 2017
 
Fair Value
Hierarchy
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
 
 
Cash and temporary cash
investments
Level 1
 
$
4,658

 
$
4,658

 
$
5,850

 
$
5,850

Financial liabilities:
 
 
 
 
 
 
 
 
 
Debt (excluding capital leases)
Level 2
 
8,392

 
9,527

 
8,310

 
9,795




25

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

13.
PRICE RISK MANAGEMENT ACTIVITIES

We are exposed to market risks primarily related to the volatility in the price of commodities, and foreign currency exchange rates, and the price of credits needed to comply with various government and regulatory programs. We enter into derivative instruments to manage some of these risks, including derivative instruments related to the various commodities we purchase or produce, and foreign currency exchange and purchase contracts, as described below under “Risk Management Activities by Type of Risk.” These derivative instruments are recorded as either assets or liabilities measured at their fair values (see Note 12), as summarized below under “Fair Values of Derivative Instruments,” with changes in fair value recognized currently in income. The effect of these derivative instruments on our income is summarized below under “Effect of Derivative Instruments on Income.”

Risk Management Activities by Type of Risk
Commodity Price Risk
We are exposed to market risks related to the volatility in the price of crude oil, refined petroleum products (primarily gasoline and distillate), grain (primarily corn), soybean oil, 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 our risk control group to ensure compliance with our stated risk management policy that has been approved by our board of directors.

To manage commodity price risk, we use economic hedges, which are not designated as fair value or cash flow hedges, and we use fair value and cash flow hedges from time to time. We also enter into certain commodity derivative instruments for trading purposes. Our objectives for entering into hedges or trading derivatives are described below.

•
Economic Hedges – Economic hedges represent commodity derivative instruments that are used to manage price volatility in certain (i) feedstock and refined petroleum product inventories, (ii) fixed-price purchase contracts, and (iii) forecasted feedstock, refined petroleum product or natural gas purchases and refined petroleum product sales. The objectives of our economic hedges are to hedge price volatility in certain feedstock and refined petroleum product inventories and to lock in the price of forecasted feedstock, refined petroleum product, or natural gas purchases or refined petroleum product sales at existing market prices that we deem favorable. Economic hedges are not designated as fair value or cash flow hedges for accounting purposes, usually due to the difficulty of establishing the required documentation at the date the derivative instrument is entered into for them to qualify as hedging instruments for accounting purposes.




26

Table of Contents



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

As of March 31, 2018, we had the following outstanding commodity derivative instruments that were used as economic hedges, as well as 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 and soybean oil contracts that are presented in thousands of pounds).
 
 
Notional Contract Volumes by
Year of Maturity
Derivative Instrument
 
2018
 
2019
Crude oil and refined petroleum products:
 
 
 
 
Swaps – long
 
9,099

 
—

Swaps – short
 
8,636

 
—

Futures – long
 
99,455

 
—

Futures – short
 
101,298

 
—

Corn:
 
 
 
 
Futures – long
 
23,800

 
125

Futures – short
 
63,330

 
4,685

Physical contracts – long
 
35,069

 
4,759

Soybean oil:
 
 
 
 
Futures – long
 
28,320

 
—

Futures – short
 
89,819

 
—


•
Trading Derivatives – Our objective for entering into commodity derivative instruments for trading purposes is to take advantage of existing market conditions for crude oil and refined petroleum products.




27

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

As of March 31, 2018, 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 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
 
2018
 
2019
Crude oil and refined petroleum products:
 
 
 
 
Swaps – long
 
300

 
—

Swaps – short
 
300

 
—

Futures – long
 
35,329

 
2,675

Futures – short
 
35,247

 
2,675

Options – long
 
112,500

 
—

Options – short
 
112,800

 
—

Corn:
 
 
 
 
Futures – long
 
250

 
—


We had no commodity derivative contracts outstanding as of March 31, 2018 and 2017 or during the three months ended March 31, 2018 and 2017 that were designated as fair value or cash flow hedges.
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 are classified as economic hedges. As of March 31, 2018, we had forward contracts to purchase $479 million of U.S. dollars. Substantially all of these commitments matured on or before April 30, 2018.

Environmental Compliance Program Price Risk
We are exposed to market risk related to the volatility in the price of credits needed to comply with various governmental and regulatory environmental compliance programs. To manage this risk, we enter into contracts to purchase these credits when prices are deemed favorable. Some of these contracts are derivative instruments; however, we elect the normal purchase exception and do not record these contracts at their fair values. Certain of these programs require us to blend biofuels into the products we produce, and we are subject to such programs in most of the countries in which we operate. 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, we must purchase biofuel credits (primarily RINs in the U.S.). We are exposed to the volatility in the market price of these credits, and we manage that risk by purchasing biofuel credits when prices are deemed favorable. The cost of meeting our obligations under these compliance programs was $206 million and $146 million for the three months ended March 31, 2018 and 2017, respectively. These amounts are reflected in cost of materials and other.




28

Table of Contents



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

We are subject to additional requirements under greenhouse gas (GHG) emission programs, including the cap-and-trade systems, as discussed in Note 12. Under these cap-and-trade systems, we purchase various GHG emission credits available on the open market. Therefore, we are exposed to the volatility in the market price of these credits. The cost to implement certain provisions of the cap-and-trade systems are significant; however, we recovered the majority of these costs from our customers for the three months ended March 31, 2018 and 2017 and expect to continue to recover the majority of these costs in the future. For the three months ended March 31, 2018 and 2017, the net cost of meeting our obligations under these compliance programs was immaterial.

Fair Values of Derivative Instruments
The following tables provide information about the fair values of our derivative instruments as of March 31, 2018 and December 31, 2017 (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 following tables, 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, 2018
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
1,009

 
$
1,029

Swaps
Receivables, net
 
6

 
12

Options
Receivables, net
 
11

 
5

Physical purchase contracts
Inventories
 
2

 
2

Foreign currency contracts
Receivables, net
 
1

 
—

Total
 
 
$
1,029

 
$
1,048

 
Balance Sheet
Location
 
December 31, 2017
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
875

 
$
955

Swaps
Receivables, net
 
11

 
11

Options
Receivables, net
 
8

 
3

Physical purchase contracts
Inventories
 
—

 
6

Foreign currency contracts
Accrued expenses
 
—

 
7

Total
 
 
$
894

 
$
982




29

Table of Contents



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

Market 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 our risk control group to ensure compliance with our stated risk management policy. 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.
Effect of Derivative Instruments on Income
The following tables provide information about the gain or loss recognized in income on our derivative instruments and the line items in the statements of income in which such gains and losses are reflected (in millions).
Derivatives Designated as
Economic Hedges
 
Location of Loss
Recognized in Income
on Derivatives
 
Three Months Ended
March 31,
2018
 
2017
Commodity contracts
 
Cost of materials and other
 
$
(48
)
 
$
(97
)
Foreign currency contracts
 
Cost of materials and other
 
(3
)
 
(6
)

Trading Derivatives
 
Location of Gain
Recognized in Income
on Derivatives
 
Three Months Ended
March 31,
2018
 
2017
Commodity contracts
 
Cost of materials and other
 
$
36

 
$
1




30

Table of Contents

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY STATEMENT FOR THE PURPOSE OF SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This Form 10-Q, including without limitation our disclosures below under the heading “OVERVIEW AND OUTLOOK,” includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify our forward-looking statements by the words “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “projection,” “predict,” “budget,” “forecast,” “goal,” “guidance,” “target,” “could,” “should,” “may,” and similar expressions.

These forward-looking statements include, among other things, statements regarding:

•
future refining segment margins, including gasoline and distillate margins;
•
future ethanol segment margins;
•
expectations regarding feedstock costs, including crude oil differentials, and operating expenses;
•
anticipated levels of crude oil and refined petroleum product inventories;
•
our anticipated level of capital investments, including deferred costs for refinery turnarounds and catalyst, capital expenditures for environmental and other purposes, and joint venture investments, and the effect of those capital investments on our results of operations;
•
anticipated trends in the supply of and demand for crude oil and other feedstocks and refined petroleum products in the regions where we operate, as well as globally;
•