UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

Commission File Number 1-3473

 

 

 

 

TESORO CORPORATION

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

210-828-8484

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No  þ

 

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 the 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.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).  Yes o     No þ

 

At June 30, 2007, the aggregate market value of the voting common stock held by non-affiliates of the registrant was approximately $7.8 billion based upon the closing price of its common stock on the New York Stock Exchange Composite tape. At February 25, 2008, there were 137,602,531 shares of the registrant’s common stock outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s Proxy Statement to be filed pursuant to Regulation 14A pertaining to the 2008 Annual Meeting of Stockholders are incorporated by reference into Part III hereof. The Company intends to file such Proxy Statement no later than 120 days after the end of the fiscal year covered by this Form 10-K.

 

 

TESORO CORPORATION
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS

 

 

This Annual Report on Form 10-K (including documents incorporated by reference herein) contains statements with respect to our expectations or beliefs as to future events. These types of statements are “forward-looking” and subject to uncertainties. See “Forward-Looking Statements” on page 54.

 

When used in this Annual Report on Form 10-K, the terms “Tesoro”, “we”, “our” and “us”, except as otherwise indicated or as the context otherwise indicates, refer to Tesoro Corporation and its subsidiaries.

 

 

Tesoro Corporation (“Tesoro”) is based in San Antonio, Texas. We were incorporated in Delaware in 1968 under the name Tesoro Petroleum Corporation, which was subsequently changed in 2004 to Tesoro Corporation. We are one of the largest independent petroleum refiners and marketers in the United States with two operating segments — (1) refining crude oil and other feedstocks at our seven refineries in the western and mid-continental United States and selling refined products in bulk and wholesale markets (“refining”) and (2) selling motor fuels and convenience products in the retail market (“retail”) through our 911 branded retail stations in 17 states. Through our refining segment, we produce refined products, primarily gasoline and gasoline blendstocks, jet fuel, diesel fuel and heavy fuel oils for sale to a wide variety of commercial customers in the western and mid-continental United States. Our retail segment distributes motor fuels through a network of retail stations, primarily under the Tesoro^® Mirastar^®, Shell^® and USA Gasoline^tm brands. See Notes M and P in our consolidated financial statements in Item 8 for additional information on our operating segments and properties.

 

Our principal executive offices are located at 300 Concord Plaza Drive, San Antonio, Texas 78216-6999 and our telephone number is (210) 828-8484. We file reports with the SEC, including annual reports on Form 10-K, quarterly reports on Form 10-Q and other reports from time to time. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available to the public on the SEC’s Internet site at http://www.sec.gov and our website at http://www.tsocorp.com as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. You may receive a copy of our Annual Report on Form 10-K, including the financial statements, free of charge by writing to Tesoro Corporation, Attention: Investor Relations, 300 Concord Plaza Drive, San Antonio, Texas 78216-6999. We also post our corporate governance guidelines, code of business conduct, code of ethics for senior financial officers and our Board of Director committee charters on our website. Our governance documents are available in print by writing to the address above. We submitted to the New York Stock Exchange on May 21, 2007 our annual certification concerning corporate governance pursuant to Section 303A.12 (a) of the New York Stock Exchange Listed Company Manual.

 

In May 2007, we acquired a 100,000 barrels per day (“bpd”) refinery and a 42,000 bpd refined products terminal located south of Los Angeles, California along with a network of 276 Shell^® branded retail stations (128 are company-operated) located throughout Southern California (collectively, the “Los Angeles Assets”) from Shell Oil Products U.S. (“Shell”). We will continue to operate the retail stations using the Shell^® brand under a long-term agreement. The purchase price for the Los Angeles Assets was $1.82 billion (which includes $257 million for petroleum inventories and direct costs of $16 million).

 

In May 2007, we also acquired 138 retail stations located primarily in California from USA Petroleum (the “USA Petroleum Assets”). The purchase price of the assets and the USA Gasoline^tm brand name was paid in cash totaling $286 million (including inventories of $15 million and direct costs of $3 million).

 

We expect to realize annual recurring synergies of approximately $100 million in connection with our acquisitions through our crude purchasing and shipping logistics as well as by maximizing the production of clean fuels for the California market. During 2007, we achieved approximately $45 million of our $100 million synergy goal mainly through shared crude cargo benefits. Based on our most recent estimates, we expect to spend approximately $1.2 billion to $1.4 billion from 2008 through 2012 at our Los Angeles refinery for projects to improve reliability, energy efficiency and conversion capability and to upgrade refining infrastructure to comply with regulatory requirements. See Note C in our consolidated financial statements in Item 8 for further information on these acquisitions.

 

Refinery Locations

 

fornia and Alaska, and the only refinery in North Dakota. Crude oil capacity and throughput rates of crude oil and other feedstocks by refinery are as follows:

 

 

 

Feedstock Supply.  We purchase crude oil and other feedstocks for our refineries from many domestic and foreign sources through term agreements with renewal provisions and in the spot market. Prices under the term agreements generally fluctuate with market prices. We purchase over 40% of our crude oil under term agreements, which are primarily short-term agreements with market-related prices, and we purchase the remainder in the spot market. Historically, our largest domestic and foreign sources of crude oil have been Alaska North Slope and Canadian, respectively. Sources of our crude oil purchases are as follows:

 

 

We process both heavy and light crude oils. Actual throughput volumes by feedstock type are summarized below (in Mbpd):

 

 

 

Refined Products.  Refining yield represents produced volumes of refined products consisting primarily of gasoline and gasoline blendstocks, jet fuel, diesel fuel and heavy fuel oils. We also manufacture other refined products, including liquefied petroleum gas, petroleum coke and asphalt. Our refining yield, in volumes, is summarized below (in Mbpd):

 

 

 

 

Transportation.  To optimize the transportation of crude oil and refined products within our refinery system and secure shipping capacity, we term-charter four U.S. flag tankers and six foreign-flag tankers, nine of which are double-hulled and one of which is double-bottomed. Our term charters expire between 2008 and 2010. We have also entered into term-charters for four new-build U.S. flag tankers that will replace our expiring charters in 2009 and 2010, with three-year terms and options to renew. In January 2008, we took delivery of our seventh foreign flagged term-charter, which runs through 2011, and we have an agreement for one additional foreign-flagged tanker to be delivered in 2008 with a term through 2013. For our Hawaii and Washington operations, we charter tugs and product barges over varying terms ending in 2008 through 2015, with options to renew. We also have arrangements to charter vessels to transport crude oil in double-hulled tankers from certain regions of the globe. Other tankers and ocean-going barges are also chartered on a short-term basis to transport crude oil and refined products.

 

We receive crude oils and ship refined products through owned and third-party pipelines. We own and operate over 900 miles of crude and product pipelines, located in California, Alaska, Hawaii, North Dakota, Utah and Montana transporting more than 380 Mbpd across our refining system. We also operate a proprietary trucking business at three of our refineries transporting crude oil and refined products to customers.

 

Terminals.  We operate refined products terminals at our refineries and at 14 other locations in California, Washington, Alaska, Hawaii, North Dakota, Utah and Idaho. We also distribute products through third-party terminals, truck racks and rail cars, which are supplied by our refineries and through purchases and exchange agreements with other refining and marketing companies.

 

California Refineries

 

Golden Eagle

 

Refining.  Our Golden Eagle refinery, located in Martinez, California on 2,206 acres about 30 miles east of San Francisco, has a crude oil capacity of 161 Mbpd. We source Golden Eagle refinery’s crude oil from California, Alaska and foreign locations. Major refined product upgrading units at the refinery include fluid catalytic cracking (“FCC”), fluid coking, hydrocracking, naphtha reforming, vacuum distillation, hydrotreating and alkylation units. These units enable the refinery to produce a high proportion of motor fuels, including cleaner-burning California Air Resources Board (“CARB”) gasoline and CARB diesel, as well as conventional gasoline and diesel. The refinery also produces heavy fuel oils, liquefied petroleum gas and petroleum coke. During the first quarter of 2008, we expect to substantially complete a project at the refinery to modify the existing fluid coking unit into a delayed coking unit which will enable us to comply with the terms of an abatement order to lower emissions while also enhancing the refinery’s capabilities in terms of reliability, lengthening turnaround cycles and reducing operating costs.

 

Transportation.  Our Golden Eagle refinery has waterborne access through the San Francisco Bay that enables us to receive crude oil and ship refined products through our marine terminals. In addition, the refinery can receive crude oil through a third-party marine terminal at Martinez. We also receive California crude oils and ship refined products from the refinery through third-party pipeline systems. In June 2007, we completed a project at our Amorco wharf which improves our crude oil flexibility by enabling us to supply all of the refinery’s crude oil requirements by water.

 

Terminals.  We operate a refined products terminal at Stockton, California and a refined products terminal at the refinery. We also distribute refined products through third-party terminals, which are supplied by our refinery and through purchases and exchange arrangements with other refining and marketing companies. We also lease third-party clean product storage capacity with waterborne access in the San Francisco Bay area.

 

Los Angeles

 

Refining.  Our Los Angeles refinery, located in Wilmington, California on 311 acres approximately 10 miles south of Los Angeles, has a total crude oil capacity of 100 Mbpd. We source our Los Angeles refinery’s crude oil from California as well as foreign locations. Major refined product upgrading units at the Los Angeles refinery include FCC, delayed coking, hydrocracking, vacuum distillation, hydrotreating, reforming, butane isomerization and alkylation units. These units enable the Los Angeles refinery to produce a high proportion of motor fuels, including CARB gasoline and CARB diesel, as well as conventional gasoline, diesel and jet fuel. The Los Angeles refinery also produces heavy oils, liquefied petroleum gas and petroleum coke.

Transportation.  Our Los Angeles refinery has waterborne access at the Port of Long Beach that enables us to receive crude oil and ship refined products through our marine terminal. In addition, the Los Angeles refinery can receive crude oil from the San Joaquin Valley and the Los Angeles Basin through third-party pipelines.

 

Terminals.  We operate a 42 Mbpd refined products terminal at the Los Angeles refinery. We also distribute refined products through third-party terminals, which are supplied by our refinery, waterborne deliveries and purchases and exchange agreements with other refining and marketing companies. We also lease storage capacity at third-party terminals in southern California, the majority of which has waterborne access.

 

Pacific Northwest Refineries

 

Washington

 

Refining.  Our Washington refinery, located in Anacortes on the Puget Sound on 917 acres about 60 miles north of Seattle, has a total crude oil capacity of 113 Mbpd. We source our Washington refinery’s crude oil from Alaska, Canada and other foreign locations. The Washington refinery also processes intermediate feedstocks, primarily heavy vacuum gas oil, provided by some of our other refineries and by spot-market purchases from third-parties. Major refined product upgrading units at the refinery include the FCC, alkylation, hydrotreating, vacuum distillation, deasphalting and naphtha reforming units, which enable our Washington refinery to produce a high proportion of light products, such as gasoline (including CARB gasoline and components for CARB gasoline), diesel and jet fuel. The refinery also produces heavy fuel oils, liquefied petroleum gas and asphalt.

 

Transportation.  Our Washington refinery receives Canadian crude oil through a third-party pipeline originating in Edmonton, Alberta, Canada. We receive other crude oil through our Washington refinery’s marine terminal. Our Washington refinery ships products (gasoline, jet fuel and diesel) through a third-party pipeline system, which serves western Washington and Portland, Oregon. We also deliver gasoline and diesel fuel through a neighboring refinery’s truck rack and distribute diesel fuel through a truck rack at our refinery. We deliver refined products, including CARB gasoline and components for CARB gasoline, through our marine terminal to ships and barges and sell liquefied petroleum gas and asphalt at our refinery.

 

Terminals.  We operate refined products terminals at Anacortes, Port Angeles and Vancouver, Washington, supplied primarily by our refining system. We also distribute refined products through third-party terminals in our market areas, supplied by our refinery and through purchases and exchange arrangements with other refining and marketing companies.

 

Alaska

 

Refining.  Our Alaska refinery is located near Kenai on the Cook Inlet on 488 acres approximately 70 miles southwest of Anchorage. Our Alaska refinery processes crude oil from Alaska and, to a lesser extent, foreign locations. The refinery has a total crude oil capacity of 72 Mbpd, and its refined product upgrading units include vacuum distillation, distillate hydrocracking, hydrotreating, naphtha reforming and light naphtha isomerization units. Our Alaska refinery produces gasoline and gasoline blendstocks, jet fuel, diesel fuel, heating oil, heavy fuel oils, liquefied petroleum gas and asphalt. In May 2007, we completed the installation of a 10 Mbpd diesel desulfurizer unit at the refinery, which enables us to manufacture ultra-low sulfur diesel (“ULSD”) and become the sole producer of ULSD in Alaska.

 

Transportation.  We receive crude oil by tanker and through our owned and operated crude oil pipeline at our marine terminal. Our crude oil pipeline is a 24-mile common carrier pipeline, which is connected to the Eastside Cook Inlet oil field. We also own and operate a common-carrier refined products pipeline that runs from the Alaska refinery to our terminal facilities in Anchorage and to the Anchorage airport. This 71-mile pipeline has the capacity to transport approximately 40 Mbpd of refined products and allows us to transport gasoline, diesel and jet fuel to the terminal facilities. Both of our owned pipelines are subject to regulation by various federal, state and local agencies, including the Federal Energy Regulatory Commission (“FERC”). Refined products are also distributed by tankers and barges from our marine terminal.

Terminals.  We operate refined products terminals at Kenai and Anchorage, which are supplied by our Alaska refinery. We also distribute refined products through a third-party terminal near Fairbanks, which is supplied through an exchange arrangement with another refining company.

 

Mid-Pacific Refinery

 

Hawaii

 

Refining.  Our 94 Mbpd Hawaii refinery is located at Kapolei on 131 acres about 22 miles west of Honolulu. We supply the Hawaii refinery with crude oil from Southeast Asia, the Middle East and other foreign sources. Major refined product upgrading units include the vacuum distillation, hydrocracking, hydrotreating, visbreaking and naphtha reforming units. The Hawaii refinery produces gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils, liquefied petroleum gas and asphalt.

 

Transportation.  We transport crude oil to Hawaii by tankers, which discharge through our single-point mooring terminal, 1.5 miles offshore from our refinery. Three underwater pipelines from the single-point mooring terminal allow crude oil and refined products to be transferred to and from the refinery’s storage tanks. We distribute refined products to customers on the island of Oahu through owned and third-party pipeline systems. Our refined products pipelines also connect the Hawaii refinery to Barbers Point Harbor, 2.5 miles away, where refined products are transferred to ships and barges.

 

Terminals.  We also distribute refined products from our refinery to customers through third-party terminals at Honolulu International Airport and Honolulu Harbor and by barge to our owned and third-party terminal facilities on the islands of Oahu, Maui, Kauai and Hawaii.

 

Mid-Continent Refineries

 

North Dakota

 

Refining.  Our 58 Mbpd North Dakota refinery is located near Mandan on 960 acres. We supply our North Dakota refinery primarily with Williston Basin sweet crude oil through our crude oil pipeline. The refinery also can access other supplies, including Canadian crude oil. Major refined product upgrading units at the refinery include FCC, naphtha reforming, hydrotreating and alkylation units. The North Dakota refinery produces gasoline, diesel fuel, jet fuel, heavy fuel oils and liquefied petroleum gas.

 

Transportation.  We own a crude oil pipeline system, consisting of over 700 miles of pipeline that delivers all of the crude oil to our North Dakota refinery. Our crude oil pipeline system gathers crude oil from the Williston Basin and adjacent production areas in North Dakota and Montana and transports it to our refinery and has the capability to transport crude oil to other regional points where there is additional demand. Our crude oil pipeline system is a common carrier subject to regulation by various federal, state and local agencies, including the FERC. We distribute approximately 85% of our refinery’s production through a third-party refined products pipeline system which serves various areas from Bismarck, North Dakota to Minneapolis, Minnesota. All gasoline and distillate products from our refinery, with the exception of railroad-spec diesel fuel, can be shipped through that pipeline to third-party terminals.

 

Terminals.  We operate a refined products terminal at the North Dakota refinery. We also distribute refined products through a third-party refined products pipeline system which connects to third-party terminals located in North Dakota and Minnesota. We distribute refined products from our refinery to customers primarily through these third-party terminals.

 

Utah

 

Refining.  Our 60 Mbpd Utah refinery is located in Salt Lake City on 145 acres. Our Utah refinery processes crude oils primarily from Utah, Colorado, Wyoming and Canada. Major refined product upgrading units include FCC, naphtha reforming, alkylation and hydrotreating units. The Utah refinery produces gasoline, diesel fuel, jet fuel, heavy fuel oils and liquefied petroleum gas.

Transportation.  Our Utah refinery receives crude oil primarily by third-party pipelines from fields in Utah, Colorado, Wyoming and Canada. We distribute the refinery’s production through a system of both owned and third-party terminals and third-party pipeline connections, primarily in Utah, Idaho and eastern Washington, with some refined product delivered in Nevada and Wyoming.

 

Terminals.  In addition to sales at the refinery, we distribute refined products to customers through a third-party pipeline to our owned terminals in Boise and Burley, Idaho and to third-party terminals in Pocatello, Idaho and Pasco, Washington.

 

Wholesale Marketing and Refined Product Distribution

 

We sell refined products including gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils and residual products in both the bulk and wholesale markets. The majority of our wholesale volumes are sold in 10 states to independent unbranded distributors that sell refined products purchased through our owned and third-party terminals. Our bulk volumes are primarily sold to independent unbranded distributors, independent and other oil companies, utilities, railroads, airlines and marine and industrial end-users, which are distributed by pipelines, ships, barges, railcars and trucks. In addition, we sell refined products that we manufacture, purchase or receive on exchange from third parties. Exchange agreements provide for the delivery of our refined products primarily to third-party terminals in exchange for the delivery of refined products from the third parties at specific locations. Our refined product sales, including intersegment sales to our retail operations, consisted of (in Mbpd):

 

 

 

 

Gasoline and Gasoline Blendstocks.  We sell gasoline and gasoline blendstocks in both the bulk and wholesale markets in the western and mid-continental United States. The demand for gasoline is seasonal in many of our markets, with lowest demand during the winter months. We also sell gasoline to wholesale customers and several major independent and other oil companies under various supply agreements. We sell, at wholesale, to unbranded distributors and high-volume retailers, and we distribute refined product through owned and third party terminals. Gasoline also is delivered to refiners and marketers in exchange for refined product received at other locations in our markets.

 

Jet Fuel.  We supply jet fuel to passenger and cargo airlines at airports in Alaska, Hawaii, California, Washington, Utah and other western states. We also supply jet fuel to the U.S. military from our refineries in Alaska, Hawaii, Washington, Utah, and North Dakota.

 

Diesel Fuel.  We sell our diesel fuel production primarily on a wholesale basis for marine, transportation, industrial and agricultural use. We sell lesser amounts to end-users through marine terminals and for power generation in Hawaii and Washington. Since completing the installation of a diesel desulfurizer unit in May 2007 at our Alaska refinery, we are able to manufacture ULSD at all of our refineries and have become the sole producer of ULSD in both Alaska and Hawaii.

Heavy Fuel Oils and Residual Products.  We sell heavy fuel oils to other refineries, third-party resellers, electric power producers and marine and industrial end-users. Our refineries supply substantially all of the marine fuels that we sell through facilities at Port Angeles, Seattle, and Tacoma, Washington, and Portland, Oregon, and through our refinery terminals at Washington, Alaska and Hawaii. Our Golden Eagle and Los Angeles refineries produce petroleum coke that we sell to industrial end-users. Tesoro is also a key supplier of liquid asphalt for asphalt and construction companies in Washington and Alaska and the sole supplier in Hawaii.

 

Sales of Purchased Products.  In the normal course of business to meet local market demands, we purchase refined products manufactured by others for resale to our customers. We purchase these refined products, primarily gasoline, jet fuel, diesel fuel and industrial and marine fuel blendstocks, mainly in the spot market. We conduct our gasoline and diesel fuel purchase and resale activity primarily on the U.S. West Coast. Our jet fuel activity primarily consists of supplying markets in Alaska, California and Hawaii. We also purchase a lesser amount of gasoline and other refined products that are sold outside of our refineries’ local markets.

fuels produced by our refineries. During 2007, greater economies of scale were created as we nearly doubled our retail network by adding 414 high-volume Shell^® and USA Gasoline^tm retail stations. Also, with the departure of a number of third-party retail brands in the Northern Great Plains we expanded our branded presence by adding 48 retail stations, nearly 50% growth of our branded stations in that region. Our expanded retail presence in California, Minnesota, North Dakota and South Dakota positions us to realize more value for finished products that we produce at our two California and North Dakota refineries. As of December 31, 2007, our retail segment included a network of 911 branded retail stations (under the Tesoro^®, Mirastar^®, Shell^® and USA Gasoline^tm brands). Our Mirastar^® brand is used exclusively at Wal-Mart stores in 13 western states under a long-term agreement. We also operate under the Shell^® brand at certain stations in California through a long-term agreement. Our retail stations (summarized by type and brand) were located in the following states as of December 31, 2007:

 

 

 

The following table summarizes our retail operations:

 

 

We compete on a global basis with a number of major integrated oil companies who produce crude oil, some of which is used in their refining operations and other companies that may have greater financial and other resources. The availability and cost of crude oil is affected by global supply and demand dynamics. Similarly, the supply and prices of refined products are impacted by global dynamics. Competition and concentrations specific to each of our refineries are as follows:

 

 

 

We sell gasoline in Alaska, California, Hawaii, North Dakota, Utah, Washington and other western and mid-continental states through a network of company-operated retail stations and branded and unbranded jobber/dealers. From time-to-time we also sell refined product to other refiners. Competitive factors that affect retail marketing include price, station appearance, location and brand awareness. Our retail marketing operations compete with other independent marketing companies, integrated oil companies and high-volume retailers.

 

We sell our diesel fuel production primarily on a wholesale basis, competing with other suppliers in all of our market areas. Refined products from foreign sources, including Canada, also compete for distillate customers in our market areas.

 

Environmental Controls and Expenditures

 

All of our operations, like those of other companies engaged in similar businesses, are subject to extensive and frequently changing federal, state, regional and local laws, regulations and ordinances relating to the protection of the environment, including those governing emissions or discharges to the air and water, the handling and disposal of solid and hazardous wastes and the remediation of contamination. While we believe our facilities are in substantial compliance with current requirements, our facilities will continue to be engaged in meeting new requirements promulgated by the U.S. Environmental Protection Agency (“EPA”) and the states and local jurisdictions in which we operate. These laws and regulations have required and are expected to continue to require us to make significant expenditures. For additional information regarding our environmental matters see “Environmental and Other” in Management’s Discussion and Analysis of Condition and Results in Operations in Item 7.

 

Oil Spill Prevention and Response

 

We operate in environmentally sensitive coastal waters, where tanker, pipeline and refined product transportation operations are closely regulated by federal, state and local agencies and monitored by environmental interest groups. The transportation of crude oil and refined product over water involves risk and subjects us to the provisions of the Federal Oil Pollution Act of 1990 and related state requirements, which require that most oil refining, transport and storage companies maintain and update various oil spill prevention and oil spill contingency plans. We have submitted these plans and received federal and state approvals necessary to comply with the Federal Oil Pollution Act of 1990 and related regulations. Our oil spill prevention plans and procedures are frequently reviewed and modified to prevent oil and refined product releases and to minimize potential impacts should a release occur.

 

We currently charter tankers to ship crude oil from foreign and domestic sources to our California, Mid-Pacific and Pacific Northwest refineries. The Federal Oil Pollution Act of 1990 requires, as a condition of operation, that we demonstrate the capability to respond to the “worst case discharge” to the maximum extent practicable. As an example, the State of Alaska requires us to provide spill-response capability to contain or control and cleanup

amounts equal to 50,000 barrels of crude oil for a tanker carrying fewer than 500,000 barrels and 300,000 barrels for a tanker carrying more than 500,000 barrels. To meet these requirements, we have entered into contracts with various parties to provide spill response services. We have entered into spill-response agreements with (1) Cook Inlet Spill Prevention and Response, Incorporated (for which we fund approximately 84% of expenditures) and Alyeska Pipeline Service Company for spill-response services in Alaska and (2) Clean Islands Council for response services throughout the State of Hawaii. For larger spill contingency capabilities, we have entered into contracts with Marine Spill Response Corporation for Hawaii, the San Francisco Bay, Puget Sound and the Ports of Los Angeles and Long Beach. In addition, we contract with other spill response organizations outside the U.S. for shipments of crude oil on chartered vessels in foreign waters. We believe these contracts, and those with other regional spill-response organizations that are in place on a location by location basis, provide the additional services necessary to meet spill-response requirements established by state and federal law.

 

We require time chartered vessels used for the transportation of crude oil and heavier products over water to be double hulled. All other time chartered vessels and all other chartered vessels are required to be double hulled vessels if available. All vessels used by us to transport crude oil and refined products over water are examined or evaluated and subject to approval prior to their use.

 

Regulation of Pipelines

 

Our crude oil pipeline system in North Dakota and our pipeline systems in Alaska are common carriers subject to regulation by various federal, state and local agencies, including the FERC under the Interstate Commerce Act. The Interstate Commerce Act provides that, to be lawful, the rates of common carrier petroleum pipelines must be “just and reasonable” and not unduly discriminatory.

 

The intrastate operations of our crude oil pipeline system are subject to regulation by the North Dakota Public Services Commission. The intrastate operations of our Alaska pipelines are subject to regulation by the Regulatory Commission of Alaska. Like the FERC, the state regulatory authorities require that we notify shippers of proposed intrastate tariff increases and they have an opportunity to protest the increases. The North Dakota Public Services Commission also files with the state authorities copies of interstate tariff charges filed with the FERC. In addition to challenges to new or proposed rates, challenges to intrastate rates that have already become effective are permitted by complaint of an interested person or by independent action of the appropriate regulatory authority.

 

At December 31, 2007, we had approximately 5,500 full-time employees — 1,376 of whom are covered by collective bargaining agreements. The agreements for 1,133 of those employees expire February 1, 2009. We consider our relations with our employees to be satisfactory.

 

Our principal properties are described above under the captions “Refining” and “Retail”. In addition, we own feedstock and refined product storage facilities at our refinery and terminal locations. We believe that our properties and facilities are generally adequate for our operations and that our facilities are maintained in a good state of repair. We are the lessee under a number of cancelable and non-cancelable leases for certain properties, including office facilities, retail facilities, ship charters, barges and equipment used in the storage, transportation and production of feedstocks and refined products. We conduct our retail business under the Tesoro^®, Tesoro Alaska^®, Mirastar^®, 2-Go Tesoro^®, Shell^® and USA Gasoline^tm brands through a network of 911 retail stations, of which 449 are company-operated. See Notes I and M in our consolidated financial statements in Item 8.

 

Alkylation Units — Units that chemically combine isobutane with hydrocarbons through the control of temperature and pressure in the presence of an acid catalyst. This process produces alkylates, which have a high octane value and are blended into gasoline to improve octane values.

 

CARB — California Air Resources Board.  Gasoline and diesel sold in the state of California requires stricter quality and emissions reduction performance than other states.

 

Cogeneration Plant — A plant designed to produce both steam and electricity used to operate the refinery.

 

Cracking — The breaking down of larger molecules into smaller molecules, utilizing catalysts and/or elevated temperatures and pressures.

 

Deasphalting — The process of recovering higher-value oils from refinery residues.

 

Delayed Coker — A process by which the heaviest crude oil fractions can be thermally cracked under conditions of elevated temperatures to produce both refined products and petroleum coke.

 

Desulfurization - The removal of sulfur from petroleum products to reduce sulfur dioxide emissions that result from the use of these fuels.

 

Distillate Hydrocracking - A catalytic hydrocracking process designed to produce primarily diesel fuel and jet fuel.

 

Exchange Agreement — An agreement providing for the delivery of refined products, primarily to third-party terminals, in exchange for the delivery of refined products from third parties at specified locations.

 

FCC — Fluid Catalytic Cracking.  Catalytic cracking is the refining process of breaking down the larger, heavier, and more complex hydrocarbon molecules into simpler and lighter molecules through the use of a catalytic agent to increase the yield of gasoline from crude oil. Fluid catalytic cracking uses a catalyst in the form of very fine particles, which behave as a fluid when aerated with a vapor.

 

Fluid Coker — A process similar to fluid catalytic cracking to remove carbon (coke) from heavy low quality crude oils into lighter products.

 

Gross Refining Margin — The margin on products manufactured and purchased, including those sold to our retail segment. Gross refining margin is calculated as revenues less costs of feedstocks, purchased refined products, transportation and distribution.

 

Heavy Crude Oil — Crude oil with an American Petroleum Institute gravity of 24 degrees or less. Heavy crude oil is generally sold at a discount to lighter crude oils.

 

Heavy Oils, Residual Products, Internally Produced Fuel and Other  — Product yields other than gasoline, jet fuel and diesel produced in the refining process. These products include residual fuels, gas oils, propane, and internally produced fuel.

 

Hydrocracking — The process of using a catalyst to crack heavy hydrocarbon molecules in the presence of hydrogen. Major products from hydrocracking are jet fuel, naphtha, propane and gasoline components such as butane.

 

Hydrotreating — The process of removing sulfur from refined products in the presence of catalysts and substantial quantities of hydrogen to reduce sulfur dioxide emissions.

 

Isomerization — A refining process that alters the fundamental arrangement of atoms in the molecule without adding or removing anything from the original material. The process is used to convert normal butane into isobutane and normal pentane into isopentane and hexane into isohexane. Both isopentane and isohexane are high-octane gasoline components.

 

Jobber/Dealer Stations — Retail stations owned by third parties that sell products purchased from or through Tesoro and carry one of our brands.

Light Crude Oil — Crude oil with an American Petroleum Institute gravity of greater than 24 degrees. Light crude oils are generally sold at a premium to heavy crude oils.

 

Manufacturing Costs — Costs associated directly with the manufacturing process including cash operating expenses, but excluding depreciation and amortization.

 

Mbpd — Thousand barrels per day.

 

Naphtha  — Naphtha is used as a gasoline blending component, a feedstock for reforming, and as a petrochemical feedstock.

 

Refining Yield — Volumes of product produced from crude oils and feedstocks.

 

Reforming — A refining process using controlled heat and pressure with catalysts to rearrange certain hydrocarbon molecules, thereby converting paraffinic and naphthenic type hydrocarbons (e.g., low-octane gasoline boiling range fractions) into petrochemical feedstocks and higher octane stocks suitable for blending into finished gasoline.

 

Retail Fuel Margin — The margin on fuel products sold through our retail segment is calculated as revenues less costs of sales. Costs of sales in fuel margin are based on purchases from our refining segment and third parties using average bulk market prices adjusted for transportation and other differentials.

 

Throughput — The quantity of crude oil and other feedstocks processed at a refinery measured in barrels per day.

 

Turnaround — The scheduled shutdown of a refinery processing unit for significant overhaul and refurbishment. Turnaround expenditures are capitalized and amortized over the period of time until the next planned turnaround of each unit.

 

ULSD — Ultra Low Sulfur Diesel. Diesel fuel with lower sulfur content for the purpose of lowering emissions, which was required for use in the U.S. beginning in 2006 for on-road consumption.

 

Vacuum Distillation — Distillation under reduced pressure which lowers the boiling temperature of crude oils in order to distill crude oil components that have high boiling points.

 

Visbreaking — A thermal cracking process in which heavy atmospheric or vacuum still bottoms are cracked at moderate temperatures to increase production of distillate products and reduce viscosity of the distillate residues.

 

The following is a list of our executive officers, their ages and their positions at Tesoro, effective as of March 1, 2008.

 

 

There are no family relationships among the officers listed, and there are no arrangements or understandings pursuant to which any of them were elected as officers. Officers are elected annually by our Board of Directors during the annual meeting of stockholders. The term of each office runs until the corresponding meeting of the Board of Directors in the next year or until a successor has been elected or qualified. Positions held for at least the past five years for each of our executive officers is described below (positions, unless otherwise specified, are with Tesoro).

 

Bruce A. Smith was named Chairman of the Board of Directors, President and Chief Executive Officer in June 1996.

William J. Finnerty was named Executive Vice President and Chief Operating Officer in February 2006. Prior to that, he served as Executive Vice President, Operations beginning in January 2005 and Senior Vice President, Supply and Distribution of Tesoro Refining and Marketing Company beginning in February 2004. He joined Tesoro in December 2003 as Vice President, Crude Oil and Logistics of Tesoro Refining and Marketing Company. Prior to joining Tesoro, Mr. Finnerty served as Vice President, Trading North America Crude, for ChevronTexaco from October 2001 to November 2003.

 

Everett D. Lewis was named Executive Vice President, Strategy and Asset Management in January 2007. Prior to that, he served as Executive Vice President, Strategy beginning in January 2005 and Senior Vice President, Corporate Strategic Planning from November 2004 to January 2005. Mr. Lewis served as Senior Vice President, Planning and Optimization from February 2003 to November 2004 and Senior Vice President, Planning and Risk Management from April 2001 to February 2003.

 

Gregory A. Wright was named Executive Vice President and Chief Administrative Officer in June 2007. Prior to that, he served as Executive Vice President and Chief Financial Officer beginning in December 2003 and as Senior Vice President and Chief Financial Officer beginning in April 2001.

 

W. Eugene Burden was named Senior Vice President, Government Affairs in February 2006. Prior to that, he served as Senior Vice President, External Affairs from November 2004 to February 2006 and as Senior Vice President, Human Resources and Government Relations from June 2002 to November 2004.

 

Claude A. Flagg was named Senior Vice President, Strategy in January 2007. Prior to that, he served as Senior Vice President, Supply and Optimization beginning in February 2005. He joined Tesoro in January 2005 as Senior Vice President, Planning and Optimization. Prior to joining Tesoro, he served as General Manager of Supply Optimization at Shell Oil Products U.S. from January 2003 to December 2004.

 

J. William Haywood was named Senior Vice President, Strategy Development effective March 2008. Prior to that, he served as Senior Vice President, Refining beginning in March 2005 and as President of the California Region of Tesoro Refining and Marketing Company from September 2002 to February 2005.

 

Joseph G. McCoy was named Senior Vice President, Supply and Optimization in February 2008. Prior to joining Tesoro, Mr. McCoy held numerous positions with Chevron, including Vice President, Trading Capability from July 2005 to October 2007 and Vice President, Global Products Supply and Trading from November 2001 to June 2005.

 

Joseph M. Monroe was named Senior Vice President, Business Development and Logistics in January 2007. Prior to that, he served as Senior Vice President, Corporate Development beginning in February 2006, Senior Vice President, Business Integration and Analysis from February 2005 to February 2006 and Senior Vice President, Organizational Effectiveness from November 2004 to February 2005. Mr. Monroe served as Senior Vice President, Strategic Planning and Business Development of Tesoro Petroleum Companies, Inc. from February 2004 to November 2004 and as Senior Vice President, Supply and Distribution of Tesoro Refining and Marketing Company from May 2002 to February 2004.

 

Claude P. Moreau was named Senior Vice President, Marketing in February 2008. Prior to that, he served as Vice President, Marketing beginning in August 2007. Before joining Tesoro, he served as Chief Commercial Officer of Trafigura AG and other various marketing and business development positions since 2003. From 2001 to 2003, Mr. Moreau served as Vice President, Manufacturing and Marketing for ChevronTexaco Latin America Products Company.

 

Charles S. Parrish was named Senior Vice President, General Counsel and Secretary in May 2006. Prior to that, he served as Vice President, General Counsel and Secretary beginning in March 2005 and as Vice President, Assistant General Counsel and Secretary beginning in November 2004. Mr. Parrish served as Vice President, Assistant General Counsel of Tesoro Petroleum Companies, Inc. from March 2003 to November 2004. From 1995 through March 2003, he served numerous roles in the Company’s legal department, primarily focused on matters related to the Company’s capital structure and Securities Act reporting.

 

Daniel J. Porter was named Senior Vice President, Refining effective March 2008. Prior to that, he served as Senior Vice President, Supply and Optimization beginning in June 2007 and as Senior Vice President, Marketing

beginning in April 2005. Mr. Porter concurrently served as President of the Northwest Region of Tesoro Refining and Marketing Company and Anacortes Refinery Manager from June 2002 to April 2005.

 

Lynn D. Westfall was named Senior Vice President, External Affairs and Chief Economist in January 2007. Prior to that, he served as Senior Vice President, Chief Economist beginning in May 2006, Vice President, Chief Economist from August 2005 to May 2006 and as Vice President, Development and Business Analysis from January 2002 to August 2005.

 

Phillip M. Anderson was named Vice President and Treasurer in June 2007. Prior to that, he served as Director, Finance and Treasury beginning in November 2005 and as Director, Business Analysis from April 2003 to October 2005. Mr. Anderson also held the position of Director, Mergers and Acquisitions from January 2002 to March 2003.

 

Arlen O. Glenewinkel, Jr. was named Vice President and Controller in December 2006. Prior to that, he served as Vice President, Enterprise Risk beginning in April 2005 and Vice President, Internal Audit, from August 2002 to April 2005.

 

Susan A. Lerette was named Vice President, Human Resources in May 2005. Prior to that, she served as Vice President, Human Resources and Communications from May 2004 to May 2005. From April 2001 to May 2004, she served as Vice President, Communications.

 

Otto C. Schwethelm was named Vice President, Chief Financial Officer in June 2007. Prior to that, he served as Vice President, Finance and Treasurer beginning in March 2006. Prior to that, he served as Vice President and Controller from February 2003 to March 2006 and as Vice President and Operations Controller from September 2002 to February 2003.

 

Sarah S. Simpson was named Vice President, Corporate Communications in June 2005. Prior to joining Tesoro, she served as Director of Corporate Communications and Community Relations at Cemex, Inc. from November 2004 to June 2005. From July 2000 to November 2004, she served as Director of Corporate Communications at Waste Management, Inc.

 

G. Scott Spendlove was named Vice President, Asset Enhancement and Planning in August 2007. Prior to that, he served as Vice President, Strategy and Long-Term Planning beginning in December 2006 and as Vice President and Controller beginning in March 2006. Mr. Spendlove also served as Vice President, Finance and Treasurer from May 2003 to March 2006 and as Vice President, Finance from January 2002 to May 2003.

 

The following is a list of our Board of Directors:

 

 

 

 

The volatility of crude oil prices, refined product prices and natural gas and electrical power prices may have a material adverse effect on our cash flow and results of operations.

 

Our earnings and cash flows from our refining and wholesale marketing operations depend on a number of factors, including fixed and variable expenses (including the cost of crude oil and other refinery feedstocks) and the margin above those expenses at which we are able to sell refined products. In recent years, the prices of crude oil and refined products have fluctuated substantially. These prices depend on numerous factors beyond our control, including the global supply and demand for crude oil, gasoline and other refined products, which are subject to, among other things:

 

 

Prices for refined products are influenced by the price of crude oil. We do not produce crude oil and must purchase all of our crude oil, the price of which fluctuates on worldwide market conditions. Generally, an increase or decrease in the price of crude oil affects the price of gasoline and other refined products. However, the prices for crude oil and prices for our refined products can fluctuate in different directions based on global market conditions. In addition, the timing of the relative movement of the prices (both among different classes of refined products and among various global markets for similar refined products) as well as the overall change in refined product prices, can reduce profit margins and could have a significant impact on our refining and wholesale marketing operations, earnings and cash flow. Also, crude oil supply contracts are generally term contracts with market-responsive pricing provisions. We purchase our refinery feedstocks weeks before manufacturing and selling the refined products. Price level changes during the period between purchasing feedstocks and selling the manufactured refined products from these feedstocks could have a significant effect on our financial results. We also purchase refined products manufactured by others for sale to our customers. Price level changes during the periods between purchasing and selling these refined products also could have a material adverse effect on our business, financial condition and results of operations.

 

Volatile prices for natural gas and electrical power used by our refineries and other operations affect manufacturing and operating costs. Natural gas and electricity prices have been and will continue to be affected by supply and demand for fuel and utility services in both local and regional markets.

 

The dangers inherent in our operations and the potential limits on insurance coverage could expose us to potentially significant liability costs.

 

Our operations are subject to hazards and risks inherent in refining operations and in transporting and storing crude oil and refined products, such as fires, natural disasters, explosions, pipeline ruptures and spills and mechanical failure of equipment at our or third-party facilities, any of which can result in damage to our properties and the properties of others. A serious accident could also result in serious injury or death to our employees or

contractors and could expose us to significant liability for personal injury claims and reputational risk. In addition, we operate seven petroleum refineries, any of which could experience a major accident, be damaged by severe weather or other natural disaster, or otherwise be forced to shut down. Any such unplanned shutdown could have a material adverse effect on our business, financial condition and results of operations. While we carry property, casualty and business interruption insurance, we do not maintain insurance coverage against all potential losses, and we could suffer losses for uninsurable or uninsured risks or in amounts in excess of existing insurance coverage. The occurrence of an event that is not fully covered by insurance could have a material adverse effect on our business, financial condition and results of operations.

 

Our business is impacted by risks inherent in refining operations.

 

The operation of refineries, pipelines and refined products terminals is inherently subject to spills, discharges or other releases of petroleum or hazardous substances. If any of these events had previously occurred or occurs in the future in connection with any of our refineries, pipelines or refined products terminals, or in connection with any facilities to which we sent wastes or by-products for treatment or disposal, other than events for which we are indemnified, we could be liable for all costs and penalties associated with their remediation under federal, state and local environmental laws or common law, and could be liable for property damage to third parties caused by contamination from releases and spills. The penalties and clean-up costs that we may have to pay for releases or the amounts that we may have to pay to third parties for damage to their property, could be significant and the payment of these amounts could have a material adverse effect on our business, financial condition and results of operations.

 

We operate in environmentally sensitive coastal waters, where tanker, pipeline and refined product transportation operations are closely regulated by federal, state and local agencies and monitored by environmental interest groups. Our California, Mid-Pacific and Pacific Northwest refineries import crude oil and other feedstocks by tanker. Transportation of crude oil and refined products over water involves inherent risk and subjects us to the provisions of the Federal Oil Pollution Act of 1990 and state laws in California, Hawaii, Washington and Alaska. Among other things, these laws require us to demonstrate in some situations our capacity to respond to a “worst case discharge” to the maximum extent possible. We have contracted with various spill response service companies in the areas in which we transport crude oil and refined products to meet the requirements of the Federal Oil Pollution Act of 1990 and state and foreign laws. However, there may be accidents involving tankers transporting crude oil or refined products, and response services may not respond to a “worst case discharge” in a manner that will adequately contain that discharge, or we may be subject to liability in connection with a discharge.

 

Our operations are subject to general environmental risks, expenses and liabilities which could affect our results of operations.

 

From time to time we have been, and presently are, subject to litigation and investigations with respect to environmental and related matters, including product liability claims related to the oxygenate MTBE. We may become involved in further litigation or other proceedings, or we may be held responsible in any existing or future litigation or proceedings, the costs of which could be material.

 

We have in the past operated retail stations with underground storage tanks in various jurisdictions, and currently operate retail stations that have underground storage tanks in 17 states in the mid-continental and western United States. Federal and state regulations and legislation govern the storage tanks, and compliance with these requirements can be costly. The operation of underground storage tanks also poses certain other risks, including damages associated with soil and groundwater contamination. Leaks from underground storage tanks which may occur at one or more of our retail stations, or which may have occurred at our previously operated retail stations, may impact soil or groundwater and could result in fines or civil liability for us.

 

Consistent with the experience of other U.S. refineries, environmental laws and regulations have raised operating costs and require significant capital investments at our refineries. We believe that existing physical facilities at our refineries are substantially adequate to maintain compliance with existing applicable laws and regulatory requirements. However, potentially material expenditures could be required in the future. For example, we may be required to comply with evolving environmental, health and safety laws, regulations or requirements that may be adopted or imposed in the future. We also may be required to address information or conditions that may be discovered in the future and require a response.

Assembly Bill 32, a California bill that creates a statewide cap on greenhouse gas emissions and requires that the state return to 1990 emission levels by 2020, was passed by the California legislature and was signed by Governor Schwarzenegger on September 27, 2006. The bill focuses on using market mechanisms, such as offsets and cap-and-trade programs, to achieve the targets. Regulations under the bill have not yet been promulgated. The bill specifies that any established greenhouse gas allowances will be assigned to the entity regulated under the cap. Implementation is slated to begin January 1, 2010 with full implementation to occur by 2020. The implementation and implications of this legislation will take many years to realize, and we cannot predict at this time what impact, if any, this legislation will have on our business.

 

Currently, various legislative and regulatory measures to address greenhouse gas emissions (including carbon dioxide, methane and nitrous oxides) are in various phases of discussion or implementation. These include proposed federal legislation and state actions to develop statewide or regional programs, each of which have imposed or would impose reductions in greenhouse gas emissions. These actions could result in increased costs to (i) operate and maintain our facilities, (ii) install new emission controls on our facilities and (iii) administer and manage any greenhouse gas emissions program. These actions could also impact the consumption of refined products, thereby affecting our operations.

 

In December 2007, the U.S. Congress passed the Energy Independence and Security Act, which, among other things sets a target of 35 miles per gallon for the combined fleet of cars and light trucks by model year 2020 and modified the industry requirements for Renewable Fuel Standard (RFS). The RFS now stands at 9 billion gallons in 2008 rising to 36 billion gallons by 2022. Both requirements could reduce demand growth for petroleum products in the future. In the near term, the RFS presents ethanol production and logistics challenges for both the ethanol and refining industries and may require additional capital expenditures or expenses by us to accommodate increased ethanol use.

 

In June 2007, the California Air Resources Board proposed amendments to the predictive model for compliant gasoline in the state of California that decreases the allowable sulfur levels to a cap of 20 parts per million and allows for additional ethanol to be blended into gasoline. The requirements begin December 31, 2009 but may be postponed by individual companies until December 31, 2011 through the use of the Alternative Emission Reduction Plan which allows for the acquisition of emissions offsets from sources not directly related to petroleum fuel use. We expect both of our California refineries to be in compliance with the regulation by the 2009 deadline.

 

We are subject to interruptions of supply and increased costs as a result of our reliance on third-party transportation of crude oil and refined products.

 

Our Washington refinery receives all of its Canadian crude oil and delivers a high proportion of its gasoline, diesel and jet fuel through third-party pipelines and the balance through marine vessels. Our Hawaii and Alaska refineries receive most of their crude oil and transport a substantial portion of refined products through ships and barges. Our Utah refinery receives substantially all of its crude oil and delivers substantially all of its refined products through third-party pipelines. Our North Dakota refinery delivers substantially all of its refined products through a third-party pipeline system. Our Golden Eagle refinery receives approximately one-third of its crude oil through pipelines and the balance through marine vessels. Substantially all of our Golden Eagle refinery’s production is delivered through third-party pipelines, ships and barges. Our Los Angeles refinery receives California crudes through third-party pipelines and the balance of its crude supply through marine vessels. Approximately two-thirds of our Los Angeles refinery production is delivered through third-party pipelines, terminals, ships and barges. In addition to environmental risks discussed above, we could experience an interruption of supply or an increased cost to deliver refined products to market if the ability of the pipelines or vessels to transport crude oil or refined products is disrupted because of accidents, governmental regulation or third-party action. A prolonged disruption of the ability of a pipeline or vessels to transport crude oil or refined product could have a material adverse effect on our business, financial condition and results of operations.

 

Terrorist attacks and threats or actual war may negatively impact our business.

 

Our business is affected by global economic conditions and fluctuations in consumer confidence and spending, which can decline as a result of numerous factors outside of our control, such as actual or threatened terrorist attacks and acts of war. Terrorist attacks, as well as events occurring in response to or in connection with them, including

future terrorist attacks against U.S. targets, rumors or threats of war, actual conflicts involving the United States or its allies, or military or trade disruptions impacting our suppliers or our customers or energy markets in general, may adversely impact our operations. As a result, there could be delays or losses in the delivery of supplies and raw materials to us, delays in our delivery of refined products, decreased sales of our refined products and extension of time for payment of accounts receivable from our customers. Strategic targets such as energy-related assets (which could include refineries such as ours) may be at greater risk of future terrorist attacks than other targets in the United States. These occurrences could significantly impact energy prices, including prices for our crude oil and refined products, and have a material adverse impact on the margins from our refining and wholesale marketing operations. In addition, disruption or significant increases in energy prices could result in government-imposed price controls. Any one of, or a combination of, these occurrences could have a material adverse effect on our business, financial condition and results of operations.

 

Our operating results are seasonal and generally are lower in the first and fourth quarters of the year.

 

Demand for gasoline is higher during the spring and summer months than during the winter months in most of our markets due to seasonal increases in highway traffic. As a result, our operating results for the first and fourth quarters are generally lower than for those in the second and third quarters.

 

None.

 

 

In the ordinary course of business, we become party to or otherwise involved in lawsuits, administrative proceedings and governmental investigations, including environmental, regulatory and other matters. Large and sometimes unspecified damages or penalties may be sought from us in some matters and some matters may require years for us to resolve. We cannot provide assurance that an adverse resolution of one or more of the matters described below during a future reporting period will not have a material adverse effect on our financial position or results of operations in future periods. However, on the basis of existing information, we believe that the resolution of these matters, individually or in the aggregate, will not have a material adverse effect on our financial position or results of operations.

 

On March 2, 2007, we settled our dispute with Tosco Corporation (“Tosco”) concerning soil and groundwater conditions at the Golden Eagle refinery. We received $58.5 million from ConocoPhillips as successor in interest to Tosco and Phillips Petroleum, both former owners and operators of the refinery. In exchange for the settlement proceeds we assumed responsibility for certain environmental liabilities arising from operations at the refinery prior to August of 2000. For further information related to this matter, see Note M in our consolidated financial statements in Item 8.

 

In March 2007, we received an offer from the Bay Area Air Quality Management District (the “District”) to settle 77 Notices of Violation (“NOVs”) for $4 million. The NOVs allege violations of air quality at our Golden Eagle refinery. In January 2008, we agreed to settle this matter for $1.5 million pending the negotiation of a final agreement with the District. For further information related to this matter, see Note M in our consolidated financial statements in Item 8.

 

On January 25, 2008 we received an offer of settlement from the Alaska Department of Environmental Conservation (“ADEC”) related to the grounding of a vessel in the Alaska Cook Inlet on February 2, 2006. The ADEC has alleged two vessels chartered by us violated provisions of our Cook Inlet Vessel Oil Prevention and Contingency Plan during the period from December 2004 to February 2006. The resolution of this matter will not have a material adverse effect on our financial position or results of operations.

 

On December 12, 2007 we received an NOV from ADEC alleging that our Alaska refinery violated provisions of its Clean Air Act Title V operating permit. We are negotiating a resolution of the NOV with ADEC and do not believe the resolution will have a material adverse effect on our financial position or results of operations.

 

As previously reported we are a defendant, along with other manufacturing, supply and marketing defendants, in ten pending cases alleging MTBE contamination in groundwater. In December 2007, we agreed to participate in a proposed settlement of seven and part of an eighth of the pending cases subject to negotiation of settlement documents. The defendants are being sued for having manufactured MTBE and having manufactured, supplied and distributed gasoline containing MTBE. The plaintiffs, all in California, are generally water providers, governmental authorities and private well owners alleging, in part, the defendants are liable for manufacturing or distributing a defective product. The suits generally seek individual, unquantified compensatory and punitive damages and attorney’s fees. We believe the final resolution of the cases included in the proposed settlement will not have a material adverse effect on our financial position or results of operations, but at this time we cannot estimate the amount or the likelihood of the ultimate resolution of the cases not subject to the settlement. We believe we have defenses to the claims in the remaining cases and intend to vigorously defend ourselves in those lawsuits.

 

 

None.

 

 

The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that Tesoro specifically incorporates it by reference into such filing.

 

The performance graph below compares the cumulative total return of our common stock to the cumulative total return of the S&P Composite Index and to a composite peer group of companies. The composite peer group (the “Peer Group”) includes Sunoco, Inc. and Valero Energy Corporation. The graph below is for the period of five years commencing December 31, 2002 and ending December 31, 2007.

 

Comparison of Five Year Cumulative Total Return*
Among the Company, the S&P 500 Index and Composite Peer Group

 

 

 

 

 

Note:  The stock price performance shown on the graph is not necessarily indicative of future performance.

Our common stock is listed under the symbol “TSO” on the New York Stock Exchange. Summarized below are high and low sales prices of and dividends declared on our common stock on the New York Stock Exchange during 2007 and 2006. All per share data presented below reflects the effect of a two-for-one stock split effected in the form of a stock dividend which was distributed on May 29, 2007.

 

 

On January 30, 2008, our Board of Directors declared a quarterly cash dividend on common stock of $0.10 per share, payable on March 17, 2008 to shareholders of record on March 3, 2008. At February 25, 2008, there were approximately 2,934 holders of record of our 137,602,531 outstanding shares of common stock. For information regarding restrictions on future dividend payments and stock repurchases, see Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and Notes I and N in our consolidated financial statements in Item 8.

 

The 2008 annual meeting of stockholders will be held at 5:00 P.M. Central Time on Tuesday, May 6, 2008, at the Grand Hyatt San Antonio, 1148 East Commerce Street, San Antonio, Texas. Holders of common stock of record at the close of business on March 14, 2008 are entitled to notice of and to vote at the annual meeting.

 

The following table summarizes, as of December 31, 2007, certain information regarding equity compensation to our employees, officers, directors and other persons under our equity compensation plans.

 

Equity Compensation Plan Information

 

 

 

 

During the three month period ended December 31, 2007, we did not repurchase any of our common stock.

 

The following table sets forth certain selected consolidated financial and operating data of Tesoro as of and for each of the five years in the period ended December 31, 2007. The selected consolidated financial information presented below has been derived from our historical financial statements. Our financial and operating results include the results of the acquisitions of our Los Angeles Assets and USA Petroleum Assets since May 2007. All share and per share amounts presented reflect the effect of our two-for-one stock split effected in the form of a stock dividend which was distributed on May 29, 2007. The following table should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 7 and our consolidated financial statements in Item 8.

 

 

 

 

 

 

Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See “Forward-Looking Statements” on page 54 and “Risk Factors” on page 20 for a discussion of the factors that could cause actual results to differ materially from those projected in these statements.

 

Our strategy is to create a value-added refining and marketing business that has (i) economies of scale, (ii) a competitive cost structure, (iii) effective management information systems that enable success and (iv) outstanding employees focused on achieving operational excellence in a global market in order to provide stockholders with competitive returns in any economic environment.

 

Our goals are focused on: (i) operating our facilities in a safe, reliable, and environmentally responsible way; (ii) improving cash flow by achieving greater operational and administrative efficiencies; and (iii) using excess cash flows from operations in a balanced way to create further shareholder value.

 

During 2007, we achieved the following relative to our goals, which are further described below under “Results of Operations” and “Capital Resources & Liquidity”: