FORM 10-K

(Mark One)

For the fiscal year ended December 31, 2004

OR

For the transition period from        to

Commission file number 1-13175

VALERO ENERGY CORPORATION

Securities registered pursuant to Section 12(b) of the Act: Common stock, $0.01 par value, and Preferred Share Purchase Rights, listed on the New York Stock Exchange.

Securities registered pursuant to Section 12(g) of the Act: None.

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).
Yes þ No o

The aggregate market value of the voting and non-voting common stock held by non-affiliates was approximately $9.4 billion based on the last sales price quoted as of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter.

As of February 28, 2005, 256,645,166 shares of the registrant’s common stock were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Valero intends to file with the Securities and Exchange Commission before April 30, 2005 a definitive Proxy Statement for Valero’s Annual Meeting of Stockholders scheduled for April 28, 2005, at which directors of Valero will be elected. Portions of the 2005 Proxy Statement are incorporated by reference in Part III of this Form 10-K and are deemed to be a part of this report.

CROSS-REFERENCE SHEET

The following table indicates the headings in the 2005 Proxy Statement where the information required in Part III of Form 10-K may be found.

Copies of all documents incorporated by reference, other than exhibits to such documents, will be provided without charge to each person who receives a copy of this Form 10-K upon written request to Jay D. Browning, Vice President and Corporate Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269-6000.

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CONTENTS

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CAUTIONARY STATEMENTS RELEVANT TO FORWARD-LOOKING INFORMATION FOR THE PURPOSE OF SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

This Form 10-K contains certain estimates, predictions, projections, assumptions and other forward-looking statements (as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect Valero’s current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions, or other future performance suggested in this report. These forward-looking statements generally can be identified by the words “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “budget,” “forecast,” “will,” “could,” “should,” “may” and similar expressions.

Some important factors (but not necessarily all factors) that could affect Valero’s sales, growth, profitability and operating results, or that otherwise could cause actual results to differ materially from those forecasted by Valero, are discussed in (a) Part I of this report under the headings “Competition” and “Environmental Matters,” (b) Part II of this report under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Forward-Looking Statements,” and (c) Valero’s other filings with the Securities and Exchange Commission. Valero does not intend to update these statements unless the securities laws require Valero to do so, and Valero does not undertake to release publicly the result of any revisions to any forward-looking statements that may be made to reflect events or circumstances after the date of this Form 10-K or to reflect the occurrence of unanticipated events.

PART I

ITEMS 1. & 2. BUSINESS & PROPERTIES

Overview. Valero Energy Corporation is a Fortune 500 company based in San Antonio, Texas, with 2004 total revenues of $54.6 billion. On January 31, 2005, Valero had 19,797 employees. Its principal executive offices are at One Valero Way, San Antonio, Texas, 78249, and its telephone number is (210) 345-2000. Valero’s common stock trades on the New York Stock Exchange under the symbol “VLO.” Valero was incorporated in Delaware in 1981 under the name Valero Refining and Marketing Company. On August 1, 1997, its name was changed to Valero Energy Corporation. When used in this report, the term “Valero” may refer, depending upon the context, to Valero Energy Corporation, to one or more of its consolidated subsidiaries or to all of them taken as a whole.

Valero owns and operates 15 refineries having a combined throughput capacity, including crude oil and other feedstocks, of approximately 2.5 million barrels per day (BPD). Valero’s refining network extends from eastern Canada to the U.S. Gulf Coast and West Coast and includes the island of Aruba. Valero produces premium, environmentally clean refined products such as reformulated gasoline (RFG), gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen). Valero also produces conventional gasolines, distillates, jet fuel, asphalt and petrochemicals.

Valero is also a leading marketer of refined products. Valero markets branded and unbranded refined products on a wholesale basis in the United States and Canada through an extensive bulk and rack marketing network. Valero also sells refined products through a network of more than 4,700 retail and wholesale branded outlets in the United States, Canada and Aruba. Valero’s retail operations include approximately 1,500 company-operated sites that sell transportation fuels and convenience store merchandise.

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Through agreements with Valero L.P., Valero has access to a logistics system that complements Valero’s refining and marketing business primarily in the U.S. Gulf Coast, West Coast and Mid-Continent regions. Valero L.P. is a publicly traded, master limited partnership (NYSE: VLI) that owns and operates crude oil pipelines, crude oil and intermediate feedstock storage facilities, and refined product pipelines and terminals primarily in Texas, California, Oklahoma, New Mexico and Colorado. Valero owns approximately 46% of Valero L.P., which includes the 2% general partner interest. Valero’s investment in and transactions with Valero L.P. are discussed further in Note 9 of Notes to Consolidated Financial Statements.

Available Information. Valero’s annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K filed with (or furnished to) the Securities and Exchange Commission (SEC) are available on Valero’s internet website at http://www.valero.com (in the “Investor Relations” section) as soon as reasonably practicable after Valero files or furnishes such material. Valero also posts its corporate governance guidelines, code of business conduct and ethics, code of ethics for senior financial officers and the charters of the committees of its board of directors in the same website location. Valero’s governance documents are available in print to any stockholder of record that makes a written request to Jay D. Browning, Vice President and Corporate Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269.

RECENT DEVELOPMENTS

Stock Split. On July 15, 2004, Valero’s board of directors approved a two-for-one split of Valero’s common stock. The stock split was effected in the form of a stock dividend. The stock dividend was distributed on October 7, 2004 to stockholders of record on September 23, 2004. All share and per share data (except par value) in this Form 10-K have been adjusted to reflect the effect of the stock split for all periods presented.

Aruba Refinery. On March 5, 2004, Valero purchased El Paso Corporation’s Aruba refinery and related marine, bunkering and marketing operations (collectively, the Aruba Acquisition) for $465 million plus approximately $168 million for working capital. The working capital amount excludes $67.8 million paid by Valero related to certain refined product inventories owned by a third-party marketing firm under an agreement in existence on the date of acquisition. The refinery generally processes heavy, sour crude oil, and produces primarily intermediate feedstocks and finished distillate products. Significant amounts of the refinery’s intermediate feedstock production are used for processing in Valero’s other refineries in the Gulf Coast, West Coast and Northeast regions. The Aruba Acquisition was funded from cash on hand ($200 million), borrowings under bank credit facilities (approximately $27 million) and net proceeds (approximately $406 million) from a public offering of 15.6 million shares of Valero common stock. The $67.8 million paid to the third-party marketing firm described above was funded through borrowings under Valero’s existing bank credit facilities.

Valero L.P.’s Proposed Acquisition of Kaneb. On November 1, 2004, Valero L.P. announced a proposed merger valued at approximately $2.8 billion in which Valero L.P. will acquire Kaneb Services LLC and Kaneb Pipe Line Partners, L.P. The merger is expected to close in the second quarter of 2005. Valero expects to contribute approximately $28 million to Valero L.P. to maintain Valero’s 2% general partner interest in Valero L.P., and Valero’s total ownership interest in Valero L.P. is anticipated to be reduced to approximately 23% as a result of the merger.

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SEGMENTS

Valero’s reportable business segments are refining and retail. Valero’s refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations. The refining segment is segregated geographically into the Gulf Coast, Mid-Continent, West Coast and Northeast regions.

Valero’s retail segment includes company-operated convenience stores, Canadian dealers/jobbers, truckstop facilities, cardlock facilities and home heating oil operations. The retail segment is segregated into two geographic regions. Valero’s retail operations in eastern Canada are referred to as the Northeast System. Valero’s retail operations in the United States are referred to as the U.S. System. See Note 21 of Notes to Consolidated Financial Statements for financial information about Valero’s segments.

VALERO’S OPERATIONS

REFINING

On December 31, 2004, Valero’s refining operations included 15 refineries in the United States, Canada and Aruba with a combined total throughput capacity of approximately 2.5 million BPD. The following table presents the locations of these refineries and their feedstock throughput capacities. These capacities exclude any throughput enhancements completed after December 31, 2004.

As of December 31, 2004

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Valero processes a wide slate of feedstocks, including sour crude oils, intermediates and residual fuel oil (resid) which can typically be purchased at a discount to West Texas Intermediate, a benchmark crude oil. In 2004, sour crude oils and resid represented 55% of Valero’s feedstock slate, sweet crude oils represented 29%, and the remaining 16% was composed of blendstocks and other feedstocks.

Valero’s refineries produce gasolines, distillates, petrochemical feedstocks, asphalt, lubricants and other refined products. In 2004, gasolines and blendstocks represented 48% of Valero’s refined product slate. Distillates – such as home heating oil, diesel fuel and jet fuel – represented 30%, while asphalt, lubricants, petrochemicals and other heavy products comprised the remaining 22%. Of the gasoline that Valero produced in 2004, approximately 37% was reformulated gasoline and CARB gasoline, which sell at a premium over conventional grades of gasoline. In 2004 approximately 79% of Valero’s distillate slate was low-sulfur diesel, CARB diesel and jet fuel, which sell at a premium over high-sulfur heating oil.

     Gulf Coast

The following table presents the percentages of principal feedstock charges and product yields (on a combined basis) for the eight refineries in this region for the year ended December 31, 2004. Total throughput volumes for the Gulf Coast refining region averaged 1,213,000 BPD in 2004.

Combined Gulf Coast Region Feedstocks and Products
2004 Actual

Corpus Christi East and West Refineries. The Corpus Christi East and West Refineries are located along the Corpus Christi Ship Channel on the Texas Gulf Coast. The West Refinery is a highly complex refinery that specializes in processing primarily lower-cost sour crude oil and resid into premium products such as RFG and RBOB.¹ The East Refinery is also a complex refinery that processes heavy, high-sulfur crude oil into conventional gasoline, diesel, jet fuel, asphalt, aromatics and other light products. Valero has been operating the East Refinery since 2001 and has substantially integrated the operations of the West Refinery and the East Refinery, allowing for the transfer of various feedstocks and blending components between the two refineries and the sharing of resources. The refineries typically receive and deliver feedstocks and products by tanker and barge via deepwater docking facilities along the Corpus Christi Ship Channel. In addition, an eight-bay truck rack services local markets. The refineries distribute refined products using the Colonial, Explorer, Valley and other major pipelines, including pipelines owned by Valero L.P.

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Aruba Refinery. The Aruba Refinery is located on the island of Aruba in the Caribbean Sea. It generally processes heavy, sour crude oil, and produces primarily intermediate feedstocks and finished distillate products. Significant amounts of the refinery’s intermediate feedstock production are used for processing in Valero’s other refineries in the Gulf Coast, West Coast and Northeast regions. The Aruba Refinery receives crude oil by ship at its two deepwater marine docks which can berth ultra-large crude carriers. The refinery’s products are delivered by ship primarily into markets in the U.S. Gulf Coast, Florida, the New York Harbor, the Caribbean and Europe.

Texas City Refinery. The Texas City Refinery is located southeast of Houston on the Texas City Ship Channel. The Texas City Refinery processes primarily sour crude oils into a wide slate of products. A 45,000 BPD coking unit and related facilities began operations at the refinery in the fourth quarter of 2003, and enables the refinery to process heavier, lower-cost crude oils. The refinery typically receives and delivers its feedstocks and products by tanker and barge via deepwater docking facilities along the Texas City Ship Channel and also has access to the Colonial, Explorer and TEPPCO pipelines for distribution of its products.

St. Charles Refinery. The St. Charles Refinery is located approximately 15 miles from New Orleans along the Mississippi River. The refinery processes sour crude oils and other feedstocks into a high percentage of gasoline, distillates and other light products. The refinery receives crude oil over five marine docks and has access to the Louisiana Offshore Oil Port where it can receive crude oil through a 24-inch pipeline. Finished products can be shipped over these docks or by pipeline into either the Plantation or Colonial pipeline network for distribution to the eastern United States.

Houston Refinery. The Houston Refinery is located on the Houston Ship Channel. It generally processes sour crude oils and low-sulfur resid into conventional gasoline and distillates. The plant also produces roofing-grade asphalt. The refinery typically receives its feedstocks via tanker at deepwater docking facilities along the Houston Ship Channel. The refinery primarily delivers its products through major refined-product pipelines, including the Colonial, Explorer and TEPPCO pipelines.

Three Rivers Refinery. The Three Rivers Refinery is located in South Texas between Corpus Christi and San Antonio. It generally processes heavy sweet and sour crude oils into conventional gasoline and distillates. The Three Rivers Refinery has access to crude oil from foreign sources delivered to the Texas Gulf Coast at Corpus Christi as well as crude oil from domestic sources through third-party pipelines. A 70-mile pipeline that can deliver 120,000 BPD of crude oil connects the Three Rivers Refinery to Corpus Christi. Valero distributes refined products produced at this refinery primarily through pipelines owned by Valero L.P.

Krotz Springs Refinery. The Krotz Springs Refinery is located between Baton Rouge and Lafayette, Louisiana on the Atchafalaya River. It generally processes sweet crude oils (received primarily by pipeline and barge) into conventional gasoline and distillates. The refinery’s location provides access to upriver markets on the Mississippi River, and its docking facilities along the Atchafalaya River are sufficiently deep to allow barge access. The facility also uses the Colonial pipeline to transport products to markets in the Southeast and Northeast.

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      West Coast

The following table presents the percentages of principal feedstock charges and product yields (on a combined basis) for the two refineries in this region for the year ended December 31, 2004. Total throughput volumes for the West Coast refining region averaged 278,000 BPD in 2004.

Combined West Coast Region Feedstocks and Products
2004 Actual

Benicia Refinery. The Benicia Refinery is located northeast of San Francisco on the Carquinez Straits of San Francisco Bay. It is a highly complex refinery that processes sour crude oils into a high percentage of premium products, primarily CARBOB gasoline. (CARBOB is a reformulated gasoline mixture that meets the specifications of the California Air Resources Board when blended with ethanol.) The refinery can receive crude oil supplies via a deepwater dock that can berth large crude oil carriers and a 20-inch crude oil pipeline connected to a southern California crude oil delivery system. Most of the refinery’s products are distributed via the Kinder Morgan pipeline in California.

Wilmington Refinery. The Wilmington Refinery is located near Los Angeles, California. The refinery processes a blend of lower-cost heavy and high-sulfur crude oils. The refinery can produce all of its gasoline as CARBOB gasoline and produces both ultra-low sulfur diesel and CARB diesel. The refinery is connected by pipeline to marine terminals and associated dock facilities that can move and store crude oil and other feedstocks. Refined products are distributed via the Kinder Morgan pipeline system and various third-party terminals in southern California, Nevada and Arizona.

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     Mid-Continent

The following table presents the percentages of principal feedstock charges and product yields (on a combined basis) for the three refineries in this region for the year ended December 31, 2004. Total throughput volumes for the Mid-Continent refining region averaged 291,000 BPD in 2004.

Combined Mid-Continent Region Feedstocks and Products
2004 Actual

McKee Refinery. The McKee Refinery is located in the Texas Panhandle. It processes primarily sweet crude oils and produces conventional gasoline, RFG, low-sulfur diesel, jet fuels and asphalt. The McKee Refinery has access to crude oil from Texas, Oklahoma, Kansas and Colorado through Valero L.P.’s pipelines and third-party pipelines. The refinery also has access at Wichita Falls, Texas to third-party pipelines that transport crude oil from the Texas Gulf Coast and West Texas to the Mid-Continent region. The refinery distributes its products primarily via Valero L.P.’s pipelines to markets in North Texas, New Mexico, Arizona, Colorado and Oklahoma.

Ardmore Refinery. The Ardmore Refinery is located in Ardmore, Oklahoma, approximately 90 miles from Oklahoma City. It generally processes heavy sweet and sour crude oils into conventional gasoline, low-sulfur diesel and asphalt. Crude oil is delivered to the refinery through Valero L.P.’s crude oil gathering and trunkline systems, third-party pipelines and trucking operations. Refined products are transported via pipelines, railcars and trucks.

Denver Refinery. The Denver Refinery is located outside Denver, Colorado. It generally processes heavy sweet crude oils into conventional gasoline and distillates. Crude oil for the refinery is supplied by a third-party pipeline and by truck. The refinery’s products are transported primarily by pipelines and trucks.

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     Northeast

The following table presents the percentages of principal feedstock charges and product yields (on a combined basis) for the two refineries in this region for the year ended December 31, 2004. Total throughput volumes for the Northeast refining region averaged 380,000 BPD in 2004.

Combined Northeast Region Feedstocks and Products
2004 Actual

Jean Gaulin Refinery. The Jean Gaulin Refinery is located in Lévis, Canada (near Quebec City). It generally processes sweet crude oils and lower-quality, light sweet acidic crude oils into conventional gasoline, low-sulfur diesel, jet fuels, heating oil and propane. The refinery receives crude oil by ship at its deepwater dock on the St. Lawrence River. Valero charters large ice-strengthened, double-hulled crude oil tankers that can navigate the St. Lawrence River year-round. The refinery’s production is transported primarily by train to markets in Quebec and New Brunswick, and by tankers and trucks primarily to markets in Canada’s Atlantic Provinces.

Paulsboro Refinery. The Paulsboro Refinery is located in Paulsboro, New Jersey, approximately 15 miles south of Philadelphia on the Delaware River. The refinery processes primarily sour crude oils into a wide slate of products including gasoline, distillates, a variety of lube oil basestocks, asphalt and fuel oil. Feedstocks and refined products are typically transported by tanker and barge via refinery-owned dock facilities along the Delaware River, Exxon Mobil Corporation’s product distribution system, an onsite truck rack, railcars and the Colonial pipeline, which allows products to be sold into the New York Harbor market.

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     Feedstock Supply

Approximately 70% of Valero’s crude oil feedstock requirements are purchased through term contracts while the remaining requirements are generally purchased on the spot market. Valero’s term supply agreements include arrangements to purchase feedstocks at market-related prices directly or indirectly from various foreign national oil companies (including feedstocks originating in Saudi Arabia, Mexico, Iraq, Kuwait, Venezuela, Ecuador and Africa) as well as international and domestic oil companies. About 75% of these crude oil feedstocks are imported from foreign sources and about 25% are domestic. In the event Valero becomes unable to purchase crude oil from any one of these sources, Valero believes that adequate alternative supplies of crude oil would be available.

The U.S. network of crude oil pipelines and terminals (including those facilities owned by Valero L.P.) allows Valero to acquire crude oil from producing leases, domestic crude oil trading centers and ships delivering cargoes of foreign and domestic crude oil. Valero’s Jean Gaulin Refinery relies on foreign crude oil that is delivered to its St. Lawrence River dock facility by ship.

Valero’s cost to acquire feedstocks, and the price for which Valero ultimately can sell refined products, depend on a number of factors beyond Valero’s control, including regional and global supply of and demand for crude oil, gasoline, diesel and other feedstocks and refined products. These in turn are dependent upon, among other things, the availability of imports, the production levels of domestic and foreign suppliers, U.S. relationships with foreign governments, political affairs and the extent of governmental regulation. Valero uses the futures market to manage a portion of the price risk inherent in purchasing crude oil in advance of its delivery date and in maintaining Valero’s inventories of crude oils and refined products.

     Refining Segment Sales

Valero’s refining segment includes sales of refined products in both the wholesale rack and bulk markets. These sales include refined products that are manufactured in Valero’s refining operations as well as refined products purchased or received on exchange from third parties. Most of Valero’s refineries have access to deepwater transportation facilities and interconnect with common-carrier pipeline systems, allowing Valero to sell products in most major geographic regions of the United States and eastern Canada. No customer accounted for more than 10% of Valero’s total operating revenues in 2004.

           Wholesale Marketing

Valero is a leading wholesale marketer of branded and unbranded transportation fuels. Valero markets these fuels on a wholesale basis in about 40 states primarily through an extensive rack marketing network. The principal purchasers of Valero’s transportation fuels from terminal truck racks are wholesalers, distributors, retailers and truck-delivered end users throughout the United States.

The majority of Valero’s rack volumes are sold through unbranded channels. The remainder is sold to distributors and dealers that are members of the Valero brand family. In the United States, these distributors and dealers operate approximately 2,700 branded sites (representing currently branded sites and sites under contract for branding with Valero). These sites are independently owned and are supplied by Valero under multi-year contracts. For wholesale branded sites, Valero promotes its Valero^® and Beacon^® brands in California, and its Valero^® and Shamrock^® brands on the U.S. east coast. Elsewhere in the United States, Valero promotes its Diamond Shamrock^® and Shamrock^® brands.

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Valero also sells a variety of other products produced at its refineries including asphalt, lube base oils and commodity petrochemicals. These products are transported via pipelines, barges, trucks and railcars.

Valero produces approximately 60,000 BPD of asphalt which is sold to customers in the paving and roofing industries. Valero is the second largest producer of asphalt in the United States. Valero produces asphalt at nine refineries and markets asphalt in 20 states through 14 terminal facilities.

Lubricant base oils and process oils are produced at Valero’s Paulsboro Refinery. The refinery can produce 12,000 BPD of highly refined paraffinic and aromatic oils for use in a variety of lubricant and process applications. These products are sold to a variety of customers, including ExxonMobil under a long-term agreement. ExxonMobil purchases about 40% of the Paulsboro Refinery’s lubricant oil production with the balance sold to independent blenders, additive manufacturers, and industrial and marine customers.

Valero produces and markets a variety of commodity petrochemicals including aromatic solvents (benzene, toluene and xylene), refinery- and chemical-grade propylene and anhydrous ammonia. Aromatic solvents and propylene are sold to customers in the chemical industry for further processing into such products as paints, plastics and adhesives. Ammonia, produced at Valero’s McKee Refinery, is sold to customers in the agriculture industry to be used as fertilizer. Valero also sells petroleum coke and sulfur to domestic and international customers principally in the utility and agricultural sectors, respectively.

           Product Supply and Trading

Valero sells a significant portion of its gasoline and distillate production through bulk sales channels. Valero’s bulk sales are made to various oil companies and traders as well as certain bulk end-users such as railroads, airlines and utilities. Valero’s bulk sales are transported primarily by pipeline, barges and tankers to major tank farms and trading hubs.

Valero also enters into refined product exchange and purchase agreements. These agreements enable Valero to minimize transportation costs, optimize refinery utilization, balance refined product availability, broaden geographic distribution and sell to markets not connected to Valero’s or Valero L.P.’s refined product pipeline systems. Exchange agreements provide for the delivery of refined products by Valero to unaffiliated companies at Valero’s and third parties’ terminals in exchange for delivery of a similar amount of refined products to Valero by these unaffiliated companies at specified locations. Purchase agreements involve Valero’s purchase of refined products from third parties with delivery occurring at specified locations. Most of these agreements are long-standing arrangements. However, they generally can be terminated with 30 to 90 days notice. Valero does not anticipate an interruption in its ability to exchange or purchase refined products in the near future.

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RETAIL

Valero’s retail segment operations include the following:

	•	sales of transportation fuels at retail stores and unattended self-service cardlocks,
	•	sales of convenience store merchandise in retail stores, and
	•	sales of home heating oil to residential customers.

Valero is one of the largest independent retailers of refined products in the central and southwest United States and eastern Canada. Valero’s retail operations are supported by Valero’s proprietary credit card program which had approximately 750,000 accounts as of December 31, 2004. Valero’s retail operations are segregated geographically into two groups: the U.S. System and the Northeast System.

     U.S. System

Sales in the U.S. System represent sales of transportation fuels and convenience store merchandise through Valero’s company-operated retail sites. For the year ended December 31, 2004, total sales of refined products through the U.S. System’s retail sites averaged approximately 122,000 BPD. On December 31, 2004, Valero had 1,043 company-operated sites in its U.S. System (of which approximately 75% were owned and 25% were leased). Valero’s company-operated stores are operated primarily under the brand names Corner Store^® and Stop N Go^®. Transportation fuels sold in Valero’s U.S. System stores are sold primarily under the brands Valero^® and Diamond Shamrock^®.

In addition to transportation fuels, Valero’s company-operated convenience stores sell snacks, candy, beer, fast foods, cigarettes and fountain drinks. Valero maintains an ongoing program to modernize and upgrade the convenience stores it operates, to identify appropriate markets for further investment, and to identify under-performing stores where future investment is deemed non-strategic. In 2004, Valero opened 10 new stores, re-imaged and upgraded 146 stores, closed 112 stores, and divested 152 stores (some of which had been closed in prior years).

     Northeast System

Sales in Valero’s Northeast System include the following:

	•	sales of refined products and convenience store merchandise through Valero’s company-operated retail sites and cardlocks,
	•	sales of refined products through sites owned by independent dealers and jobbers, and
	•	sales of home heating oil to residential customers.

Valero’s Northeast System includes retail operations in eastern Canada where Valero is a major supplier of refined products serving Quebec, Ontario and the Atlantic Provinces of Newfoundland, Nova Scotia, New Brunswick and Prince Edward Island. For the year ended December 31, 2004, total retail sales of refined products through the Northeast System averaged approximately 77,000 BPD. Gasoline and diesel fuel are sold under the Ultramar^® brand through a network of approximately 1,025 outlets throughout eastern Canada. On December 31, 2004, Valero owned or leased approximately 470 retail stores in the Northeast System and distributed gasoline to approximately 555 dealers and independent jobbers. In addition, the Northeast System operated 87 cardlocks, which are card- or key-activated, self-service, unattended stations that allow the purchase of gasoline and diesel fuel 24 hours a day. The Northeast System operations also include a large home heating oil business that provides home heating oil to approximately 180,000 households in eastern Canada. Valero’s home heating oil business tends to be seasonal to the extent of increased demand for home heating oil during the winter.

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COMPETITION

The refining and marketing industry continues to be highly competitive. Valero’s competitors include fully integrated major oil companies (e.g., ExxonMobil and ConocoPhillips) and other independent refining and marketing entities (e.g., Sunoco and Premcor) that operate in all of Valero’s market areas. Many of Valero’s competitors are engaged on a national or international basis in many segments of the petroleum business, including exploration, production, transportation, refining and marketing, on scales much larger than Valero’s. These competitors may have greater flexibility in responding to or absorbing market changes occurring in one or more of these segments. All of Valero’s crude oil and feedstock supplies are purchased from third-party sources, while some competitors have proprietary sources of crude oil available for their own refineries.

Financial returns in the refining and marketing industry depend largely on refining margins and retail fuel margins, both of which fluctuate significantly. Refining margins are impacted by levels of refined product inventories, the balance of refined product supply and demand, quantities of refined product imports, and utilization rates of domestic refineries. Historically, refining margins have been volatile, and they are likely to continue to be volatile in the future. Valero’s ability to process significant amounts of sour crude oils enhances Valero’s competitive position in the industry relative to refiners that process primarily sweet crude oils because sour crude oils typically can be purchased at a discount to sweet crude oils.

Valero’s retail business faces competition from fully integrated major oil companies and independent jobbers selling gasoline under national and private brands. Valero also competes with large grocery stores and other merchandisers (the so-called “hypermarts”) that also sell transportation fuels.

ENVIRONMENTAL MATTERS

The principal environmental risks associated with Valero’s operations are emissions into the air and releases into the soil, surface water or groundwater. Valero’s operations are subject to environmental regulation by the U.S. Environmental Protection Agency (EPA) and numerous federal, state and local authorities under extensive federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the environment, waste management, pollution prevention and characteristics and compositions of fuels. The significant federal laws applicable to Valero’s operations include the Clean Air Act, the Clean Water Act, the Comprehensive Environmental Response, Compensation and Liability Act (CERCLA), and the Solid Waste Disposal Act, as amended by the Resource Conservation and Recovery Act (RCRA). A discussion of significant environmental regulations affecting Valero’s operations follows.

EPA’s Tier II Gasoline and Diesel Standards. The EPA’s Tier II standards, adopted under the Clean Air Act, phase in limitations on the sulfur content of gasoline (which began in 2004) and diesel fuel sold to highway consumers (beginning in 2006). Most of Valero’s refineries are being modified to comply with the Tier II gasoline and diesel standards. Valero believes that capital expenditures of approximately $2 billion will be required through 2008 for its refineries to meet the Tier II specifications, of which approximately $790 million has been spent through December 31, 2004. This estimate includes amounts related to projects at three Valero refineries to provide hydrogen necessary for removing sulfur from gasoline and diesel. Valero expects that its cost estimates will change as additional engineering is completed and progress is made toward construction of these various projects.

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EPA’s Section 114 Initiative. In 2000, the EPA issued to a majority of refiners operating in the United States a series of information requests pursuant to Section 114 of the Clean Air Act as part of an enforcement initiative. Valero received a Section 114 information request pertaining to all of its refineries owned at that time. Valero completed its response to the request, and it has not been named in any enforcement proceeding by the EPA. Several other refiners, however, have either reached global settlements with the EPA regarding this enforcement initiative or have been subject to enforcement proceedings by the EPA. Valero believes that it will be able to reach a settlement with the EPA during 2005 applicable to all of its U.S. refineries. Valero expects to incur penalties and related expenses in connection with a potential settlement, but Valero believes that any settlement penalties will be immaterial to its consolidated results of operations and financial position. In addition, Valero expects that a settlement of this matter will require significant capital improvements or changes in operating parameters, or both, at most of Valero’s refineries. However, Valero expects that most of the required capital improvements or changes in operating parameters will be consistent with many of Valero’s existing or forecasted strategic capital projects or emission reduction projects already planned for the next several years.

Houston/Galveston SIP. Valero’s Houston and Texas City Refineries are located in the Houston/Galveston area, which is classified as “severe nonattainment” for compliance with the EPA’s one-hour air-quality standard for ozone. In October 2001, the EPA approved a State Implementation Plan (SIP) to bring the Houston/Galveston area into compliance with the one-hour ozone standard by 2007. The EPA-approved plan was based on a requirement for industry sources to reduce emissions of nitrogen oxides (NOx) by 90% from a 1997-1999 average actual emissions baseline. Certain industry and business groups challenged the plan based on technical feasibility of the 90% NOx control and its effectiveness in achieving compliance with the ozone standard. In December 2002, the Texas Commission on Environmental Quality (TCEQ) adopted a revised approach for the Houston/Galveston SIP. This alternative plan requires an 80% reduction in NOx emissions and a 64% reduction in so-called highly reactive volatile organic compounds (HRVOC). This alternative plan is subject to EPA review and approval. Valero will be required to install NOx and HRVOC control and monitoring equipment and implement certain operating practices by 2007 at its Houston and Texas City Refineries at a cost estimated by Valero to be approximately $68 million based on the proposed TCEQ approach.

Capital Expenditures Attributable to Compliance with Environmental Regulations. In 2004, Valero’s capital expenditures attributable to compliance with environmental regulations were approximately $523 million, and are currently estimated to be approximately $900 million for 2005 and approximately $745 million for 2006. The estimates for 2005 and 2006 do not include amounts related to constructed facilities for which the portion of expenditures relating to compliance with environmental regulations is not determinable.

Government regulations are complex, are subject to different interpretations and are becoming increasingly more stringent. Therefore, future legislative action and regulatory initiatives could result in changes to operating permits, additional remedial actions or increased capital expenditures and operating costs that cannot be assessed with certainty at this time. In addition, because certain air emissions at Valero’s refineries have been grandfathered under particular environmental laws, any major upgrades at any of its refineries could require potentially material additional expenditures to comply with environmental laws and regulations.

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PROPERTIES

Valero’s principal properties are described above under the caption “Valero’s Operations.” In addition, Valero owns feedstock and refined product storage facilities in various locations. Valero believes that its properties and facilities are generally adequate for its operations and that its facilities are maintained in a good state of repair. As of December 31, 2004, Valero was the lessee under a number of cancelable and non-cancelable leases for certain properties. Valero’s leases are discussed more fully in Note 23 of Notes to Consolidated Financial Statements.

Valero’s patents relating to its refining operations are not material to Valero as a whole. The trademarks and tradenames under which Valero conducts its retail and branded wholesale business – including Valero^®, Diamond Shamrock^®, Shamrock^®, Ultramar^®, Beacon^®, Corner Store^® and Stop N Go^® – and other trademarks employed in the marketing of petroleum products are important to Valero’s wholesale and retail marketing operations.

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EXECUTIVE OFFICERS OF THE REGISTRANT

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ITEM 3. LEGAL PROCEEDINGS

     Unocal

Union Oil Company of California v. Valero Energy Corporation, United States District Court, Central District of California (filed January 22, 2002). In 2002, Union Oil Company of California (Unocal) sued Valero alleging patent infringement. The complaint seeks a 5.75 cent per gallon royalty on all reformulated gasoline infringing on Unocal’s '393 and '126 patents. These patents cover certain compositions of cleaner-burning gasoline. The complaint seeks treble damages for Valero’s alleged willful infringement of Unocal’s patents and Valero’s alleged conduct to induce others to infringe the patents. In a previous lawsuit involving its '393 patent, Unocal prevailed against five other major refiners.

In 2001, the Federal Trade Commission (FTC) began an antitrust investigation concerning Unocal’s misconduct with a joint industry research group and regulators during the time that Unocal was prosecuting its patents at the U.S. Patent and Trademark Office (PTO). In 2003, the FTC filed a complaint against Unocal for antitrust violations. The FTC’s complaint seeks an injunction against future '393 or '126 patent enforcement activity by Unocal against any person or entity with respect to gasoline to be sold in California. The trial for the FTC’s antitrust charges against Unocal began before an administrative law judge (ALJ) on October 19, 2004. Closing arguments are expected to occur in May 2005, with an initial decision from the ALJ expected in mid to late June 2005. The ALJ’s decision will likely be appealed to the full Commission.

In addition to the FTC proceedings, the '393 and '126 patents are being reexamined by the PTO. The PTO has issued notices of rejection of all claims of each of these patents. These rejections are subject to additional proceedings, including administrative appeal by Unocal, followed by an appeal in federal district court or the court of appeals. Ultimate invalidation would preclude Unocal from pursuing claims based on the '393 or '126 patents.

Unocal’s patent lawsuit against Valero is indefinitely stayed as a result of the PTO reexamination proceedings. Notwithstanding the judgment against the other refiners in the previous litigation, Valero believes that it has several strong defenses to Unocal’s lawsuit, including those arising from Unocal’s misconduct, and Valero believes it will prevail in the lawsuit. However, due to the inherent uncertainty of litigation, it is reasonably possible that Valero will not prevail in the lawsuit, and an adverse result could have a material effect on Valero’s results of operations and financial position. An estimate of the possible loss or range of loss from such an adverse result cannot reasonably be made.

     MTBE Litigation

As of February 28, 2005, Valero was named as a defendant in 63 cases alleging liability related to MTBE contamination in groundwater. The plaintiffs are generally water providers, governmental authorities and private water companies alleging that refiners and marketers of MTBE and gasoline containing MTBE are liable for manufacturing or distributing a defective product. Valero is named in these suits together with many other refining industry companies. Valero is being sued primarily as a refiner and marketer of MTBE and gasoline containing MTBE. Valero does not own or operate gasoline station facilities in most of the geographic locations in which damage is alleged to have occurred. The suits generally seek individual, unquantified compensatory and punitive damages and attorneys’ fees. All but one of these cases have been removed to federal court by the defendants and have been, or soon will be, consolidated for pre-trial proceedings in the U.S. District Court for the Southern District of New York. Four of these cases have been selected by the court as focus cases for discovery and pre-trial motions. Activity in the “non-focus” cases is generally stayed pending certain determinations in the focus cases. Valero believes that it has strong defenses to these claims and is vigorously defending the cases. Valero believes that an adverse result in any one of these suits would not have a material effect on its results of operations or financial position. However, Valero believes that an adverse result in all or a substantial number of these cases could have a material effect on

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Valero’s results of operations and financial position. An estimate of the possible losses or range of losses from an adverse result in all or substantially all of these cases cannot reasonably be made.

     Environmental Proceedings

United States Environmental Protection Agency Region II, In the Matter of: Mobil Oil Corporation, Notice of Violation CAA-02-2001-1305 (May 15, 2001) (Paulsboro Refinery). The EPA issued notices of violation (NOVs) relating to Mobil Oil Corporation’s operation of the Paulsboro Refinery prior to Valero’s ownership of the refinery. Valero purchased the refinery from Mobil in 1998. The NOVs allege that Mobil performed certain actions on the refinery’s fluid catalytic cracking unit without satisfying certain permitting and other requirements under the New Source Review provisions of the Clean Air Act. Mobil tendered the NOVs to Valero for indemnification under the refinery purchase agreement between Mobil and Valero. Valero has assumed the defense of these NOVs. The EPA has not asserted a specific demand for administrative or civil penalties or equitable relief under the NOVs, but potential penalties under the NOVs could exceed $100,000. Valero is seeking to settle these matters in the settlement of the Section 114 enforcement action described above under the caption “Environmental Matters.”

United States Environmental Protection Agency, Region IX (June 3, 2004) (Benicia Refinery). The EPA issued an NOV relating to various waste management permitting issues related to Valero’s Benicia Refinery and asphalt plant. In June 2004, the EPA proposed a penalty of $208,180 for this matter. The EPA has now offered to settle this matter for an amount less than $100,000. Valero expects to settle this matter in late March 2005.

Bay Area Air Quality Management District (BAAQMD) (Benicia Refinery). Valero has received 114 violation notices (VNs) since April 2002 from the BAAQMD for incidents at Valero’s Benicia Refinery and asphalt plant. Sixty-six of the VNs relate to alleged excess emissions from fugitive leaks, fire, process upset or instrument malfunction. Fifteen VNs allege visible emissions resulting from power failure, operational upset or instrument malfunction. Three VNs allege public nuisances resulting from fire, power failure or release. The remaining 30 VNs allege recordkeeping discrepancies for late reporting or failure to meet a permit condition, or odor associated with a process upset. In the first quarter of 2005, Valero settled 56 of these VNs (originating primarily in 2002 and 2003) for an amount immaterial to Valero, but in excess of $100,000. No penalties have been assessed for the remaining VNs. Valero is negotiating with the BAAQMD to resolve all of these matters. Valero expects to settle the remaining VNs for an amount immaterial to Valero, but in excess of $100,000.

City of Houston Bureau of Air Quality Control (HBAQC), et al. (Houston Refinery). The HBAQC and the Texas Commission on Environmental Quality (TCEQ) issued 39 VNs from September 2002 to January 2005 to the Houston Refinery for various alleged noncompliance issues. The HBAQC issued 36 VNs for alleged incidents related to or resulting from excess emissions. The three VNs issued by the TCEQ related to excess emissions, failure to monitor/report upset emissions, and waste management. No penalties have been assessed for the VNs. Valero continues to negotiate with the agencies and expects to settle all 39 VNs for an amount immaterial to Valero, but in excess of $100,000. Valero is seeking to settle these matters within Valero’s settlement with the EPA of the Section 114 enforcement action described above under the caption “Environmental Matters.”

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New Jersey Department of Environmental Protection (NJDEP) (Paulsboro Refinery). Valero has received 29 NJDEP Administrative Orders and Notices of Civil Administrative Penalty Assessments (Orders) from February 2002 through February 2005 for alleged incidents at Valero’s Paulsboro Refinery. Fifteen of the Orders relate to excess emissions, for which the NJDEP has proposed penalties totaling $189,250. Eight of the Orders relate to failure to repair fugitive leaks or tank seals, for which penalties of $408,800 are proposed. Two Orders are for alleged Title V permit deviations (proposed penalties of $36,000), two are for alleged failures to operate according to approved plans or permit conditions (proposed penalties of $7,000), one is for failure to make a required notification (proposed penalties of $6,000), and one is for exceeding the refinery’s total annual benzene limit. Valero is negotiating a settlement with the NJDEP and expects to settle all of the Orders for an amount immaterial to Valero, but in excess of $100,000. Valero is seeking to settle most of these matters with the NJDEP together with Valero’s settlement with the EPA of the Section 114 enforcement action described above under the caption “Environmental Matters.” In addition to the foregoing matters, the NJDEP has issued demands for stipulated penalties (totaling $100,000 in the aggregate) to the refinery for two alleged failures of a stack test required by an Administrative Consent Order entered in May 2000. Valero believes that it has strong defenses to these demands and intends to challenge them in an administrative hearing.

South Coast Air Quality Management District (SCAQMD) (Wilmington Refinery). The SCAQMD issued 19 VNs to Valero’s Wilmington Refinery in 2003-2004 for alleged excess emissions and one permitting discrepancy. No penalties have been assessed for the alleged violations. Valero is negotiating with the SCAQMD to resolve these issues and expects to settle all of the VNs for an amount immaterial to Valero, but possibly in excess of $100,000.

Texas Commission on Environmental Quality (TCEQ) (Corpus Christi East Refinery). Valero received three notices of enforcement (NOE) from the TCEQ relating to alleged emission events and recordkeeping issues from August 2003 to April 2004 at Valero’s Corpus Christi East Refinery, primarily relating to vacuum off-gas compressor outages. Valero is negotiating with the TCEQ to resolve these matters, and expects to settle them for an amount immaterial to Valero, but in excess of $100,000.

     Other Litigation

Valero is also a party to additional claims and legal proceedings arising in the ordinary course of business. Valero believes it is unlikely that the final outcome of any of the claims or proceedings to which it is a party would have a material adverse effect on its financial position, results of operations or liquidity; however, due to the inherent uncertainty of litigation, the range of any possible loss cannot be estimated with a reasonable degree of precision and Valero cannot provide assurance that the resolution of any particular claim or proceeding would not have an adverse effect on its results of operations, financial position or liquidity.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of security holders during the fourth quarter of 2004.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Valero’s common stock is traded on the New York Stock Exchange under the symbol “VLO.”

As of February 28, 2005, there were 6,475 holders of record of Valero’s common stock.

The following table shows the high and low sales prices of and dividends declared on Valero’s common stock for each quarter of 2004 and 2003. The amounts presented below for the quarters ended on and prior to September 30, 2004 have been adjusted to reflect the effect of a two-for-one split of Valero’s common shares, which was effected in the form of a common stock dividend distributed on October 7, 2004.

On February 3, 2005, Valero’s board of directors declared a regular quarterly cash dividend of $0.08 per common share payable March 16, 2005 to holders of record at the close of business on February 16, 2005.

Dividends are considered quarterly by the board of directors and may be paid only when approved by the board.

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The following table discloses purchases of shares of Valero’s common stock made by or on behalf of Valero during the fourth quarter of 2004.

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ITEM 6. SELECTED FINANCIAL DATA

The selected financial data for the five-year period ended December 31, 2004 was derived from Valero’s audited consolidated financial statements. The following table should be read together with the historical consolidated financial statements and accompanying notes included in Item 8, “Financial Statements and Supplementary Data” and with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The following summaries are in millions of dollars except for per share amounts:

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following review of the results of operations and financial condition of Valero should be read in conjunction with Items 1 & 2, “Business & Properties,” and Item 8, “Financial Statements and Supplementary Data,” included in this report. In the discussions that follow, all per-share amounts assume dilution.

FORWARD-LOOKING STATEMENTS

This Form 10-K, including without limitation the discussion below under the heading “Results of Operations - Outlook,” contains certain estimates, predictions, projections, assumptions and other “forward-looking statements” (as defined in Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934) that involve various risks and uncertainties. While these forward-looking statements, and any assumptions upon which they are based, are made in good faith and reflect Valero’s current judgment regarding the direction of its business, actual results will almost always vary, sometimes materially, from any estimates, predictions, projections, assumptions or other future performance suggested in this report. These forward-looking statements can generally be identified by the words “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “budget,” “forecast,” “will,” “could,” “should,” “may” and similar expressions. These forward-looking statements include, among other things, statements regarding:

	•	future refining margins, including gasoline and heating oil margins;
	•	future retail margins, including gasoline, diesel, home heating oil and convenience store merchandise margins;
	•	expectations regarding feedstock costs, including crude oil discounts, and operating expenses;
	•	anticipated levels of crude oil and refined product inventories;
	•	Valero’s anticipated level of capital investments, including deferred refinery turnaround and catalyst costs and capital expenditures for environmental and other purposes, and the effect of those capital investments on Valero’s results of operations;
	•	anticipated trends in the supply of and demand for crude oil and other feedstocks and refined products in the United States, Canada and elsewhere;
	•	expectations regarding environmental and other regulatory initiatives; and
	•	the effect of general economic and other conditions on refining and retail industry fundamentals.

Valero’s forward-looking statements are based on its beliefs and assumptions derived from information available at the time the statements are made. Differences between actual results and any future performance suggested in these forward-looking statements could result from a variety of factors, including the following:

	•	acts of terrorism aimed at either Valero’s facilities or other facilities that could impair Valero’s ability to produce and/or transport refined products or receive feedstocks;
	•	political conditions in crude oil producing regions, including the Middle East and South America;
	•	the domestic and foreign supplies of refined products such as gasoline, diesel fuel, jet fuel, home heating oil and petrochemicals;
	•	the domestic and foreign supplies of crude oil and other feedstocks;
	•	the ability of the members of the Organization of Petroleum Exporting Countries (OPEC) to agree on and to maintain crude oil price and production controls;
	•	the level of consumer demand, including seasonal fluctuations;
	•	refinery overcapacity or undercapacity;
	•	the actions taken by competitors, including both pricing and the expansion and retirement of refining capacity in response to market conditions;
	•	environmental and other regulations at both the state and federal levels and in foreign countries;

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	•	the level of foreign imports of refined products;
	•	accidents or other unscheduled shutdowns affecting Valero’s refineries, machinery, pipelines or equipment, or those of Valero’s suppliers or customers;
	•	changes in the cost or availability of transportation for feedstocks and refined products;
	•	the price, availability and acceptance of alternative fuels and alternative-fuel vehicles;
	•	cancellation of or failure to implement planned capital projects and realize the various assumptions and benefits projected for such projects or cost overruns in constructing such planned capital projects;
	•	earthquakes, hurricanes, tornadoes and irregular weather, which can unforeseeably affect the price or availability of natural gas, crude oil and other feedstocks and refined products;
	•	rulings, judgments or settlements in litigation or other legal or regulatory matters, including unexpected environmental remediation costs in excess of any reserves or insurance coverage;
	•	the introduction or enactment of federal or state legislation which may adversely affect Valero’s business or operations;
	•	changes in the credit ratings assigned to Valero’s debt securities and trade credit;
	•	changes in the value of the Canadian dollar relative to the U.S. dollar; and
	•	overall economic conditions.

Any one of these factors, or a combination of these factors, could materially affect Valero’s future results of operations and whether any forward-looking statements ultimately prove to be accurate. Valero’s forward-looking statements are not guarantees of future performance, and actual results and future performance may differ materially from those suggested in any forward-looking statements. Valero does not intend to update these statements unless it is required by the securities laws to do so.

All subsequent written and oral forward-looking statements attributable to Valero or persons acting on its behalf are expressly qualified in their entirety by the foregoing. Valero undertakes no obligation to publicly release the result of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

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OVERVIEW

Generally, Valero’s operations are affected by:

	•	company-specific factors, primarily refinery utilization rates and refinery maintenance turnarounds,
	•	seasonal factors, such as the demand for refined products, and
	•	industry factors, such as movements in and the level of crude oil prices including the effect of quality differential between grades of crude oil, the demand for and prices of refined products, industry supply capacity, and competitor refinery maintenance turnarounds.

Valero’s profitability is substantially determined by the spread between the price of refined products and the price of crude oil, referred to as the “refined product margin.” Since approximately 50% of Valero’s total throughput represents sour crude oil feedstocks, Valero’s profitability is also significantly affected by the spread between sweet crude oil and sour crude oil prices, referred to as the “sour crude oil discount.” For the year 2004, both refined product margins and sour crude oil discounts were the best ever experienced by Valero. The strength of those positive industry fundamentals significantly enhanced Valero’s results of operations for the year ended December 31, 2004, resulting in earnings per share of $6.53. This represented a 156% increase over the $2.55 per share earnings reported for 2003, as adjusted to reflect the effect of a two-for-one stock split discussed below.

Valero’s operating results during 2004 benefited significantly from recent investments that increased Valero’s capacity to process lower-cost feedstocks. In March 2004, Valero continued its strategic growth through the acquisition of the Aruba Refinery and related marine, bunkering and marketing operations. The Aruba Refinery, which processes heavy, sour crude oil, contributed approximately $290 million to Valero’s operating income for 2004. In addition, the 45,000 BPD coker unit at the Texas City Refinery, which began operations late in the fourth quarter of 2003 and also processes heavier, lower-cost crude oil, generated nearly $200 million of operating income in 2004. Furthermore, during 2004, Valero realized the benefits from a full year of operations of the St. Charles Refinery that was acquired on July 1, 2003. The St. Charles Refinery generated approximately $335 million of operating income in 2004.

The positive 2004 results from Valero’s operations, as well as certain investing and financing activities during 2004, significantly improved Valero’s financial position and are expected to favorably position Valero to meet its objectives of increased shareholder return, continued growth and improved earnings stability. Valero’s debt-to-capitalization ratio (net of cash) decreased from approximately 40% at December 31, 2003 to 30.7% at the end of 2004. During 2004, Valero’s debt-to-capitalization ratio was positively impacted by the generation of $3.0 billion of cash from operating activities and the sale of 15.6 million shares of common stock which partially funded the Aruba Acquisition.

As discussed further under “Outlook” below, Valero’s increasing ability to process heavier sour crude oils is expected to enable Valero to further benefit from wide sour crude oil discounts that Valero believes will occur. Valero believes that it is well-positioned to benefit from an expected continuation of favorable refining industry fundamentals.

On July 15, 2004, Valero’s board of directors approved a two-for-one split of Valero’s common stock, which was distributed in the form of a stock dividend on October 7, 2004 to stockholders of record on September 23, 2004. All share and per share data (except par value) in this Form 10-K have been adjusted to reflect the effect of the stock split for all periods presented.

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RESULTS OF OPERATIONS

2004 Compared to 2003

Financial Highlights
(millions of dollars, except per share amounts)

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Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)

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Refining Operating Highlights by Region (g)
(millions of dollars, except per barrel amounts)

30

Average Market Reference Prices and Differentials (h)
(dollars per barrel)

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General

Operating revenues increased 44% from the year ended December 31, 2003 to the year ended December 31, 2004 primarily as a result of higher refined product prices combined with additional throughput volumes from refinery operations. The increases in operating income from $1.2 billion for 2003 to $3.0 billion for 2004 and net income from $621.5 million for 2003 to $1.8 billion for 2004 were attributable primarily to improved fundamentals for Valero’s refining segment as discussed below.

Refining

Operating income for Valero’s refining segment was $3.2 billion for the year ended December 31, 2004, an increase of $1.9 billion from the year ended December 31, 2003. The increase in refining segment operating income resulted primarily from a 45% increase in refining throughput margin per barrel and an 18% increase in refining throughput volumes, partially offset by an increase in operating expenses.

Refining total throughput margin for 2004 increased due to the following factors:

	•	Discounts on Valero’s sour crude oil feedstocks improved during 2004 compared to 2003 due to ample supplies of sour crude oils and heavy sour residual fuel oils on the world market. In addition, discounts on sour crude oil feedstocks benefited from increased demand for sweet crude oil resulting from several factors, including (i) the global movement to cleaner fuels, which has required refineries to lower the sulfur content of the gasoline they produce, (ii) high gasoline margins, which increased the demand for sweet versus sour crude oil due to the higher gasoline content of sweet crude oil, and (iii) a global increase in refined product demand, particularly in Asia, which has resulted in more gasoline production by less complex foreign refineries that require sweet crude oil as feedstock.
	•	Gasoline margins increased in all of Valero’s refining regions during 2004 compared to 2003 due mainly to strong demand. Gasoline demand was up in 2004 primarily due to strong U.S. and global economic activity.
	•	Distillate margins also increased in all of Valero’s refining regions in 2004 compared to 2003 due mainly to increased foreign and U.S. demand resulting from improved economies.
	•	Petrochemical feedstock margins improved significantly in 2004 compared to 2003 due to increased demand for such feedstocks resulting from a stronger worldwide economy.
	•	Valero’s throughput volumes increased 327,000 barrels per day in 2004 compared to 2003 due mainly to incremental throughput of 117,000 barrels per day at the St. Charles Refinery, which was acquired in July 2003, and 183,000 barrels per day of throughput at the Aruba Refinery during the partial period commencing on its acquisition date of March 5, 2004.

The above increases in throughput margin for 2004 were partially offset by the effects of:

	•	lower margins on products such as asphalt, No. 6 fuel oil, sulfur and petroleum coke due to an increase in the price of crude oil in 2004 compared to 2003,
	•	an approximate $20 million reduction resulting from Valero ceasing consolidation of Valero L.P. commencing in March 2003,
	•	a higher level of turnaround activity in 2004 compared to 2003, and
	•	approximately $231 million of hedging losses in 2004 related to forward sales of distillates and associated crude oil purchases.

Refining operating expenses were 29% higher for the year ended December 31, 2004 compared to the year ended December 31, 2003 due primarily to the acquisitions of the St. Charles Refinery in July 2003 and the Aruba Refinery in March 2004, higher energy costs (primarily related to an increase in natural gas prices), increased maintenance expense, an increase in employee compensation and benefits expense including increased variable and incentive compensation, and increases in insurance expense, injected catalyst,

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professional fees and regulatory costs. Although total refining operating expenses increased 29% from 2003 to 2004, this increase was 9% on a per-barrel basis. The lower percentage increase on a per-barrel basis was due to the throughput increases that resulted from the St. Charles and Aruba Acquisitions. Refining depreciation and amortization expense increased 24% from the year ended December 31, 2003 to the year ended December 31, 2004 due mainly to the implementation of new capital projects, the acquisitions of the St. Charles and Aruba Refineries and increased turnaround and catalyst amortization.

Retail

Retail operating income was $175.0 million for the year ended December 31, 2004, a decrease of $36.7 million from the year ended December 31, 2003. Retail fuel margins in the United States decreased due to a rise in crude oil prices during 2004 which could not be fully passed through to the consumer, and fuel sales declined in the United States due to fewer stores. Retail depreciation and amortization expense was higher in 2004 due mainly to gains recognized in 2003 on the disposition of certain home heating oil businesses and service stations. In the Northeast, operating income declined due mainly to an increase in selling expenses resulting primarily from a significant increase in the Canadian dollar exchange rate from 2003 to 2004.

Corporate Expenses and Other

General and administrative expenses, including corporate depreciation and amortization expense, increased $67.6 million for the year ended December 31, 2004 compared to the year ended December 31, 2003. Employee compensation and benefits increased approximately $41 million from 2003 to 2004, including the recognition of increased variable and incentive compensation expense of approximately $21 million as a result of improved financial performance between the respective years. The remainder of the increase was attributable primarily to costs related to legal and regulatory matters and increased charitable contributions.

Equity in earnings of Valero L.P. represents Valero’s equity interest in the earnings of Valero L.P. after March 18, 2003. On March 18, 2003, Valero’s ownership interest in Valero L.P. decreased from 73.6% to 49.5%. As a result of this decrease in ownership of Valero L.P. combined with certain other partnership governance changes, Valero ceased consolidating Valero L.P. as of that date and began using the equity method to account for its investment in Valero L.P. The minority interest in net income of Valero L.P. represented the minority unitholders’ share of the net income of Valero L.P. during the periods that Valero consolidated such operations.

“Other income (expense), net” for the year ended December 31, 2004 includes an impairment charge of $57.2 million to write off the carrying amount of Valero’s equity investment in Clear Lake Methanol Partners, L.P., as further described in Note 10 of Notes to Consolidated Financial Statements. Excluding the effect of this impairment charge, other income declined $6.0 million due primarily to the nonrecurrence of a $17.0 million gain recognized in 2003 related to the sale of certain notes received as partial consideration for the 2002 sale of the Golden Eagle Business (described further in Note 10 of Notes to Consolidated Financial Statements), partially offset by a $10 million increase in equity income in 2004 from the Javelina joint venture due to higher natural gas liquids prices.

Distributions on preferred securities of subsidiary trusts ceased during 2003 due to the redemption of the 8.32% Trust Originated Preferred Securities (TOPrS) in June 2003 and the settlement of the Premium Equity Participating Security Units (PEPS Units) in August 2003.

Income tax expense increased $541.2 million from 2003 to 2004 mainly as a result of a 175% increase in income before income tax expense. Valero’s effective tax rate for the year ended December 31, 2004,

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however, decreased from the year ended December 31, 2003 due mainly to the Aruba Acquisition, the results of operations of which are substantially non-taxable in Aruba through December 31, 2010.

2003 Compared to 2002

Financial Highlights
(millions of dollars, except per share amounts)

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Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)

35

Refining Operating Highlights by Region (f)
(millions of dollars, except per barrel amounts)