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EX-32.01 - EXHIBIT 32.01 - VALERO ENERGY CORP/TXvloexh3201-3312017.htm
EX-31.02 - EXHIBIT 31.02 - VALERO ENERGY CORP/TXvloexh3102-3312017.htm
EX-31.01 - EXHIBIT 31.01 - VALERO ENERGY CORP/TXvloexh3101-3312017.htm
 
 
 
 
 
 
 
 
 
 
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, 2017
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 28, 2017 was 447,231,409.
 
 
 
 
 



VALERO ENERGY CORPORATION
TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 





i


PART I – FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VALERO ENERGY CORPORATION
CONSOLIDATED BALANCE SHEETS
(millions of dollars, except par value)
 
March 31,
2017
 
December 31,
2016
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and temporary cash investments
$
4,463

 
$
4,816

Receivables, net
5,104

 
5,901

Inventories
6,025

 
5,709

Prepaid expenses and other
316

 
374

Total current assets
15,908

 
16,800

Property, plant, and equipment, at cost
38,571

 
37,733

Accumulated depreciation
(11,580
)
 
(11,261
)
Property, plant, and equipment, net
26,991

 
26,472

Deferred charges and other assets, net
3,148

 
2,901

Total assets
$
46,047

 
$
46,173

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of debt and capital lease obligations
$
120

 
$
115

Accounts payable
6,037

 
6,357

Accrued expenses
707

 
694

Taxes other than income taxes
971

 
1,084

Income taxes payable
64

 
78

Total current liabilities
7,899

 
8,328

Debt and capital lease obligations, less current portion
8,369

 
7,886

Deferred income taxes
7,196

 
7,361

Other long-term liabilities
1,932

 
1,744

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
7,096

 
7,088

Treasury stock, at cost;
226,338,916 and 222,000,024 common shares
(12,310
)
 
(12,027
)
Retained earnings
26,366

 
26,366

Accumulated other comprehensive loss
(1,334
)
 
(1,410
)
Total Valero Energy Corporation stockholders’ equity
19,825


20,024

Noncontrolling interests
826

 
830

Total equity
20,651

 
20,854

Total liabilities and equity
$
46,047

 
$
46,173

See Condensed Notes to Consolidated Financial Statements.



1


VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
(millions of dollars, except per share amounts)
(unaudited)
 
Three Months Ended
March 31,
 
2017
 
2016
Operating revenues (a)
$
21,772

 
$
15,714

Costs and expenses:
 
 
 
Cost of sales (excluding the lower of cost or market inventory
valuation adjustment)
19,428

 
13,507

Lower of cost or market inventory valuation adjustment

 
(293
)
Operating expenses
1,117

 
1,030

General and administrative expenses
190

 
156

Depreciation and amortization expense
500

 
485

Total costs and expenses
21,235

 
14,885

Operating income
537

 
829

Other income, net
17

 
9

Interest and debt expense, net of capitalized interest
(121
)
 
(108
)
Income before income tax expense
433

 
730

Income tax expense
112

 
217

Net income
321

 
513

Less: Net income attributable to noncontrolling interests
16

 
18

Net income attributable to Valero Energy Corporation stockholders
$
305

 
$
495

 
 
 
 
Earnings per common share
$
0.68

 
$
1.05

Weighted-average common shares outstanding (in millions)
448

 
469

Earnings per common share – assuming dilution
$
0.68

 
$
1.05

Weighted-average common shares outstanding –
assuming dilution (in millions)
451

 
471

Dividends per common share
$
0.70

 
$
0.60

_______________________________________________
 
 
 
Supplemental information:
 
 
 
(a)    Includes excise taxes on sales by certain of our international operations
$
1,272

 
$
1,395

See Condensed Notes to Consolidated Financial Statements.



2


VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(millions of dollars)
(unaudited)
 
Three Months Ended
March 31,
 
2017
 
2016
Net income
$
321

 
$
513

 
 
 
 
Other comprehensive income:
 
 
 
Foreign currency translation adjustment
74

 
122

Net gain on pension and other postretirement
benefits
3

 
3

Other comprehensive income before
income tax expense (benefit)
77

 
125

Income tax expense (benefit) related to
items of other comprehensive income
1

 
(7
)
Other comprehensive income
76

 
132

 
 
 
 
Comprehensive income
397

 
645

Less: Comprehensive income attributable
to noncontrolling interests
16

 
19

Comprehensive income attributable to
Valero Energy Corporation stockholders
$
381

 
$
626

See Condensed Notes to Consolidated Financial Statements.



3


VALERO ENERGY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(millions of dollars)
(unaudited)
 
Three Months Ended
March 31,
 
2017
 
2016
Cash flows from operating activities:
 
 
 
Net income
$
321

 
$
513

Adjustments to reconcile net income to net cash provided by
operating activities:
 
 
 
Depreciation and amortization expense
500

 
485

Lower of cost or market inventory valuation adjustment

 
(293
)
Deferred income tax expense (benefit)
(4
)
 
121

Changes in current assets and current liabilities
151

 
(177
)
Changes in deferred charges and credits and
other operating activities, net
20

 
(9
)
Net cash provided by operating activities
988

 
640

Cash flows from investing activities:
 
 
 
Capital expenditures
(279
)
 
(316
)
Deferred turnaround and catalyst costs
(245
)
 
(161
)
Investments in joint ventures
(117
)
 
(2
)
Acquisition of undivided interest in crude system assets
(72
)
 

Other investing activities, net
(1
)
 
(2
)
Net cash used in investing activities
(714
)
 
(481
)
Cash flows from financing activities:
 
 
 
Repayments of debt and capital lease obligations
(5
)
 
(3
)
Purchase of common stock for treasury
(314
)
 
(265
)
Common stock dividends
(315
)
 
(282
)
Proceeds from issuance of Valero Energy Partners LP common units
35

 

Distributions to noncontrolling interests
(public unitholders) of Valero Energy Partners LP
(9
)
 
(7
)
Distributions to other noncontrolling interests
(25
)
 

Other financing activities, net
(19
)
 
13

Net cash used in financing activities
(652
)
 
(544
)
Effect of foreign exchange rate changes on cash
25

 
49

Net decrease in cash and temporary cash investments
(353
)
 
(336
)
Cash and temporary cash investments at beginning of period
4,816

 
4,114

Cash and temporary cash investments at end of period
$
4,463

 
$
3,778

See Condensed Notes to Consolidated Financial Statements.




4



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” may refer to Valero Energy Corporation, one or more of its consolidated subsidiaries, or all of them taken as a whole.

These unaudited financial statements have been prepared in accordance with United States (U.S.) generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature unless disclosed otherwise. Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017.

The balance sheet as of December 31, 2016 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, 2016.

Reclassifications
As of January 1, 2017, we revised our reportable segments to reflect a new reportable segment — VLP. The results of the VLP segment include the results of Valero Energy Partners LP (VLP), our majority-owned master limited partnership. Our prior period segment information has been retrospectively adjusted to reflect our current segment presentation. See Note 9 for additional information.

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.

Accounting Pronouncements Adopted During the Period
In July 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2015-11, “Inventory (Topic 330),” to simplify the measurement of inventory measured using the first-in, first-out or average cost methods. The provisions of this ASU require the inventory to be measured at the lower of cost and net realizable value rather than the lower of cost or market. Net realizable value is defined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The provisions of this ASU are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods within those annual periods, with early adoption permitted. Our adoption of this ASU effective January 1, 2017 did not affect our financial position or results of operations since the majority of our inventory is stated at last-in, first-out (LIFO).




5




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

In October 2016, the FASB issued ASU No. 2016-16, “Income Taxes (Topic 740),” to improve the accounting for the income tax consequences of intra-entity transfers of assets other than inventory. The provisions of this ASU require an entity to recognize the income tax consequences of intra-entity transfers of assets other than inventory immediately when the transfer occurs. These provisions are effective for annual reporting periods beginning after December 15, 2017, and interim reporting periods within those annual periods, with early adoption permitted. The provisions should be applied on a modified retrospective basis with a cumulative-effect adjustment to the opening balance of retained earnings as of the beginning of the period of adoption to recognize the income tax consequences of intra-entity transfers of assets that occurred before the adoption date. Our early adoption of this ASU using the modified retrospective method effective January 1, 2017 did not have a material affect on our financial position or results of operations. Adoption of this guidance more accurately reflects the economics of an intra-entity asset transfer when it occurs by eliminating the previous exception that prohibited the recognition of the income tax consequences of an intra-entity asset transfer until the asset had been sold to an outside party.

In October 2016, the FASB issued ASU No. 2016-17, “Consolidation (Topic 810),” to provide guidance on how a reporting entity that is a single decision maker of a variable interest entity (VIE) should treat indirect interests in the entity held through related parties that are under common control with the reporting entity when determining whether it is the primary beneficiary. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2016, and interim reporting periods within those annual periods, with early adoption permitted. The provisions should be applied on a retrospective basis to all relevant prior periods beginning with the fiscal year in which the VIE guidance was adopted with a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Our adoption of this ASU effective January 1, 2017 did not affect our financial position or results of operations.

In January 2017, the FASB issued ASU No. 2017-01, “Business Combinations (Topic 805),” to assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The provisions of this ASU provide a more robust framework to use in determining when a set of assets and activities is a business by clarifying the requirements related to inputs, processes, and outputs. These provisions are to be applied prospectively and are effective for annual reporting periods beginning after December 15, 2017, with early adoption permitted. Our early adoption of this ASU effective January 1, 2017 did not have an affect on our financial position or results of operations. However, more of our future acquisitions may be accounted for as asset acquisitions.

Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” to clarify the principles for recognizing revenue. The ASU is effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within those annual periods. We recently completed our evaluation of the provisions of this ASU and concluded that our adoption of the ASU will not materially change the amount or timing of revenues recognized by us, nor will it materially affect our financial position. The majority of our revenues are generated from the sale of refined petroleum products and ethanol. These revenues are largely based on the current spot (market) prices of the products sold, which represents consideration specifically allocable to the products being sold on a given day, and we recognize those revenues upon delivery and transfer of title to the products to our customers. The time at which delivery and transfer of title occurs is the point when our control of the products is transferred to our customers and when our performance obligation to our customers is fulfilled. We will adopt this ASU effective January 1, 2018, and



6




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

we expect to use the modified retrospective method of adoption as permitted by the ASU. Under that 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. During 2017, we are developing our revenue disclosures and enhancing our accounting systems.

In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10),” to enhance the reporting model for financial instruments regarding certain aspects of recognition, measurement, presentation, and disclosure. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim reporting periods within those annual periods. This ASU is to be applied using a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The adoption of this ASU effective January 1, 2018 will not affect our financial position or results of operations, but will result in revised disclosures.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (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. The 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 anticipate adopting the new standard on January 1, 2019 and we expect to use the modified retrospective method of adoption as permitted by the ASU. We recently completed our evaluation of the provisions of this standard, and a multi-disciplined implementation team has gained an understanding of the standard’s accounting and disclosure provisions. This team is developing enhanced contracting and lease evaluation processes and information systems to support such processes, as well as new and enhanced accounting systems to account for our leases and support the required disclosures. We continue to evaluate the effect that adopting this standard will have on our financial statements and related disclosures.

In March 2017, the FASB issued ASU 2017-07, “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” The new standard requires that an employer report the service cost component 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 to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. This ASU is to be applied retrospectively for income statement items and prospectively for any capitalized benefit costs. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2017, and interim reporting periods within those annual periods, with early adoption permitted. The adoption of this guidance effective January 1, 2018 is not expected to materially affect our financial position or results of operations.




7




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

2.
INVENTORIES

Inventories consisted of the following (in millions):
 
March 31,
2017

December 31,
2016
Refinery feedstocks
$
2,318

 
$
2,068

Refined petroleum products and blendstocks
3,189

 
3,153

Ethanol feedstocks and products
268

 
238

Materials and supplies
250

 
250

Inventories
$
6,025

 
$
5,709


Inventories are valued at the lower of cost or market. As of December 31, 2015, we had a valuation reserve of $766 million in order to state our inventories at market. During the three months ended March 31, 2016, we recorded a change in our lower of cost or market inventory valuation reserve that resulted in a net benefit to our results of operations of $293 million.

As of March 31, 2017 and December 31, 2016, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by $1.8 billion and $1.9 billion, respectively. As of March 31, 2017 and December 31, 2016, our non-LIFO inventories accounted for $663 million and $641 million, respectively, of our total inventories.




8




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

3.
DEBT AND CAPITAL LEASE OBLIGATIONS

There was no significant activity related to our debt during the three months ended March 31, 2017 and 2016.

Summary of Credit Facilities
We had outstanding borrowings, letters of credit issued, and availability under our credit facilities as follows (in millions):
 
 
 
 
 
 
March 31, 2017
 
 
Facility
Amount
 
Maturity Date
 
Outstanding
Borrowings
 
Letters of
Credit
Issued
 
Availability
Committed facilities:
 
 
 
 
 
 
 
 
 
 
Valero Revolver
 
$
3,000

 
November 2020
 
$

 
$
150

 
$
2,850

VLP Revolver
 
$
750

 
November 2020
 
$
30

 
$

 
$
720

Canadian Revolver
 
C$
25

 
November 2017
 
C$

 
C$
10

 
C$
15

Accounts receivable
sales facility
 
$
1,300

 
July 2017
 
$
100

 
n/a

 
$
1,183

Letter of credit facilities
 
$
225

 
June 2017 and
November 2017
 
n/a

 
$

 
$
225

Uncommitted facilities:
 
 
 
 
 
 
 
 
 
 
Letter of credit facilities
 
n/a

 
n/a
 
n/a

 
$
235

 
n/a


As of March 31, 2017 and December 31, 2016, the weighted-average interest rate on the VLP Revolver was 2.3125 percent. As of March 31, 2017 and December 31, 2016, the weighted-average interest rate on the accounts receivable sales facility was 1.4805 percent and 1.3422 percent, respectively.
 
 
 
 
Capital Leases
In January 2017, we recognized capital lease assets and related obligations of approximately $490 million for the lease of storage tanks located at three of our refineries. These lease agreements have initial terms of 10 years each with successive 10-year automatic renewal terms.

4.
COMMITMENTS AND CONTINGENCIES

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. However, because



9




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

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 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.

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,
 
2017
 
2016
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests (a)
 
Total
Equity
 
Valero
Stockholders’
Equity
 
Non-
controlling
Interests (a)
 
Total
Equity
Balance as of
beginning of period
$
20,024

 
$
830

 
$
20,854

 
$
20,527

 
$
827

 
$
21,354

Net income
305

 
16

 
321

 
495

 
18

 
513

Dividends
(315
)
 

 
(315
)
 
(282
)
 

 
(282
)
Stock-based
compensation expense
13

 

 
13

 
12

 

 
12

Stock purchases
in connection with
stock-based
compensation plans
(10
)
 

 
(10
)
 
(42
)
 

 
(42
)
Stock purchases under
purchase program
(292
)
 

 
(292
)
 
(198
)
 

 
(198
)
Distributions to
noncontrolling interests

 
(34
)
 
(34
)
 

 
(7
)
 
(7
)
Other
24

 
14

 
38

 
13

 

 
13

Other comprehensive income
76

 

 
76

 
131

 
1

 
132

Balance as of end of period
$
19,825

 
$
826

 
$
20,651

 
$
20,656

 
$
839

 
$
21,495

___________________________ 
(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.
 
 
 
 
 
 
 
 
 
 
 
 




10




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

Share Activity
There was no significant share activity during the three months ended March 31, 2017 and 2016.
 
 
 
 
 
 
 
 
Common Stock Dividends
On May 3, 2017, our board of directors declared a quarterly cash dividend of $0.70 per common share payable on June 7, 2017 to holders of record at the close of business on May 17, 2017.
 
 
 
 
 
 
 
 
 
 
 
 
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,
 
2017
 
2016
 
Foreign
Currency
Translation
Adjustment
 
Defined
Benefit
Plans
Items
 
Total
 
Foreign
Currency
Translation
Adjustment
 
Defined
Benefit
Plans
Items
 
Total
Balance as of
beginning of period
$
(1,021
)
 
$
(389
)
 
$
(1,410
)
 
$
(605
)
 
$
(328
)
 
$
(933
)
Other comprehensive income
before reclassifications
74

 

 
74

 
121

 
8

 
129

Amounts reclassified from
accumulated other
comprehensive loss

 
2

 
2

 

 
2

 
2

Net other comprehensive income
74

 
2

 
76

 
121

 
10

 
131

Balance as of end of period
$
(947
)
 
$
(387
)
 
$
(1,334
)
 
$
(484
)
 
$
(318
)
 
$
(802
)
 
 
 
 
 
 
 
6.
VARIABLE INTEREST ENTITIES

Overview
In the normal course of business, we have financial interests in certain entities that have been determined to be VIEs. We consolidate a VIE when we have a variable interest in an entity for which we are the primary beneficiary such that we have (a) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses of or the right to receive benefits from the VIE that could potentially be significant to the VIE. In order to make this determination, we evaluated our contractual arrangements with the VIEs, including arrangements for the use of assets, purchases of products and services, debt, equity, or management of operating activities.

Our significant 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; and
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.




11




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

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 to the 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, 2017
 
VLP
 
DGD
 
Other
 
Total
Assets
 
 
 
 
 
 
 
Cash and temporary cash investments
$
66

 
$
159

 
$
15

 
$
240

Other current assets
2

 
48

 

 
50

Property, plant, and equipment, net
940

 
360

 
131

 
1,431

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Current liabilities
$
17

 
$
16

 
$
7

 
$
40

Debt and capital lease obligations,
less current portion
525

 

 
45

 
570

 
December 31, 2016
 
VLP
 
DGD
 
Other
 
Total
Assets
 
 
 
 
 
 
 
Cash and temporary cash investments
$
71

 
$
167

 
$
15

 
$
253

Other current assets
3

 
87

 

 
90

Property, plant, and equipment, net
865

 
355

 
133

 
1,353

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Current liabilities
$
15

 
$
17

 
$
7

 
$
39

Debt and capital lease obligations,
less current portion
525

 

 
46

 
571





12




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

7.
EMPLOYEE BENEFIT PLANS

The components of net periodic benefit cost related to our defined benefit plans were as follows (in millions):
 
Pension Plans
 
Other Postretirement
Benefit Plans
 
2017
 
2016
 
2017
 
2016
Three months ended March 31:
 
 
 
 
 
 
 
Service cost
$
31

 
$
28

 
$
1

 
$
2

Interest cost
21

 
21

 
3

 
3

Expected return on plan assets
(37
)
 
(35
)
 

 

Amortization of:
 
 
 
 
 
 
 
Net actuarial (gain) loss
13

 
12

 
(1
)
 

Prior service credit
(5
)
 
(5
)
 
(4
)
 
(4
)
Net periodic benefit cost
$
23

 
$
21

 
$
(1
)
 
$
1


Our anticipated contributions to our pension and other post retirement benefit plans during 2017 have not changed from amounts previously disclosed in our financial statements for the year ended December 31, 2016. We contributed $7 million and $8 million, respectively, to our pension plans and $5 million and $4 million, respectively, to our other postretirement benefit plans during the three months ended March 31, 2017 and 2016.




13




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

8.
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,
 
2017
 
2016
 
Participating
Securities
 
Common
Stock
 
Participating
Securities
 
Common
Stock
Earnings per common share:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
 
 
$
305

 
 
 
$
495

Less dividends paid:
 
 
 
 
 
 
 
Common stock
 
 
314

 
 
 
281

Participating securities
 
 
1

 
 
 
1

Undistributed earnings (excess distributions
over earnings)
 
 
$
(10
)
 
 
 
$
213

Weighted-average common shares outstanding
2

 
448

 
2

 
469

Earnings (loss) per common share:
 
 
 
 
 
 
 
Distributed earnings
$
0.70

 
$
0.70

 
$
0.60

 
$
0.60

Undistributed earnings (excess distributions
over earnings)

 
(0.02
)
 
0.45

 
0.45

Total earnings per common share
$
0.70

 
$
0.68

 
$
1.05

 
$
1.05

 
 
 
 
 
 
 
 
Earnings per common share –
assuming dilution:
 
 
 
 
 
 
 
Net income attributable to Valero stockholders
 
 
$
305

 
 
 
$
495

Weighted-average common shares outstanding
 
 
448

 
 
 
469

Common equivalent shares
 
 
3

 
 
 
2

Weighted-average common shares outstanding –
assuming dilution
 
 
451

 
 
 
471

Earnings per common share – assuming dilution
 
 
$
0.68

 
 
 
$
1.05


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



14




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

9.
SEGMENT INFORMATION

Effective January 1, 2017, we revised our reportable segments to align with certain changes in how our chief operating decision maker manages and allocates resources to our business. Accordingly, we created a new reportable segment — VLP. The results of the VLP segment, which include the results of our majority-owned master limited partnership referred to by the same name, were transferred from the refining segment. Our prior period segment information has been retrospectively adjusted to reflect our current segment presentation.

As a result, we have three reportable segments as follows:
Refining segment includes our refining operations, the associated marketing activities, and certain logistics assets that support our refining operations that are not owned by VLP;
Ethanol segment includes our ethanol operations, the associated marketing activities, and logistics assets that support our ethanol operations; and
VLP segment includes the results of VLP, which provides transportation and terminaling services in support our refining segment.

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

Our reportable segments are strategic business units that offer different products and services. They are managed separately as each business requires unique technologies and marketing strategies. Performance is evaluated based on segment operating income, which includes revenues and expenses that are directly attributable to management of the respective segment. Intersegment sales are generally derived from transactions made at prevailing market rates.



15




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

The following table reflects activity related to our reportable segments (in millions):
 
Refining
 
Ethanol
 
VLP
 
Corporate
and
Eliminations
 
Total
Three months ended March 31, 2017:
 
 
 
 
 
 
 
 
 
Operating revenues:
 
 
 
 
 
 
 
 
 
Operating revenues from external customers
$
20,887

 
$
885

 
$

 
$

 
$
21,772

Intersegment revenues

 
60

 
106

 
(166
)
 

Total operating revenues
20,887

 
945

 
106

 
(166
)
 
21,772

Costs and expenses:
 
 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
 
 
Cost of sales from external customers
18,641

 
787

 



 
19,428

Intersegment cost of sales
166

 

 

 
(166
)
 

Total cost of sales
18,807

 
787

 

 
(166
)
 
19,428

Operating expenses
984

 
109

 
24

 

 
1,117

General and administrative expenses

 

 

 
190

 
190

Depreciation and amortization expense
449

 
27

 
12

 
12

 
500

Total costs and expenses
20,240

 
923

 
36

 
36

 
21,235

Operating income (loss)
$
647

 
$
22

 
$
70

 
$
(202
)
 
$
537

 
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2016:
 
 
 
 
 
 
 
 
 
Operating revenues:
 
 
 
 
 
 
 
 
 
Operating revenues from external customers
$
14,920

 
$
794

 
$

 
$

 
$
15,714

Intersegment revenues

 
34

 
79

 
(113
)
 

Total operating revenues
14,920

 
828

 
79

 
(113
)
 
15,714

Costs and expenses:
 
 
 
 
 
 
 
 
 
Cost of sales (excluding the lower of cost or
market inventory valuation adjustment):
 
 
 
 
 
 
 
 
 
Cost of sales from external customers
12,799

 
708

 

 

 
13,507

Intersegment cost of sales
113

 

 

 
(113
)
 

Total cost of sales (excluding the lower
of cost or market inventory
valuation adjustment)
12,912

 
708

 

 
(113
)
 
13,507

Lower of cost or market inventory
valuation adjustment
(263
)
 
(30
)
 

 

 
(293
)
Operating expenses (a)
907

 
99

 
24

 

 
1,030

General and administrative expenses

 

 

 
156

 
156

Depreciation and amortization expense (a)
449

 
12

 
12

 
12

 
485

Total costs and expenses
14,005

 
789

 
36

 
55

 
14,885

Operating income (loss)
$
915

 
$
39

 
$
43

 
$
(168
)
 
$
829

___________________________ 
(a)
The VLP segment information for the three months ended March 31, 2016 has been retrospectively adjusted for VLP’s acquisitions that occurred subsequent to March 31, 2016.



16




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

Total assets by reportable segment were as follows (in millions):
 
March 31,
2017
 
December 31,
2016
Refining
$
38,219

 
$
38,095

Ethanol
1,338

 
1,316

VLP
1,039

 
972

Corporate
5,451

 
5,790

Total assets
$
46,047

 
$
46,173


10.
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,
 
2017
 
2016
Decrease (increase) in current assets:
 
 
 
Receivables, net
$
817

 
$
(47
)
Inventories
(291
)
 
147

Income taxes receivable
41

 
45

Prepaid expenses and other
12

 
(126
)
Increase (decrease) in current liabilities:
 
 
 
Accounts payable
(306
)
 
108

Accrued expenses
20

 
(137
)
Taxes other than income taxes
(123
)
 
(113
)
Income taxes payable
(19
)
 
(54
)
Changes in current assets and current liabilities
$
151

 
$
(177
)

Noncash investing and financing activities during the three months ended March 31, 2017 included the recognition of a capital lease asset and related obligation associated with an agreement for storage tanks near three of our refineries. This noncash transaction is further described in Note 3. There were no significant noncash investing or financing activities during the three months ended March 31, 2016.

Cash flows related to interest and income taxes were as follows (in millions):
 
Three Months Ended
March 31,
 
2017
 
2016
Interest paid in excess of amount capitalized
$
128

 
$
95

Income taxes paid, net
96

 
95




17




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

11.
 FAIR VALUE MEASUREMENTS

Recurring Fair Value Measurements
The tables below 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, 2017 and December 31, 2016.

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 tables below 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, 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
$
661

 
$
12

 
$

 
$
673

 
$
(637
)
 
$

 
$
36

 
$

Investments of certain
benefit plans
59

 

 
11

 
70

 
n/a

 
n/a

 
70

 
n/a

Total
$
720

 
$
12

 
$
11

 
$
743

 
$
(637
)
 
$

 
$
106

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 

 
 
 
 
 

 
 
Commodity derivative
contracts
$
636

 
$
9

 
$

 
$
645

 
$
(637
)
 
$
(8
)
 
$

 
$
(61
)
Environmental credit
obligations

 
289

 

 
289

 
n/a

 
n/a

 
289

 
n/a

Physical purchase
contracts

 
3

 

 
3

 
n/a

 
n/a

 
3

 
n/a

Foreign currency
contracts
2

 

 

 
2

 
n/a

 
n/a

 
2

 
n/a

Total
$
638

 
$
301

 
$

 
$
939

 
$
(637
)
 
$
(8
)
 
$
294

 




18




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

 
December 31, 2016
 
 
 
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
$
874

 
$
38

 
$

 
$
912

 
$
(875
)
 
$

 
$
37

 
$

Foreign currency
contracts
3

 

 

 
3

 
n/a

 
n/a

 
3

 
n/a

Investments of certain
benefit plans
58

 

 
11

 
69

 
n/a

 
n/a

 
69

 
n/a

Total
$
935

 
$
38

 
$
11

 
$
984

 
$
(875
)
 
$

 
$
109

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity derivative
contracts
$
872

 
$
23

 
$

 
$
895

 
$
(875
)
 
$
(20
)
 
$

 
$
(88
)
Environmental credit
obligations

 
188

 

 
188

 
n/a

 
n/a

 
188

 
n/a

Physical purchase
contracts

 
5

 

 
5

 
n/a

 
n/a

 
5

 
n/a

Total
$
872

 
$
216

 
$

 
$
1,088

 
$
(875
)
 
$
(20
)
 
$
193

 



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 12, 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.



19




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) and Quebec’s Regulation respecting the cap-and-trade system for greenhouse gas emission allowances (the Quebec 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 12 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, 2017 and December 31, 2016 that were measured at fair value on a recurring basis.

There was no activity during the three months ended March 31, 2017 and 2016 related to the fair value amounts categorized in Level 3 as of March 31, 2017 and December 31, 2016.

Nonrecurring Fair Value Measurements
There were no assets or liabilities that were measured at fair value on a nonrecurring basis as of March 31, 2017 and December 31, 2016.




20




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

Other Financial Instruments
Financial instruments that we recognize in our balance sheets at their carrying amounts are shown in the table below along with their associated fair values (in millions):
 
March 31, 2017
 
December 31, 2016
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
Financial assets:
 
 
 
 
 
 
 
Cash and temporary cash investments
$
4,463

 
$
4,463

 
$
4,816

 
$
4,816

Financial liabilities:
 
 
 
 
 
 
 
Debt (excluding capital leases)
7,926

 
8,935

 
7,926

 
8,882


The methods and significant assumptions used to estimate the fair value of these financial instruments are as follows:
The fair value of cash and temporary cash investments approximates the carrying value due to the low level of credit risk of these assets combined with their short maturities and market interest rates (Level 1).
The fair value of debt is determined primarily using the market approach based on quoted prices provided by third-party brokers and vendor pricing services (Level 2).

12.
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 11), 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.




21




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

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.

As of March 31, 2017, 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
 
2017
 
2018
Crude oil and refined petroleum products:
 
 
 
 
Swaps – long
 
22,246

 

Swaps – short
 
22,660

 

Futures – long
 
110,287

 
2,100

Futures – short
 
115,080

 
6,981

Corn:
 
 
 
 
Futures – long
 
18,040

 
5

Futures – short
 
40,575

 
2,185

Physical contracts – long
 
16,273

 
2,177

Soybean oil:
 
 
 
 
Futures – long
 
125,338

 

Futures – short
 
158,758

 




22




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

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.

As of March 31, 2017, we had the following outstanding commodity derivative instruments that were entered into for trading purposes. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes represent thousands of barrels, except those identified as corn contracts that are presented in thousands of bushels).
 
 
Notional Contract Volumes by
Year of Maturity
Derivative Instrument
 
2017
 
2018
Crude oil and refined petroleum products:
 
 
 
 
Swaps – long
 
3,105

 

Swaps – short
 
3,105

 

Futures – long
 
24,358

 
4,300

Futures – short
 
22,304

 
6,400

Options – long
 
106,990

 
29,700

Options – short
 
104,990

 
29,700

Corn:
 
 
 
 
Futures – long
 
2,250

 

Futures – short
 
2,000

 


We had no commodity derivative contracts outstanding as of March 31, 2017 and 2016 or during the three months ended March 31, 2017 and 2016 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, 2017, we had forward contracts to purchase $350 million of U.S. dollars. These commitments matured on or before April 30, 2017.

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



23




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

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 $146 million and $161 million for the three months ended March 31, 2017 and 2016, respectively. These amounts are reflected in cost of sales.

We are subject to additional requirements under greenhouse gas (GHG) emission programs, including the cap-and-trade systems, as discussed in Note 11. 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, 2017 and 2016 and expect to continue to recover the majority of these costs in the future. For the three months ended March 31, 2017 and 2016, 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, 2017 and December 31, 2016 (in millions) and the line items in the balance sheets in which the fair values are reflected. See Note 11 for additional information related to the fair values of our derivative instruments.

As indicated in Note 11, we net fair value amounts recognized for multiple similar derivative contracts executed with the same counterparty under master netting arrangements, including cash collateral assets and obligations. The tables below, however, are presented on a gross asset and gross liability basis, which results in the reflection of certain assets in liability accounts and certain liabilities in asset accounts.
 
Balance Sheet
Location
 
March 31, 2017
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
661

 
$
636

Swaps
Receivables, net
 
7

 
7

Options
Receivables, net
 
5

 
2

Physical purchase contracts
Inventories
 

 
3

Foreign currency contracts
Accrued expenses
 

 
2

Total
 
 
$
673

 
$
650




24




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

 
Balance Sheet
Location
 
December 31, 2016
 
 
Asset
Derivatives
 
Liability
Derivatives
Derivatives not designated as
hedging instruments
 
 
 
 
 
Commodity contracts:
 
 
 
 
 
Futures
Receivables, net
 
$
874

 
$
872

Swaps
Receivables, net
 
32

 
21

Options
Receivables, net
 
6

 
2

Physical purchase contracts
Inventories
 

 
5

Foreign currency contracts
Receivables, net
 
3

 

Total
 
 
$
915

 
$
900


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 income statement line items 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,
2017
 
2016
Commodity contracts
 
Cost of sales
 
$
(97
)
 
$
(139
)
Foreign currency contracts
 
Cost of sales
 
(6
)
 
(3
)

Trading Derivatives
 
Location of Gain
Recognized in Income
on Derivatives
 
Three Months Ended
March 31,
2017
 
2016
Commodity contracts
 
Cost of sales
 
$
1

 
$
41




25


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 margins, including gasoline and distillate margins;
future ethanol 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;
expectations regarding environmental, tax, and other regulatory initiatives; and
the effect of general economic and other conditions on refining, ethanol, and midstream industry fundamentals.

We based our forward-looking statements on our current expectations, estimates, and projections about ourselves and our industry. We caution that these statements are not guarantees of future performance and involve risks, uncertainties, and assumptions that we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual results may differ materially from the future performance that we have expressed or forecast in the forward-looking statements. 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 our facilities or other facilities that could impair our ability to produce or transport refined petroleum products or receive feedstocks;
political and economic conditions in nations that produce crude oil or consume refined petroleum products;
demand for, and supplies of, refined petroleum products such as gasoline, diesel, jet fuel, petrochemicals, and ethanol;
demand for, and supplies of, crude oil and other feedstocks;
the ability of the members of the Organization of Petroleum Exporting Countries to agree on and to maintain crude oil price and production controls;
the level of consumer demand, including seasonal fluctuations;
refinery overcapacity or undercapacity;
our ability to successfully integrate any acquired businesses into our operations;



26


the actions taken by competitors, including both pricing and adjustments to refining capacity in response to market conditions;
the level of competitors’ imports into markets that we supply;
accidents, unscheduled shutdowns, or other catastrophes affecting our refineries, machinery, pipelines, equipment, and information systems, or those of our suppliers or customers;
changes in the cost or availability of transportation for feedstocks and refined petroleum products;
the price, availability, and acceptance of alternative fuels and alternative-fuel vehicles;
the levels of government subsidies for alternative fuels;
the volatility in the market price of biofuel credits (primarily RINs needed to comply with the U.S. federal Renewable Fuel Standard) and GHG emission credits needed to comply with the requirements of various GHG emission programs;
delay of, 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, grain and other feedstocks, and refined petroleum products and ethanol;
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;
legislative or regulatory action, including the introduction or enactment of legislation or rulemakings by governmental authorities, including tax and environmental regulations, such as those implemented under the California Global Warming Solutions Act (also known as AB 32), the Quebec cap-and-trade system, and the U.S. EPA’s regulation of GHGs, which may adversely affect our business or operations;
changes in the credit ratings assigned to our debt securities and trade credit;
changes in currency exchange rates, including the value of the Canadian dollar, the pound sterling, and the euro relative to the U.S. dollar;
overall economic conditions, including the stability and liquidity of financial markets; and
other factors generally described in the “Risk Factors” section included in our annual report on Form 10-K for the year ended December 31, 2016 that is incorporated by reference herein.

Any one of these factors, or a combination of these factors, could materially affect our future results of operations and whether any forward-looking statements ultimately prove to be accurate. Our 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. We do not intend to update these statements unless we are required by the securities laws to do so.

All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing. We undertake no obligation to publicly release 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.

This Form 10-Q includes references to financial measures that are not defined under U.S. GAAP. These non-GAAP financial measures include adjusted net income attributable to Valero stockholders, gross margin, and adjusted operating income. We have included these non-GAAP financial measures to help facilitate the comparison of operating results between periods. See the accompanying financial tables in “RESULTS OF OPERATIONS” and note (c) to the accompanying tables for reconciliations of these non-GAAP financial measures to the most directly comparable U.S. GAAP financial measures. Also in note (c), we disclose the reasons why we believe our use of the non-GAAP financial measures provides useful information.



27


OVERVIEW AND OUTLOOK

Overview
We reported net income attributable to Valero stockholders of $305 million in the first quarter of 2017 compared to $495 million in the first quarter of 2016, which represents a decrease of $190 million. This decrease is primarily due to lower operating income in the first quarter of 2017 compared to the first quarter of 2016 (net of the resulting decrease of $105 million in income tax expense between the periods). Operating income was $537 million in the first quarter of 2017 compared to $829 million in the first quarter of 2016, which represents a decrease of $292 million.

Operating income and net income attributable to Valero stockholders in the first quarter of 2016 were positively impacted by a noncash benefit from a lower of cost or market inventory valuation adjustment. By excluding that benefit from both amounts, adjusted operating income was $536 million and adjusted net income attributable to Valero stockholders was $283 million for the first quarter of 2016. Compared to these adjusted amounts, operating income and net income attributable to Valero stockholders in the first quarter of 2017 increased by $1 million and $22 million, respectively.

The $1 million increase in adjusted operating income is due primarily to the following:

Refining segment. Refining segment operating income decreased by $5 million due to lower margins on other refined products (e.g. petroleum coke, propane, and sulfur), an increase in charges from the VLP segment related to additional transportation and terminaling services provided by that segment to the refining segment, and higher operating expenses, partially offset by higher margins on refined petroleum products. This is more fully described on pages 37 and 38.
Ethanol segment. Ethanol segment operating income increased by $13 million due to higher ethanol margins, which improved because of higher ethanol prices. This is more fully described on pages 38 and 39.
VLP segment. VLP segment operating income increased by $27 million due to incremental revenues generated from transportation and terminaling services provided to the refining segment associated with businesses acquired from Valero in 2016 and the acquisition of an undivided interest in crude system assets in January 2017. This is more fully described on page 39.
General and administrative expenses. General and administrative expenses increased by $34 million primarily due to an increase in environmental reserves.

Additional details and analysis of the changes in operating income and adjusted operating income for our business segments and other components of net income and adjusted net income attributable to Valero stockholders, including a reconciliation of non-GAAP financial measures used in this Overview to their most comparable measures reported under U.S. GAAP, are provided below under “RESULTS OF OPERATIONS” beginning on page 30.

Effective January 1, 2017, we revised our reportable segments to reflect a new reportable segment — VLP. The results of operations of the VLP segment were previously included in the refining segment. Our prior period segment information has been retrospectively adjusted to reflect our current segment presentation. See Note 9 of Condensed Notes to Consolidated Financial Statements for additional segment information.




28


Outlook
In the second quarter of 2017, we expect margins to improve as demand follows typical seasonal patterns. Below are several factors that have impacted or may impact our results of operations during the second quarter of 2017:
Gasoline margins are expected to improve as domestic and export demand strengthen with the upcoming driving season. Distillate margins are expected to remain near current levels.
Medium and heavy sour crude oil discounts are expected to remain weaker than their five-year averages as supplies of sour crude oils available in the market continue to decline.
Ethanol margins are expected to improve as domestic gasoline demand strengthens.





29


RESULTS OF OPERATIONS

The following tables highlight our results of operations, our operating performance, and market prices that directly impact our operations. In addition, these tables include financial measures that are not defined under U.S. GAAP and represent non-GAAP financial measures. These non-GAAP financial measures are reconciled to their most comparable U.S. GAAP financial measures and include adjusted net income attributable to Valero stockholders, adjusted operating income, and gross margin. In note (c) to these tables, we disclose the reasons why we believe our use of non-GAAP financial measures provides useful information.

Effective January 1, 2017, we revised our reportable segments to align with certain changes in how our chief operating decision maker manages and allocates resources to our business. Accordingly, we created a new reportable segment — VLP. The results of the VLP segment, which include the results of our majority-owned master limited partnership referred to by the same name, were transferred from the refining segment. Our prior period segment information has been retrospectively adjusted to reflect our current segment presentation. The narrative following these tables provides an analysis of our results of operations.

Financial Highlights By Segment and Total Company
(millions of dollars)
 
Three Months Ended March 31, 2017
 
Refining
 
Ethanol
 
VLP