10-K 1 a20111231-tsox10k.htm 2011.12.31-TSO-10K
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 10‑K
(Mark One)
R
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2011
or
¨
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 1‑3473

TESORO CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
95-0862768
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
19100 Ridgewood Parkway, San Antonio, Texas 78259-1828

(Address of principal executive offices) (Zip Code)
 
 
 
210-626-6000
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
 
 
 
Common Stock, $0.16 2/3 par value
 
New York Stock Exchange
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 R 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 ¨ No  R
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  R   No  ¨
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 R  No ¨  
Indicate by check mark whether if the 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. ¨
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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer R
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No  R

At June 30, 2011, the aggregate market value of common limited partner units held by non-affiliates of the registrant was approximately $3.3 billion based upon the closing price of its common units on the New York Stock Exchange Composite tape. At February 16, 2012, there were 140,800,815 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 2011 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.
 


Table of Contents                                        

TESORO CORPORATION
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
 
PART I
Page
 
 
 
 
 
 
 
 
 
 
 
 
PART II
 
 
 
 
 
 
 
PART III
 
 
PART IV
 
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 “Important Information Regarding Forward-Looking Statements” on page 32.
As used in this Annual Report on Form 10-K, the terms “Tesoro,” “we,” “us” or “our” may refer to Tesoro Corporation, one or more of its consolidated subsidiaries or all of them taken as a whole.

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PART I

ITEMS 1. AND 2.  BUSINESS AND PROPERTIES

Statements in this Annual Report on Form 10-K, that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See “Important Information Regarding Forward-Looking Statements” in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7 for a discussion of forward-looking statements and of factors that could cause actual outcomes and results to differ materially from those projected.

Tesoro Corporation (“Tesoro”) was incorporated in Delaware in 1968. Based in San Antonio, Texas, we are one of the largest independent petroleum refiners and marketers in the United States. Our subsidiaries, operating through two business segments, primarily manufacture and sell transportation fuels. Our refining operating segment (“refining”), which operates seven refineries in the western United States, refines crude oil and other feedstocks into transportation fuels, such as gasoline and gasoline blendstocks, jet fuel and diesel fuel, as well as other products, including heavy fuel oils, liquefied petroleum gas, petroleum coke and asphalt. This operating segment sells refined products in wholesale and bulk markets to a wide variety of customers within the operations area. Our retail operating segment (“retail”) sells transportation fuels and convenience products in 18 states through a network of 1,175 retail stations, primarily under the Tesoro®, Shell®, and USA GasolineTM brands. See Notes P and S to our consolidated financial statements in Item 8 for additional information on our operating segments and properties.

Our principal executive offices are located at 19100 Ridgewood Parkway, San Antonio, Texas 78259-1828 and our telephone number is (210) 626-6000. Our common stock trades on the New York Stock Exchange under the symbol “TSO.” We file reports with the Securities and Exchange Commission (“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, 19100 Ridgewood Parkway, San Antonio, Texas 78259-1828. We also post our corporate governance guidelines, code of business conduct, code of business conduct and ethics for senior financial executives and our Board of Director committee charters on our website.


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REFINING
Tesoro Refinery Locations
Overview

We currently own and operate seven petroleum refineries located in the western United States and sell transportation fuels to a wide variety of customers. Our refineries produce a high proportion of the transportation fuels that we sell. Our seven refineries have a combined crude oil capacity of 665 thousand barrels per day (“Mbpd”). Crude oil capacity and throughput rates of crude oil and other feedstocks by refinery are as follows:

 
 
 
 
Throughput (Mbpd)
Refinery
 
Crude Oil Capacity (Mbpd) (a)
 
2011
 
2010
 
2009
California
 
 
 
 
 
 
 
 
Martinez
 
166

 
140

 
124

 
141

Los Angeles
 
97

 
101

 
99

 
100

Pacific Northwest
 
 
 
 
 
 
 
 
Washington (b)
 
120

 
98

 
39

 
84

Alaska
 
72

 
55

 
54

 
51

Mid-Pacific
 
 
 
 
 
 
 
 
Hawaii
 
94

 
71

 
64

 
68

Mid-Continent
 
 
 
 
 
 
 
 
North Dakota
 
58

 
59

 
50

 
54

Utah
 
58

 
55

 
50

 
51

Total (c)
 
665

 
579

 
480

 
549

____________
(a)
Crude oil capacity by refinery as reported by the Energy Information Administration (2010). Throughput can exceed crude oil capacity due to the processing of other feedstocks in addition to crude oil.
(b)
Our Washington refinery was temporarily shut down from April 2010 to November 2010.
(c)
See discussion regarding changes in total refining throughput in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7.

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Feedstock Purchases.  We purchase crude oil and other feedstocks from both domestic and foreign sources either through term agreements with renewal provisions or in the spot market. We purchase approximately 46% of our crude oil under term agreements with renewal options, which are primarily short-term agreements priced at market. We purchase domestic crude oils produced primarily in California, Alaska, North Dakota, Colorado and Utah. We purchase foreign crude oils produced primarily in South America, Russia and Canada. Sources of our crude oil purchases were as follows:
Crude Oil Source
 
2011
 
2010
 
2009
Domestic
 
58
%
 
65
%
 
62
%
Foreign
 
42

 
35

 
38

Total
 
100
%
 
100
%
 
100
%

Our refineries process both heavy and light crude oils. Light crude oils, when refined, produce a higher proportion of high value transportation fuels such as gasoline, diesel and jet fuel, and as a result are generally more expensive than heavy crude oils. In contrast, heavy crude oils produce more low value by-products and heavy residual oils. These lower value products can be upgraded to higher value products through additional more complex and expensive refining processes. Throughput volumes by feedstock type and region are summarized below (in Mbpd):
 
 
2011
 
2010
 
2009
 
 
Volume
 
%
 
Volume
 
%
 
Volume
 
%
California
 
 
 
 
 
 
 
 
 
 
 
 
Heavy crude (a)
 
156

 
65
 
161

 
72
 
160

 
66
Light crude
 
60

 
25
 
42

 
19
 
57

 
24
Other feedstocks
 
25

 
10
 
20

 
9
 
24

 
10
Total
 
241

 
100
 
223

 
100
 
241

 
100
Pacific Northwest
 
 
 
 
 
 
 
 
 
 
 
 
Heavy crude (a)
 
3

 
2
 
1

 
1
 

 
Light crude
 
144

 
94
 
87

 
94
 
126

 
93
Other feedstocks
 
6

 
4
 
5

 
5
 
9

 
7
Total
 
153

 
100
 
93

 
100
 
135

 
100
Mid-Pacific
 
 
 
 
 
 
 
 
 
 
 
 
Heavy crude (a)
 
12

 
17
 
19

 
30
 
17

 
25
Light crude
 
59

 
83
 
45

 
70
 
51

 
75
Total
 
71

 
100
 
64

 
100
 
68

 
100
Mid-Continent
 
 
 
 
 
 
 
 
 
 
 
 
Light crude
 
110

 
96
 
96

 
96
 
101

 
96
Other feedstocks
 
4

 
4
 
4

 
4
 
4

 
4
Total
 
114

 
100
 
100

 
100
 
105

 
100
Total Refining Throughput
 
 
 
 
 
 
 
 
 
 
 
 
Heavy crude (a)
 
171

 
30
 
181

 
38
 
177

 
32
Light crude
 
373

 
64
 
270

 
56
 
335

 
61
Other feedstocks
 
35

 
6
 
29

 
6
 
37

 
7
Total
 
579

 
100
 
480

 
100
 
549

 
100
____________
(a) We define heavy crude oil as crude oils with an American Petroleum Institute gravity of 24 degrees or less.


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Refined Products.  The total products produced in the refining and manufacturing processes are referred to as the refining yield. The refining yield consists primarily of transportation fuels, including gasoline and gasoline blendstocks, jet fuel and diesel fuel, but also may include other products including heavy fuel oils, liquefied petroleum gas, petroleum coke and asphalt. Our refining yield by region is summarized below (in Mbpd):
 
 
2011
 
2010
 
2009
 
 
Volume
 
%
 
Volume
 
%
 
Volume
 
%
California
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
134

 
51
 
124

 
51
 
130

 
49
Jet fuel
 
20

 
8
 
19

 
8
 
18

 
7
Diesel fuel
 
63

 
24
 
54

 
22
 
52

 
20
Heavy fuel oils, residual products, internally produced fuel and other
 
45

 
17
 
47

 
19
 
63

 
24
Total
 
262

 
100
 
244

 
100
 
263

 
100
Pacific Northwest
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
66

 
42
 
34

 
35
 
60

 
43
Jet fuel
 
30

 
19
 
24

 
25
 
26

 
19
Diesel fuel
 
27

 
17
 
11

 
12
 
23

 
16
Heavy fuel oils, residual products, internally produced fuel and other
 
35

 
22
 
27

 
28
 
30

 
22
Total
 
158

 
100
 
96

 
100
 
139

 
100
Mid-Pacific
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
19

 
26
 
15

 
23
 
16

 
23
Jet fuel
 
18

 
25
 
15

 
23
 
17

 
25
Diesel fuel
 
13

 
18
 
12

 
19
 
12

 
17
Heavy fuel oils, residual products, internally produced fuel and other
 
22

 
31
 
23

 
35
 
24

 
35
Total
 
72

 
100
 
65

 
100
 
69

 
100
Mid-Continent
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
66

 
56
 
59

 
57
 
62

 
58
Jet fuel
 
11

 
9
 
10

 
10
 
9

 
8
Diesel fuel
 
32

 
27
 
26

 
25
 
27

 
25
Heavy fuel oils, residual products, internally produced fuel and other
 
10

 
8
 
9

 
8
 
10

 
9
Total
 
119

 
100
 
104

 
100
 
108

 
100
Total Refining Yield
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
285

 
47
 
232

 
46
 
268

 
46
Jet fuel
 
79

 
13
 
68

 
13
 
70

 
12
Diesel fuel
 
135

 
22
 
103

 
20
 
114

 
20
Heavy fuel oils, residual products, internally produced fuel and other
 
112

 
18
 
106

 
21
 
127

 
22
Total
 
611

 
100
 
509

 
100
 
579

 
100

Marine. We time charter four U.S.-flag tankers and three foreign-flag tankers to optimize the transportation of crude oil and refined products within our refinery system and ensure adequate shipping capacity. All of the tankers are double-hulled. The foreign-flag tankers, with charters that expire between 2012 and 2013, are Aframax class vessels.  We use our U.S.-flag tankers to move crude and products between Alaska, Hawaii and the West Coast.  The U.S.-flag tankers, whose charters will expire between 2012 and 2013 unless we exercise renewal options, are medium range class vessels.  Additionally, we time charter seven barges and two tugs with varying terms ending in 2012 to 2016.


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Tesoro Logistics LP. On April 26, 2011, Tesoro Logistics LP (“TLLP”) completed the initial public offering (the “Offering”) of 14,950,000 common units at a price of $21.00 per unit, which included a 1,950,000 unit over-allotment option that was exercised by the underwriters. Tesoro Logistics GP, LLC, a 100% consolidated subsidiary, serves as the general partner of TLLP. Headquartered in San Antonio, Texas, TLLP's assets consist of a crude oil gathering system in the Bakken Shale/Williston Basin area, eight refined products terminals in the midwestern and western United States, a crude oil and refined products storage facility and five related short-haul pipelines in Utah.
TLLP intends to expand its business through organic growth, including constructing new assets and increasing the utilization of existing assets, and by acquiring assets from us and third parties. TLLP's expansion of the logistics business will allow us to maximize the economic value of our assets within the midstream and downstream value chain. We believe TLLP is well positioned to achieve its primary business objectives and execute business strategies based on its competitive strengths, including its long-term fee-based contracts, their relationship with us, assets positioned in the high demand Bakken Shale/Williston Basin area and financial flexibility.

We hold an approximate 52% interest in TLLP, including the interest of the general partner. This interest includes 304,890 common units, 15,254,890 subordinated units and 622,649 general partner units. We received net proceeds of approximately $283 million from the Offering, after deducting offering expenses and debt issuance costs.

We have agreements with TLLP which establish fees for administrative and operational services provided by Tesoro and its subsidiaries to TLLP, provide indemnifications by Tesoro and its subsidiaries for certain environmental and other liabilities, and establish commercial terms for services provided by TLLP and its subsidiaries to us. TLLP is a variable interest entity (“VIE”) as defined under U.S. generally accepted accounting principles (“U.S. GAAP”) and is consolidated into our consolidated financial statements. Intercompany transactions with TLLP and its subsidiaries are eliminated in our consolidated financial statements.

Pipelines and Storage. We receive crude oils and ship refined products through owned and third-party pipelines. TLLP, through one of its subsidiaries, owns and operates a crude oil gathering system in North Dakota and Montana (the “High Plains System”), which includes an approximate 27 Mbpd truck-based crude oil gathering operation, approximately 700 miles of common carrier pipeline (the "High Plains Pipeline") and related storage assets with current capacity to deliver up to 85 Mbpd to our North Dakota refinery, which is presently limited to processing 60 Mbpd of shipments. In addition, we own and operate over 200 miles of crude oil and product pipelines, located primarily in Alaska and Hawaii.

Gunvor SA (“Gunvor”), formerly Castor Petroleum, entered into a Transportation and Storage Agreement (“TSA”) with Petroterminal de Panama, S.A. (“PTP”) in September 2007. Concurrent with the execution of the TSA, Tesoro Panama Company S.A. (“TPSA”), a wholly owned subsidiary of Tesoro, entered into a Transportation and Storage Agreement (the “TPSA Agreement”) with Gunvor. The TSA provides Gunvor the use of the Trans-Panama pipeline (the “Panama Pipeline”) and several tanks at the Atlantic and Pacific terminals for a seven-year period, beginning in April 2010. The Panama Pipeline is 81 miles long, with a capacity exceeding 860 Mbpd, and runs across Panama near the Costa Rican border from Port Chiriqui Grande, Bocas del Toro on the Caribbean to Port Charco Azul on the Pacific coast. The TPSA Agreement with Gunvor allocates and delegates to TPSA a portion of Gunvor's rights, duties, and obligations set forth in Gunvor's TSA agreement with PTP.  TPSA has leased access to, and is obligated for, pipeline capacity of more than 100 Mbpd and tank capacity of approximately 4.4 million barrels. These rights in the Panama Pipeline allow us to deliver crude oils acquired in Africa, the Atlantic region of South America and the North Sea to refineries in the Pacific basin.

Trucking. We operate a proprietary trucking business at our Utah and Hawaii refineries to transport crude oil to the refinery or refined products to our retail outlets and other customers. TLLP also manages a truck-based crude oil gathering operation in the Bakken Shale/Williston Basin area.

Terminalling. We operate nine refined products terminals at our refineries and other locations in California, Washington, Alaska and Hawaii. We also distribute products through third-party terminals and truck racks in our market areas and through purchase and exchange arrangements with other refining and marketing companies. TLLP operates eight refined products terminals in California, Utah, Alaska, North Dakota, Washington and Idaho, which provide storage and truck loading services to Tesoro, its subsidiaries and third-parties.

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California Refineries

Martinez

Refining.  Our 166 Mbpd Martinez refinery is located in Martinez, California on approximately 2,200 acres about 30 miles east of San Francisco. We source crude oil for this refinery from California, Alaska and foreign locations. The Martinez refinery also processes intermediate feedstocks. The refinery's major processing units include crude distillation, vacuum distillation, delayed coking, hydrocracking, naphtha reforming, hydrotreating, fluid catalytic cracking and alkylation units. The refinery produces a high proportion of transportation fuels, including cleaner-burning California Air Resources Board (“CARB”) gasoline and CARB diesel fuel, as well as conventional gasoline and diesel fuel. The refinery also produces heavy fuel oils, liquefied petroleum gas and petroleum coke.

Transportation.  Our Martinez refinery's two leased marine terminals have access through the San Francisco Bay that enables us to receive crude oil and ship refined products. In December 2011, we announced our intention to offer TLLP the Martinez Crude Oil Marine Terminal. 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 pipelines.

Terminals.  We operate a refined products terminal at our Martinez refinery. Additionally, TLLP operates a leased refined products terminal at Stockton, California. We distribute refined products through these and third-party terminals in our market areas and through purchase and exchange arrangements with other refining and marketing companies. We also lease third-party clean product tanks with access to the San Francisco Bay.

Los Angeles

Refining.  Our 97 Mbpd Los Angeles refinery is located in Wilmington, California on approximately 300 acres about 20 miles south of Los Angeles. We source crude oil for our Los Angeles refinery from California as well as foreign locations. The Los Angeles refinery also processes intermediate feedstocks. The refinery's major processing units include crude distillation, vacuum distillation, delayed coking, hydrocracking, naphtha reforming, hydrotreating, fluid catalytic cracking, butane isomerization and alkylation units. The refinery produces a high proportion of transportation fuels, including CARB gasoline and CARB diesel fuel, as well as conventional gasoline, diesel fuel and jet fuel. The refinery also produces heavy fuel oils, liquefied petroleum gas and petroleum coke.
 
Transportation.  Our Los Angeles refinery leases a marine terminal at the Port of Long Beach that enables us to receive crude oil and ship refined products. The refinery can also receive crude oils from the San Joaquin Valley and the Los Angeles Basin and ship refined products from the refinery through third-party pipelines.

Terminals.  TLLP owns and operates a refined products terminal adjacent to our Los Angeles refinery. Additionally, we distribute refined products through third-party terminals in our market areas and through purchases and exchange arrangements with other refining and marketing companies. We also lease refined product storage tanks at third-party terminals in Southern California, the majority of which have access to marine terminals.

Pacific Northwest Refineries

Washington

Refining. Our 120 Mbpd Anacortes, Washington refinery is located in northwest Washington on approximately 900 acres about 70 miles north of Seattle. We source our Washington refinery's crude oil from Alaska, North Dakota, Canada and other foreign locations. We intend to build an unloading facility to offload additional crude oils from the Bakken Shale/Williston Basin. These crude oils will improve our product yield and provide us an increased crude oil cost advantage. In July 2011, we announced our intention to offer TLLP this unloading facility upon completion. The Washington refinery also processes intermediate feedstocks, primarily heavy vacuum gas oil, produced by some of our other refineries and purchased in the spot-market from third-parties.

The refinery's major processing units include crude distillation, vacuum distillation, deasphalting, naphtha reforming, hydrotreating, fluid catalytic cracking, butane isomerization and alkylation units, which enable us to produce a high proportion of transportation fuels, such as gasoline including CARB gasoline and components for CARB gasoline, diesel fuel and jet fuel. The refinery also produces heavy fuel oils, liquefied petroleum gas and asphalt.


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Transportation.  Our Washington refinery receives Canadian crude oil through a third-party pipeline originating in Edmonton, Alberta, Canada. We receive other crude oils and butanes through our Washington refinery's marine terminal and its rail facility. The refinery ships transportation fuels including gasoline, jet fuel and diesel fuel through a third-party pipeline system, which serves western Washington and Portland, Oregon. We also deliver refined products through our marine terminal via ships and barges to West Coast and Pacific Rim markets.

Terminals.  We operate truck terminals for distillates, propane and asphalt at our Washington refinery and a refined products terminal at Port Angeles, Washington, all of which are supplied primarily by our refinery. Additionally, our Washington refinery is the primary supplier to TLLP's Vancouver, Washington terminal. We also distribute refined products through third-party terminals in our market areas, and through purchases and exchange arrangements with other refining and marketing companies.

Alaska

Refining.  Our 72 Mbpd Alaska refinery is located on the Cook Inlet near Kenai on approximately 450 acres about 60 miles southwest of Anchorage. Our Alaska refinery processes crude oil from Alaska and foreign locations. The refinery's major processing units include crude distillation, vacuum distillation, distillate hydrocracking, hydrotreating, naphtha reforming, diesel desulfurizing and light naphtha isomerization units, which produce transportation fuels, including gasoline and gasoline blendstocks, jet fuel and diesel fuel, as well as other products, including heating oil, heavy fuel oils, liquefied petroleum gas and asphalt.

Transportation.  We receive crude oil into our Kenai marine terminal by tanker and through our owned and operated crude oil pipeline. Our crude oil pipeline is a 24-mile common-carrier pipeline 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 TLLP and third-party terminal facilities in Anchorage and to the Anchorage International Airport. This 69-mile pipeline has the capacity to transport approximately 48 Mbpd of refined products and allows us to transport gasoline, diesel fuel and jet fuel. Both of our owned pipelines are subject to regulation by various state and local agencies. We also deliver refined products through our Kenai marine terminal and from the Port of Anchorage marine facility to customers via ships and barges.

Terminals.  We operate a refined products terminal at Nikiski, which is supplied by our Alaska refinery. Additionally, our Alaska refinery supplies fuels to TLLP's Anchorage terminal. We also distribute refined products through a third-party terminal, which is supplied through an exchange arrangement with another refining company.

Mid-Pacific Refinery

Hawaii

We announced in January 2012 that we intend to sell our Hawaii operations as part of a previously announced strategy to focus on the Mid-Continent and West Coast markets. The assets for sale include the Kapolei refinery, 32 retail stations and the associated logistical assets.

Refining.  Our 94 Mbpd Hawaii refinery is located in Kapolei on approximately 130 acres about 20 miles west of Honolulu. We supply the refinery with crude oil from South America, Southeast Asia, the Middle East, Russia and other foreign sources. The refinery's major processing units include crude distillation, vacuum distillation, visbreaking, hydrocracking, hydrotreating, and naphtha reforming units, which produce gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils, liquefied petroleum gas and asphalt.

Transportation.  We transport crude oil to Hawaii in tankers, which discharge through our single-point mooring, approximately two miles offshore from the refinery. Our three underwater pipelines from the single-point mooring allow crude oil and refined products to be transferred to and from the refinery. We own and operate a refined products pipeline from our Hawaii refinery to the Sand Island terminal, which we operate, and to third-party terminals on the island of Oahu. Furthermore, our four refined products pipelines connect the Hawaii refinery to Barbers Point Harbor, approximately three miles away, where refined products are loaded on ships and barges to transport to the neighboring islands. The Barbers Point Harbor pipelines are also connected to other third-party origination and destination points.

Terminals.  We operate refined products terminals on Maui and on the Big Island of Hawaii and operate a diesel terminal on Oahu. We also have an aviation fuel terminal on Kauai, and distribute refined products from our refinery to customers through third-party terminals in our market areas.


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Mid-Continent Refineries

North Dakota

Refining.  Our 58 Mbpd North Dakota refinery is located on the Missouri River near Mandan on approximately 950 acres. We supply the refinery primarily with crude oil produced from the Bakken Shale/Williston Basin. The refinery also has the ability to access other crude oil supplies, including Canadian crude oil. The refinery's major processing units include crude distillation, fluid catalytic cracking, naphtha reforming, hydrotreating and alkylation units, which produce transportation fuels, including gasoline, diesel fuel and jet fuel, as well as other products, including heavy fuel oils and liquefied petroleum gas.

We are expanding our North Dakota refinery's crude oil throughput capacity from 58 Mbpd to 68 Mbpd by the end of the second quarter of 2012. We expect to supply the plant with additional crude oil from the burgeoning crude oil production in the nearby Bakken Shale/Williston Basin area via the Tesoro High Plains System.

Transportation.  Our North Dakota refinery's crude oil supply is gathered and transported to us by TLLP's High Plains System. This system includes both pipeline and truck gathered barrels and can also supply crude oil from other sources, including Canada, through third-party pipeline connections.

We distribute a significant portion of our refinery’s production through a third-party refined products pipeline system, which serves various areas from Mandan, North Dakota to Minneapolis, Minnesota. Most of the gasoline and distillate products from our refinery can be shipped through that pipeline system to third-party terminals.

Terminals.  We distribute our refined products through TLLP's terminal at our North Dakota refinery and through third-party terminals in our market area.

Utah

Refining.  Our 58 Mbpd Utah refinery is located in Salt Lake City on approximately 150 acres. Our Utah refinery processes crude oils primarily from Utah, Colorado, Wyoming and Canada. The refinery's major processing units include crude distillation, fluid catalytic cracking, naphtha reforming, hydrotreating and alkylation units, which produce transportation fuels, including gasoline, diesel fuel and jet fuel, as well as other products, including heavy fuel oils and liquefied petroleum gas. We intend to make capital improvements to the Utah refinery designed to improve yields of gasoline and diesel, improve the flexibility of processing crude feedstocks, and increase throughput capacity by 4 Mbpd.

Transportation.  Our Utah refinery receives crude oil primarily through third-party pipelines from oil fields in Utah, Colorado, Wyoming and Canada. We use proprietary trucking to supply the remainder of our Utah refinery's crude oil requirements. We distribute the refinery's production through a system of both TLLP and third-party terminals and third-party pipeline systems, primarily in Utah, Idaho and eastern Washington, with some refined products delivered by truck to Nevada and Wyoming.

Terminals.  We distribute our refined products through TLLP's terminals, including one adjacent to the refinery and two others located in Boise and Burley, Idaho as well as third-party terminals.


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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. We currently sell over 300 Mbpd in the wholesale market primarily through independent unbranded distributors that sell refined products purchased from us through 76 owned and third-party terminals. Our bulk sales are primarily to independent unbranded distributors, other refining and marketing companies, utilities, railroads, airlines and marine and industrial end-users. These products are distributed by pipelines, ships, barges, railcars and trucks. Our sales include refined products that we manufacture, purchase or receive through exchange arrangements. Our refined product sales, including intersegment sales to our retail operations, were as follows:
 
 
2011
 
2010
 
2009
Refined Product Sales (Mbpd)
 
 
 
 
 
 
Gasoline and gasoline blendstocks
 
341

 
288
 
306
Jet fuel
 
91

 
92
 
84
Diesel fuel
 
143

 
116
 
121
Heavy fuel oils, residual products and other
 
85

 
76
 
85
Total Refined Product Sales
 
660

 
572
 
596

Gasoline and Gasoline Blendstocks.  We sell gasoline and gasoline blendstocks in both the bulk and wholesale markets in the western United States. The demand for gasoline is seasonal in many of these markets, with lowest demand typically during the winter months. We sell gasoline to wholesale customers and several other refining and marketing companies under various supply agreements and exchange arrangements. We sell, at wholesale, to unbranded distributors and high-volume retailers, and we distribute refined product through owned and third-party terminals.

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 in Hawaii and North Dakota.

Diesel Fuel.  We sell diesel fuel 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. We are able to manufacture Ultra-Low Sulfur Diesel (“ULSD”) at all of our refineries and we currently are the sole producer of ULSD in Hawaii.

Heavy Fuel Oils and Residual Products.  We sell heavy fuel oils to other refiners, 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 in Washington and Portland in Oregon, and through our refinery terminals in Washington, Alaska and Hawaii. Our Martinez and Los Angeles refineries produce petroleum coke that we sell primarily to industrial end-users. Tesoro is also a supplier of liquid asphalt for paving and construction companies in Washington, Alaska and Hawaii.

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


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RETAIL
Tesoro's Branded Retail Network

We sell gasoline and diesel fuel in the western United States through company-operated retail stations and agreements with third-party branded dealers and distributors (or “jobber/dealers”). Our retail network provides a committed outlet for a portion of the transportation fuels produced by our refineries. Many of our company-operated retail stations include convenience stores that sell a wide variety of merchandise items. As of December 31, 2011, our retail segment included a network of 1,175 branded retail stations under the Tesoro®, Shell® and USA GasolineTM brands. Our retail stations (summarized by type and brand) were located in the following states as of December 31, 2011:
 
 
Type
 
Brand
State
 
Company-Operated
 
Jobber/Dealer
 
Total
 
Tesoro (a)
 
Shell®
 
USA Gasoline ™
 
Total
California
 
252

 
192

 
444

 

 
363

 
81

 
444

Minnesota
 

 
174

 
174

 
70

 
104

 

 
174

Idaho
 
6

 
117

 
123

 
26

 
94

 
3

 
123

Utah
 
28

 
66

 
94

 
42

 
48

 
4

 
94

North Dakota
 

 
89

 
89

 
89

 

 

 
89

Alaska
 
29

 
47

 
76

 
75

 

 
1

 
76

South Dakota
 

 
55

 
55

 
7

 
48

 

 
55

Washington
 
22

 
18

 
40

 
28

 

 
12

 
40

Hawaii
 
29

 
3

 
32

 
32

 

 

 
32

Nevada
 
1

 
12

 
13

 
1

 
11

 
1

 
13

Oregon
 
2

 
11

 
13

 
2

 
10

 
1

 
13

Other states (b)
 
7

 
15

 
22

 
1

 
14

 
7

 
22

Total
 
376

 
799

 
1,175

 
373

 
692

 
110

 
1,175

____________
(a) The Tesoro brand includes stores operated under the Tesoro®, Tesoro Alaska® and 2-Go Tesoro® brand names.
(b) Other states include Iowa, New Mexico, Colorado, Nebraska, Wisconsin, Wyoming and Arizona.


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The following table summarizes our retail operations:
 
 
2011
 
2010
 
2009
 
 
 
 
 
 
 
Fuel Revenues (in millions)
 
 
 
 
 
 
Company-operated
 
$
2,728

 
$
2,196

 
$
1,877

Jobber/dealer
 
2,367

 
1,387

 
1,123

Total Fuel Revenues
 
$
5,095

 
$
3,583

 
$
3,000

 
 
 
 
 
 
 
Number of Branded Retail Stations (end of year)
 
 
 
 
 
 
Company-operated
 
376

 
381

 
387

Jobber/dealer
 
799

 
499

 
499

Total Retail Stations
 
1,175

 
880

 
886

 
 
 
 
 
 
 
Average Number of Branded Retail Stations (during the year)
 
 
 
 
 
 
Company-operated
 
377

 
383

 
388

Jobber/dealer
 
780

 
499

 
487

Total Average Retail Stations
 
1,157

 
882

 
875

 
 
 
 
 
 
 
Fuel Sales (millions of gallons)
 
 
 
 
 
 
Company-operated
 
733

 
739

 
746

Jobber/dealer
 
793

 
597

 
583

Total Fuel Sales
 
1,526

 
1,336

 
1,329


Retail Acquisitions

During 2011, we entered into agreements to expand our network of retail stations with the addition of 290 stations between 2012 and 2014, as part of our commitment to enhancing integration and growing our marketing business.

We entered into an agreement with SUPERVALU, Inc. in September 2011, to acquire approximately 50 retail stations located primarily in Washington, Oregon, California, Nevada, Idaho, Utah and Wyoming. In January 2012, we completed the acquisition for a total purchase price of approximately $36 million, including inventories of approximately $3 million. We assumed the obligations under the seller's leases and other agreements arising after the closing date. SUPERVALU, Inc. retained certain pre-closing liabilities, including environmental matters. We expect total fuels sales of approximately 5 Mbpd.

We entered into an agreement with Thrifty Oil Co. and certain of its affiliates effective August 2011, to lease approximately 240 retail stations located primarily in southern California, for an aggregate amount of approximately $25 million annually. We estimate that these stations will provide an additional 20-25 Mbpd of ratable off-take for our refining system after we invest approximately $30 million to rebrand the network. Each retail station lease is for an initial term of 10 years, with the option to renew for two additional five-year terms. We are scheduled to take possession of the retail stations in a phased transition, with approximately 190 stations taken during the course of 2012 and the balance to come during 2014.

COMPETITION

The refining industry is highly competitive. Our competitors include a number of companies that have greater financial and other resources. We compete in the world market for the crude oil and feedstocks we process, and then we compete for the customers who purchase our refined products. The availability and cost of crude oil and other feedstocks, as well as the prices of the products we produce, are heavily influenced by global supply and demand dynamics. We obtain all of our crude oil from third-party sources and compete with other refiners for these supplies. We compete with a number of major, integrated multi-national oil companies who can supply their refineries with crude oil from their own production.

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We sell gasoline through our network of retail stations and on a wholesale basis. We sell most of our distillate production through wholesale channels. We compete with other refiners and with importers for customers in most of our market areas. Competition and concentrations specific to each of our refineries are as follows:

Our Martinez, Los Angeles and Washington refineries compete with several refiners in the contiguous West Coast states. When foreign demand exceeds domestic demand, products are exported from the West Coast to other parts of the world. Our exports to foreign markets significantly increased from 2010 to 2011. When regional demand exceeds supply, products are imported to the West Coast from other parts of the country and the world. These include imports from the Gulf Coast as well as foreign sources such as the Far East, Europe and Canada.
Our Alaska refinery competes with three other in-state refineries that together have a crude oil processing capacity of approximately 294 Mbpd. It also competes with refineries on the West Coast. Our jet fuel sales in Alaska are concentrated in Anchorage, where we are one of the principal suppliers at the Anchorage International Airport.
Our Hawaii refinery competes primarily with one other in-state refinery, also located in Kapolei. It is owned by a major integrated oil company and has a crude oil capacity of approximately 54 Mbpd. All crude oil processed in Hawaii is from out of state. Product imports from the U.S. mainland and foreign sources are also required to meet the state's fuel demand. Our jet fuel sales are concentrated at the Honolulu International Airport, where we are the principal supplier. We serve five airports on other Hawaiian islands and compete with other suppliers for U.S. military contracts.
Our North Dakota refinery is the only refinery in the state and primarily competes with refineries in Wyoming, Montana, the Midwest and with pipeline supply from the Gulf Coast region. The Midwest region ranks second among the regions in crude oil throughput in the United States. This region produces crude oil from the Bakken Shale/Williston Basin and imports crude oil from Canada.
Our Utah refinery is the largest of five refineries located in Utah. The other refineries have a combined capacity to process approximately 110 Mbpd of crude oil. These five refineries collectively supply a high proportion of the gasoline and distillate products consumed in the states of Utah and Idaho, with additional supplies provided from refineries in surrounding states.

Our retail marketing operations compete with other independent marketers, integrated oil companies and high-volume retailers. We sell gasoline in California, Minnesota, Idaho, Utah, North Dakota and other western states through a network of company-operated retail stations and branded and unbranded jobber/dealers. Competitive factors that affect retail marketing include product price, station appearance, location and brand awareness. Large national retailers as well as regional retailers continue to enter the fuel retail business. Many of these competitors are substantially larger than we are and through their greater resources may be better able to withstand volatile market conditions and low profitability.

GOVERNMENT REGULATION AND LEGISLATION

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 land, 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, we will continue to engage in efforts to meet new legislative and regulatory requirements applicable to our operations. Compliance with these laws and regulations may require us to make significant expenditures. For example, the U.S. Environmental Protection Agency (“EPA”) has proposed multiple regulations to control greenhouse gas emissions under the Federal Clean Air Act. The U.S. Congress may also consider legislation regarding greenhouse gas emissions in the future. The Energy and Security Independence Act of 2007 mandates the blending of increasing amounts of renewable fuels annually in the supply of transportation fuels used domestically. This use of renewable fuels is required of all manufacturers of transportation fuels sold domestically. The EPA implements the renewable fuel standard (“RFS2”) through regulation and requires transportation fuel manufacturers to provide proof of purchase of these renewable fuels. The costs associated with RFS2 compliance are uncertain and fluctuate with market dynamics.

The impact of these regulatory and legislative developments, if enacted or implemented, or both, is likely to result in increased compliance costs, additional operating restrictions on our business and an increase in the cost of the products we manufacture. Depending on market conditions, we will attempt to pass these costs on to consumers. If that is not possible, the changes could have an adverse impact on our financial position, results of operations, and liquidity. We cannot currently determine the amounts of such future impacts. For additional information regarding our environmental matters see “Environmental and Other Matters” in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7.

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Oil Spill Prevention and Response

We operate in environmentally sensitive coastal waters, where tanker, pipeline and other petroleum product transportation operations are regulated by federal, state and local agencies and monitored by environmental interest groups. The transportation of crude oil and refined products 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 petroleum 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. We frequently review and modify our oil spill prevention plans and procedures to prevent crude oil and refined product releases and to minimize potential impacts should a release occur.

We currently use time charter tankers to ship crude oil from foreign and domestic sources to our California, Mid-Pacific and Pacific-Northwest refineries. The tanker owners contract with Federally Certified Oil Spill Response Organizations (“OSROs”) to comply with federal, state and local requirements, except in Alaska where we contract with the OSROs. The OSROs are capable of responding to an oil spill equal to the greatest tanker volume delivering crude oil to our refineries. Those volumes range from 350,000 barrels at our California refineries to one million barrels at our Hawaii refinery.

We have entered into spill-response contracts with various OSROs to provide spill-response services, if required, to respond to a spill of oil originating from our facilities. We have spill-response agreements in Alaska with Cook Inlet Spill Prevention and Response, Incorporated and with Alyeska Pipeline Service Company. We have a spill-response services agreement in Hawaii with Clean Islands Council. We also have entered into contracts with Marine Spill Response Corporation for Hawaii, the San Francisco Bay, Puget Sound, the Port of Los Angeles and the Port of Long Beach; and the Clean Rivers Cooperative, Inc. for the Columbia River, and Bay West, Inc. in our Mid-Continent region. These OSROs are capable of responding to an oil spill on water equal to the greatest volume above ground storage tank at our facilities or pipelines. Those volumes range from 50,000 to 600,000 barrels. We also contract with two spill-response organizations outside the U.S. to support our shipments in foreign waters. In addition, we contract with various spill-response specialists to ensure appropriate expertise is available for any contingency. We believe these contracts provide the additional services necessary to meet or exceed all regulatory spill-response requirements and support our commitment to environmental stewardship.

The OSROs are rated and certified by the United States Coast Guard and are required to annually demonstrate their response capability to the United States Coast Guard and state agencies. The OSROs rated and certified to respond to open water spills must demonstrate the capability to recover up to 50,000 barrels of oil per day and store up to 100,000 barrels of recovered oil at any given time. The OSROs rated and certified to respond to inland spills must demonstrate the capability to recover from 1,875 to 7,500 barrels of oil per day and store from 3,750 to 15,000 barrels of recovered oil at any given time. We maintain our own spill-response resources to mitigate the impact of a spill from a tanker at our refineries until an OSRO can deploy its resources. Our spill response capability meets the United States Coast Guard and state requirements to either deploy on-water containment equipment two and one-half times the length of a vessel at our dock or have smaller vessels available to recover 50 barrels of oil per day and store 100 barrels of recovered oil at any given time.

The services provided by the OSROs principally consist of operating response-related equipment, managing certain aspects of a response and providing technical expertise. The OSROs provide various resources in response to an oil spill. The resources include dedicated vessels that have skimming equipment to recover oil, storage barges to temporarily store recovered oil, containment boom to control the spread of oil on water and land and to protect shorelines, and various pumps and other equipment supporting oil recovery efforts and the protection of natural resources. The OSROs have full-time personnel and contract with third-parties to provide additional personnel when needed.

As a general matter, our agreements with these organizations do not contain specific physical or financial limitations. General physical limitations of these organizations would include the geographical area for which services are available and the amount of resources available at the initiation of a request for services or the duration of response and recovery efforts.

Additionally, we require all tankers and barges engaged in moving crude oil, heavy and finished products to be double hulled. All vessels used by us to transport crude oil and refined products over water are examined or evaluated and subject to our approval prior to their use.


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Regulation of Pipelines

Our pipeline systems in Alaska are common carriers subject to tariff regulation by various state and local agencies. Operations on portions of our pipelines are regulated by the U.S. Department of Transportation in Alaska, California and Hawaii.

The intrastate operations of our Alaska pipelines are subject to regulation by the Regulatory Commission of Alaska. The state regulatory authorities require that we notify shippers of proposed tariff increases to provide the shippers an opportunity to protest the increases. 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.

WORKING CAPITAL

We fund our business operations through a combination of available cash and equivalents and cash flows generated from operations. In addition, our revolving lines of credit are available for additional working capital needs. For additional information regarding working capital see the “Capital Resources and Liquidity” section in Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7.

SEASONALITY

Generally, demand for gasoline is higher during the spring and summer months than during the fall and winter months in most of our markets due to seasonal changes in highway traffic. As a result, our operating results for both the refining and retail segments for the first and fourth quarters are generally lower than for those in the second and third quarters.

EMPLOYEES

At December 31, 2011, we had approximately 5,400 full-time employees - approximately 1,350 of whom are covered by collective bargaining agreements. The agreements expired on January 31, 2012 for approximately 1,076 employees, and will expire on February 29, 2012 for approximately 29 employees and April 30, 2012 for approximately 249 employees. We expect these agreements to be renewed in 2012 however, we are currently in negotiations with hourly represented employees at our Anacortes, Hawaii, Mandan, Martinez and Salt Lake City refineries and there is no assurance an agreement will be reached without a strike, work stoppage or other labor action at any of these locations.

PROPERTIES

Our principal properties are described above under the captions “Refining” and “Retail.” We believe that our properties and facilities are adequate for our operations and that our facilities are adequately maintained. We are the lessee under a number of cancellable and noncancellable 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®, Shell® and USA GasolineTM brands through a network of 1,175 retail stations, of which 376 are company-operated. See Notes L and P to our consolidated financial statements in Item 8.


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GLOSSARY OF TERMS

Alkylation - A process that chemically combines isobutane with other 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.

API - American Petroleum Institute - the main U.S trade association for the oil and natural gas industry.

API Gravity - A scale for denoting the lightness or heaviness of crude oils and other liquid hydrocarbons. Calibrated in API degrees (or degrees API), it is used universally to express a crude oil's relative density in an inverse measure - the lighter the crude, the higher the API gravity, and vice versa.

CARB  - California Air Resources Board - Gasoline and diesel fuel sold in the state of California are regulated by CARB and require stricter quality and emissions reduction performance than required by other states.

Cracking - The process of breaking down larger hydrocarbon molecules into smaller molecules, using catalysts and/or elevated temperatures and pressures.

Deasphalting - A solvent extraction process of recovering higher-value oils from refining residues.

Delayed Coking - 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.

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

Exchange Arrangement - An agreement providing for the delivery of crude oil or refined products to a third party, in exchange for the delivery of crude oil or refined products from the third party.

Fluid Catalytic Cracking - A process that breaks down 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. Fluid catalytic cracking uses a catalyst in the form of very fine particles, which behave as a fluid when aerated with a vapor.

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 API gravity of 24 degrees or less. Heavy crude oils are generally sold at a discount to lighter crude oils.

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

Hydrocracking - A process that uses 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 - A process that removes sulfur from refined products in the presence of catalysts and substantial quantities of hydrogen to reduce sulfur dioxide emissions that result from the use of the products.

Isomerization - A 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 us and carry one of our brands.

Light Crude Oil - Crude oil with an API gravity greater than 24 degrees. Light crude oils are generally sold at a premium to heavy crude oils.



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

Mbpd - Thousand barrels per day.

Naphtha - Refined product 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 process that uses controlled heat and pressure with catalysts to rearrange certain hydrocarbon molecules 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 calculated as revenues less cost of sales. Cost 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 the unit.

Ultra-Low Sulfur Diesel (ULSD)  - Diesel fuel produced with lower sulfur content to lower emissions, which is required for on-road use in the U.S.

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 unit residues are cracked at moderate temperatures to increase production of distillate products and reduce viscosity of the distillate residues.































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EXECUTIVE OFFICERS OF THE REGISTRANT

The following is a list of our executive officers, their ages and their positions at Tesoro, effective as of February 16, 2012.
Name
 
Age
 
Position
 
Position Held Since
Gregory J. Goff
 
55
 
President and Chief Executive Officer
 
May 2010
Daniel R. Romasko
 
48
 
Executive Vice President, Operations
 
March 2011
Charles S. Parrish
 
54
 
Executive Vice President, General Counsel and Secretary
 
April 2009
G. Scott Spendlove
 
48
 
Senior Vice President, Chief Financial Officer
 
May 2010
Claude A. Flagg
 
58
 
Senior Vice President, Strategy and Business Development
 
November 2010
David K. Kirshner
 
55
 
Senior Vice President, Commercial
 
October 2011
Arlen O. Glenewinkel, Jr.
 
55
 
Vice President and Controller
 
December 2006
Tracy D. Jackson
 
42
 
Vice President and Treasurer
 
February 2011

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 in conjunction with 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 are described below (positions, unless otherwise specified, are with Tesoro).

Gregory J. Goff was named President and Chief Executive Officer in May 2010. Before joining Tesoro, he has served as Senior Vice President, Commercial for ConocoPhillips Corporation (“ConocoPhillips”), an international, integrated energy company, from 2008 until 2010. Mr. Goff held various other positions at ConocoPhillips beginning in 1981, including President of ConocoPhillips specialty businesses and business development from 2006 to 2008; President of ConocoPhillips U.S. Lower 48 and Latin America exploration and production business from 2004 to 2006; President of ConocoPhillips Europe and Asia Pacific downstream from 2002 to 2004; Chairman and Managing Director of Conoco Limited, a UK-based refining and marketing affiliate, from 2000 to 2002; and director and CEO of Conoco JET Nordic from 1998 to 2000.

Daniel R. Romasko was named Executive Vice President, Operations in March 2011. Prior to that he served as Vice President, Operations Integrity and Vice President, Technical Operations and Competence at Suncor Energy, an integrated energy company. Mr. Romasko also worked for Petro-Canada, an oil and natural gas company, from July 2007 to August 2009 as the General Manager of their Fort Hills syncrude operations, which merged with Suncor in 2009. Prior to joining Suncor, Mr. Romasko spent 20 years with ConocoPhillips, an international energy company with downstream operations. At ConocoPhillips he held leadership positions in transportation, pipeline, supply and trading, and global specialty products and built extensive experience in refining, including most recently serving as Operations Manager for the Borger, Texas refinery from April 2004 to July 2007.

Charles S. Parrish was named Executive Vice President, General Counsel and Secretary in April 2009. Prior to that, he served as Senior Vice President, General Counsel and Secretary beginning in May 2006; Vice President, General Counsel and Secretary beginning in March 2005 and as Vice President, Assistant General Counsel and Secretary beginning in November 2004.

G. Scott Spendlove was named Senior Vice President and Chief Financial Officer in May 2010. From May 2010 until February 2011, he also assumed responsibilities as Treasurer. Prior to that, he served as Senior Vice President, Risk Management beginning in June 2008, Vice President, Asset Enhancement and Planning beginning in August 2007, Vice President, Strategy and Long-Term Planning beginning in December 2006 and Vice President and Controller beginning in March 2006. Mr. Spendlove also served as Vice President, Finance and Treasurer beginning in March 2003 and Vice President, Finance beginning in January 2002.

Claude A. Flagg was named Senior Vice President, Strategy and Business Development in November 2010.  Prior to being in his current position, he served as Senior Vice President, System Optimization beginning in February 2005.  He joined Tesoro in January 2005 as Senior Vice President of Planning and Optimization. 

David K. Kirshner was named Senior Vice President, Commercial in October 2011. Prior to joining Tesoro, he served as Vice President, Supply, Trading and Transportation for Hess Corporation beginning in 2001.

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.

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Tracy D. Jackson was named Vice President and Treasurer in February 2011. Ms. Jackson served as the Company's Treasurer starting in November 2010 and the Vice President of Internal Audit beginning in May 2007. Prior to that, she served as Executive Director of Internal Audit at Valero Corporation beginning in May 2005.

BOARD OF DIRECTORS OF THE REGISTRANT

The following is a list of our Board of Directors, effective as of February 16, 2012:
Steven H. Grapstein
 
Non-Executive Chairman of the Board of Tesoro Corporation; Chief Executive Officer of Como Holdings USA, Inc.
Rodney F. Chase
 
Chairman of the Audit Committee of Tesoro Corporation; Non-Executive Chairman of Genel Energy plc; Director of Computer Sciences Corporation
Gregory J. Goff
 
President and Chief Executive Officer of Tesoro Corporation; Chairman of the Board of Tesoro Logistics, LP; Director of Polyone Corporation
Robert W. Goldman
 
Chairman of the Governance Committee of Tesoro Corporation; Director of El Paso Corporation; Director of The Babcock & Wilcox Company; Director of Parker Drilling Co.
David Lilley
 
Former Chairman, President and Chief Executive Officer of Cytec Industries, Inc.; Director of Rockwell Collins, Inc.; Director of Public Service Enterprise Group Incorporated
J.W. Nokes
 
Chairman of the Environmental, Health and Safety Committee of Tesoro Corporation; Retired Executive Vice President for ConocoPhillips; Director of Post Oak Bank (Houston, Texas); Non-Executive Chairman of Albemarle Corporation
Susan Tomasky
 
Former President of AEP Transmission, a division of American Electric Power Company, Inc.; Director of BPL Global, Ltd.
Michael E. Wiley
 
Chairman of the Compensation Committee of Tesoro Corporation; Retired Chairman, President and Chief Executive Officer of Baker Hughes, Inc.; Trustee of Fidelity Funds; Director of Bill Barrett Corporation
Patrick Y. Yang
 
Head of Global Technical Operations for F. Hoffman-La Roche Ltd.


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ITEM 1A. RISK FACTORS

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.

Earnings and cash flows from our refining and wholesale marketing operations depend on a number of factors, including to a large extent the cost of crude oil and other refinery feedstocks which has fluctuated significantly in recent years. While prices for refined products are influenced by the price of crude oil, the constantly changing margin between the price we pay for crude oil and other refinery feedstocks, and the prices at which we are able to sell refined products, also fluctuates significantly from time to time. 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:

changes in the global economy and the level of foreign and domestic production of crude oil and refined products;
availability of crude oil and refined products and the infrastructure to transport crude oil and refined products;
local factors, including market conditions, the level of operations of other refineries in our markets, and the volume of refined products imported;
threatened or actual terrorist incidents, acts of war, and other global political conditions;
government regulations; and
weather conditions, hurricanes or other natural disasters.

In addition, 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 impact 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.

Adverse changes in global economic conditions and the demand for transportation fuels may impact our business and financial condition in ways that we currently cannot predict.

The U.S. economic recovery from the recent recession continues to be tenuous, and the risk of further significant global economic downturn continues. Further prolonged downturns or failure to recover could result in declines in consumer and business confidence and spending as well as increased unemployment and reduced demand for transportation fuels. This continues to adversely affect the business and economic environment in which we operate, especially on the U.S. West Coast. These conditions increase the risks associated with the creditworthiness of our suppliers, customers and business partners. The consequences of such adverse effects could include interruptions or delays in our suppliers' performance of our contracts, reductions and delays in customer purchases, delays in or the inability of customers to obtain financing to purchase our products, and bankruptcy of customers. Any of these events may adversely affect our cash flow, profitability and financial condition.

Competition from integrated oil companies that produce their own supply of feedstocks and from high volume retailers and large convenience store retailing operators who may have greater financial resources, could materially affect our business, financial condition and results of operations.

We compete on a global basis with a number of integrated and nationally owned oil companies who produce crude oil, some of which is used in their refining operations. Unlike these oil companies, we must purchase all of our crude oil from unaffiliated sources. Because these oil companies benefit from increased commodity prices, have greater access to capital and have stronger capital structures, they are able to better withstand poor and volatile market conditions, such as a lower refining margin environment, shortages of crude oil and other feedstocks or extreme price fluctuations. In addition, we compete with producers and marketers in other industries that supply alternative forms of energy and fuels to satisfy the requirements of our industrial, commercial and individual customers.


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We also face strong competition in the fuel and convenience store retailing market for the sale of retail gasoline and convenience store merchandise. Our competitors include service stations operated by integrated major oil companies and well-recognized national high volume retailers or regional large chain convenience store operators, often selling gasoline or merchandise at aggressively competitive prices.

Some of these competitors may have access to greater financial resources, which may provide them with a better ability to bear the economic risks inherent in all phases of our industry. Fundamental changes in the supply dynamics of foreign product imports could lead to reduced margins for the refined products we market, which could have an adverse effect on the profitability of our fuel retailing business.

Meeting the requirements of evolving environmental, health and safety laws and regulations including those related to climate change could adversely affect our performance.

Consistent with the experience of other U.S. refiners, 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, we may be required to address conditions that may be discovered in the future and require a response. Also, potentially material expenditures could be required in the future as a result of evolving environmental, health and safety, and energy laws, regulations or requirements that may be adopted or imposed in the future. Future developments in federal and state laws and regulations governing environmental, health and safety and energy matters are especially difficult to predict.

Currently, multiple legislative and regulatory measures to address greenhouse gas emissions (including carbon dioxide, methane and nitrous oxides) are in various phases of consideration, promulgation or implementation. These include requirements effective in January 2010 to report emissions of greenhouse gases to the EPA and proposed federal legislation and regulation as well as state actions to develop statewide or regional programs, each of which require or could require reductions in our greenhouse gas emissions. Requiring reductions in our greenhouse gas emissions could result in increased costs to (i) operate and maintain our facilities, (ii) install new emission controls at our facilities and (iii) administer and manage any greenhouse gas emissions programs, including acquiring emission credits or allotments.

Requiring reductions in our greenhouse gas emissions and increased use of renewable fuels could also decrease the demand for our refined products, and could have a material adverse effect on our business, financial condition and results of operations. For example:

In California, Assembly Bill 32 (“AB 32”), created a statewide cap on greenhouse gas emissions and requires that the state return to 1990 emission levels by 2020. AB 32 also created a low carbon fuel standard which would require a 10% reduction in the carbon intensity of fuels by 2020. Although a California court determined that this standard is unconstitutional in January 2012, the California Air Resources Board has appealed the decision, and we cannot predict the outcome of the pending appeal.
The U.S. Congress passed the Energy Independence and Security Act in December 2007, that created a second renewable fuels standard (“RFS2”). This standard requires the total volume of renewable transportation fuels (including ethanol and advanced biofuels) sold or introduced in the U.S. to reach 15.2 billion gallons in 2012 and rise to 36 billion gallons by 2022.
The EPA proposed regulations in 2009, that would require the reduction of emissions of greenhouse gases from light trucks and cars, and would establish permitting thresholds for stationary sources that emit greenhouse gases and require emissions controls for those sources. Promulgation of the final rule on April 1, 2010, has resulted in a cascade of related rulemakings by the EPA pursuant to the Clean Air Act relative to controlling greenhouse gas emissions.

Our operations are subject to operational hazards that could expose us to potentially significant losses.

Our operations are subject to potential operational hazards and risks inherent in refining operations and in transporting and storing crude oil and refined products. Any of these risks, such as fires, explosions, maritime disasters, security breaches, pipeline ruptures and spills, mechanical failure of equipment, and severe weather and natural disasters, at our or third-party facilities, could result in business interruptions or shutdowns and damage to our properties and the properties of others. A serious accident at our facilities 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. Any such event or unplanned shutdown could have a material adverse effect on our business, financial condition and results of operations.


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We carry property, casualty and business interruption insurance but we do not maintain insurance coverage against all potential losses. Marine vessel charter agreements do not include indemnity provisions for oil spills so we also carry marine charterer's liability insurance. 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 or failure by one or more insurers to honor its coverage commitments for an insured event could have a material adverse effect on our business, financial condition and results of operations.

While we do not act as an owner or operator of any marine tankers, we do maintain marine charterer's liability insurance with
a primary coverage of $500 million, subject to a $25,000 deductible, and an additional $500 million in umbrella policies for a total of $1 billion in coverage for liabilities, costs and expenses arising from a discharge of pollutants. In addition, Tesoro maintains $10 million in marine terminal operator's liability coverage, subject to a $150,000 deductible, and an additional $500 million in umbrella coverage for a total of $510 million in coverage for sudden and accidental pollution events and liability arising from marine terminal operations. We cannot assure you that we will not suffer losses in excess of such coverage.

Our business may be negatively affected by work stoppages, slowdowns or strikes by our employees.

Currently, approximately 1,350 of our employees are covered by collective bargaining agreements.  The agreements expired on January 31, 2012 for approximately 1,076 employees, and will expire on February 29, 2012 for approximately 29 employees and April 30, 2012 for approximately 249 employees.  We are currently in negotiations with hourly represented employees at our Anacortes, Hawaii, Mandan, Martinez and Salt Lake City refineries and there is no assurance an agreement will be reached without a strike, work stoppage or other labor action at any of these locations.  Any prolonged strike, work stoppage or other labor action at any of these locations could have an adverse effect on our financial condition or results of operations.

Our business is impacted by environmental risks inherent in refining operations.

The operation of refineries, pipelines and refined products terminals is inherently subject to the risks of spills, discharges or other inadvertent releases of petroleum or hazardous substances. These events could occur in connection with any of our refineries, pipelines or refined products terminals, or in connection with any facilities which receives our wastes or by-products for treatment or disposal. If any of these events occur, or is found to have previously occurred, we could be liable for 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 damages 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 and adjacent to environmentally sensitive coastal waters where tanker, pipeline and refined product transportation and storage 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 and storage of crude oil and refined products over and adjacent to 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 and the owners of tankers that we charter to deliver crude oil to our refineries to demonstrate in some situations the capacity to respond to a spill up to one million barrels of oil from a tanker and up to 600,000 barrels of oil from an above ground storage tank adjacent to water (a “worst case discharge”) to the maximum extent possible.

We and the owners of tankers we charter have contracted with various spill response service companies in the areas in which we transport and store 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, pipelines or above ground storage tanks transporting or storing 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. Additionally, we cannot ensure that all resources of a contracted response service company could be available for our or a chartered tanker owner's use at any given time. There are many factors that could inhibit the availability of these resources, including, but not limited to, weather conditions, governmental regulations or other global events. By requirement of state or federal rulings, these resources could be diverted to respond to other global events.

Our operations are also 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 methyl tertiary butyl ether (“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.

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We operate and have in the past operated retail stations with underground storage tanks in various jurisdictions. Federal and state regulations and legislation govern the storage tanks, and compliance with these requirements can be costly. The operation of underground storage tanks poses certain risks, including leaks. 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.

From time to time, our cash needs may exceed our internally generated cash flow, and our business could be materially and adversely affected if we are not able to obtain the necessary funds from financing activities.

We have substantial cash needs. Our short-term cash needs are primarily to satisfy working capital requirements, including crude oil purchases, which fluctuate with the pricing and sourcing of crude oil. Our longer-term cash needs also include capital expenditures for infrastructure, environmental and regulatory compliance, maintenance turnarounds at our refineries and upgrade and business strategy projects.

We generally supply our cash needs with cash generated from our operations; however, from time to time, particularly when the price of crude oil increases significantly, our cash requirements may exceed our cash flow. In such instances, we may not have sufficient borrowing capacity, and may not be able to sufficiently increase borrowing capacity under our existing credit facilities to support our short-term and long-term capital requirements. Debt and equity capital markets continue to be volatile, and we may not be able to secure additional financing on terms and at a cost acceptable to us, if at all. If we cannot generate cash flow and funding is not available when needed, or is available only on unfavorable terms, we may not be able to operate our refineries at the desired capacity, fund our capital requirements, take advantage of business opportunities, respond to competitive pressures or complete our business strategies, which could have a material adverse effect on our business, financial condition and results of operations.

Our inventory risk management activities are designed to manage the risk of volatile prices associated with our physical inventory and may result in substantial derivative gains and losses.

We enter into derivative transactions to manage the risks from changes in the prices of crude oil and refined products.  Our inventory risk management activities are designed to manage the risk stemming from the volatile prices associated with our physical inventories and may result in substantial derivatives gains and losses. We hedge price risk on inventories above or below our target levels to minimize the impact these price fluctuations have on our earnings and cash flows.  Consequently, our derivatives hedging results may fluctuate significantly from one reporting period to the next depending on commodity price fluctuations and our relative physical inventory positions.  Since we only use hedge accounting for certain foreign physical inventories that offset these derivatives transactions, we are not able under U.S. GAAP to mark the physical inventory values to market and, as a result, there is frequently a timing difference between the impact on our cash flow and earnings from the derivative transaction versus the offsetting physical inventory balance.  During the years ended December 31, 2011 and 2010, we incurred pre-tax hedging losses of $6 million and $29 million, respectively, which were recorded in the Statements of Consolidated Operations.  See “Quantitative and Qualitative Disclosures about Market Risk” in Part II, Item 7A.

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 fuel 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 their 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 Martinez refinery receives approximately one-third of its crude oil through third-party pipelines and the balance through marine vessels. Substantially all of our Martinez refinery's production is delivered through third-party pipelines, ships and barges. Our Los Angeles refinery receives California crude oils through third-party pipelines and the balance of its crude oil supply through marine vessels. Approximately two-thirds of our Los Angeles refinery's 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 products could have a material adverse effect on our business, financial condition and results of operations.


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We rely upon certain critical information systems for the operation of our business, and the failure of any critical information system may result in harm to our business. 

We are heavily dependent on our technology infrastructure and maintain and rely upon certain critical information systems for the effective operation of our business. These information systems include data network and telecommunications, internet access and our websites, and various computer hardware equipment and software applications, including those that are critical to the safe operation of our refineries, pipelines and terminals. These information systems are subject to damage or interruption from a number of potential sources including natural disasters, software viruses or other malware, power failures, cyber-attacks, and other events. To the extent that these information systems are under our control, we have implemented measures such as virus protection software, intrusion detection systems, and emergency recovery processes, to address the outlined risks. However, security measures for information systems cannot be guaranteed to be failsafe. Any compromise of our data security or our inability to use or access these information systems at critical points in time could unfavorably impact the timely and efficient operation of our business and subject us to additional costs and liabilities, which could adversely affect our results of operations.  Finally, federal legislation relating to cyber-security threats may be enacted that could impose additional requirements on our 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, 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.

Generally, demand for gasoline is higher during the spring and summer months than during the winter months in most of our markets due to seasonal changes 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.

Compliance with and changes in tax laws could adversely affect our performance.

We are subject to extensive tax laws and regulations, including federal, state, and foreign income taxes and transactional taxes such as excise, sales/use, payroll, franchise, and ad valorem taxes. New tax laws and regulations and changes in existing tax laws and regulations are continuously being enacted that could result in increased tax expenditures in the future. Many of these tax liabilities are subject to audits by the respective taxing authority. These audits may result in additional taxes as well as interest and penalties.

ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

ITEM 3. LEGAL PROCEEDINGS

In the ordinary course of business, we become party to 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 certain matters may require years to resolve. Although we cannot provide assurance, we believe that an adverse resolution of the matters described below will not have a material adverse impact on our consolidated financial position, results of operations or liquidity.


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We received an offer in January 2012, from the South Coast Air Quality Management District to settle notice of violations (“NOV”) issued by the District between December 2009 and February 2011 for $367,000. The NOVs allege violations of air quality regulations at our Los Angeles refinery. We are evaluating the District's offer but the resolution of this matter will not have a material impact on our financial position, results of operations or liquidity.

In December 2011, we agreed to settle a lawsuit filed on February 5, 2010 by the EPA alleging we violated the Clean Air Act and corresponding regulatory requirements concerning the testing and reporting of transportation fuels and fuel additives. We received a NOV from the EPA in February 2009, for the alleged violations arising from a compliance review conducted by the EPA in 2006 for the years 2003 through the time of the review in 2006. We have agreed to pay $965,000 and take certain actions, including developing protocols for collecting samples from and mixing refined products in storage tanks, to settle this matter pending execution of the settlement agreement. The ultimate resolution of this matter will not have a material impact on our financial position, results of operations or liquidity.

We received notice from the California Attorney General in February 2011, that the State Water Resources Control Board referred an investigation to the Attorney General alleging violations of the California Health and Safety Code at twelve of our retail gasoline stations. The allegations relate to the testing, monitoring, repairing and reporting of information concerning the underground storage tanks at the stations. In November 2011, we settled this matter for $325,000.

We are a defendant, along with other manufacturing, supply and marketing defendants, in five remaining lawsuits, as one was settled in 2011, alleging MTBE contamination in groundwater. The defendants are being sued for having manufactured MTBE and having manufactured, supplied and distributed gasoline containing MTBE. The plaintiffs in the five cases, all in California, are municipalities and governmental authorities. The plaintiffs allege, in part, that 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 intend to vigorously assert our defenses against these claims. In December 2011, we reached agreement to settle two of the remaining five lawsuits pending a court's approval of the settlement. While we cannot currently estimate the amount or timing of the resolution of the remaining matters, we believe that the outcome will not have a material impact on our financial position, results of operations or liquidity.
The names of the courts in which the proceedings are pending and the date instituted are as follows:
Name of Case
Name of Court where proceeding is pending
Date Instituted
City of Fresno v. Chevron USA Inc., et al., Tesoro Petroleum Corporation and Tesoro Refining and Marketing Company, Inc.
United States District Court of Southern District of New York
October 29, 2004
Orange County Water District v. Unocal Corporation et al., Tesoro Petroleum Corporation and Tesoro Refining and Marketing Company, Inc.
United States District Court of Southern District of New York
October 28, 2004
City of Pomona v. Chevron USA Inc., Tesoro Corporation and Tesoro Refining and Marketing Inc.
United States District Court of Southern District of New York
January 16, 2009
Great Oaks Water Company v. USA Petroleum Corporation, et al., Tesoro Corporation and Tesoro Refining and Marketing Company
Superior Court of California, County of Santa Clara
January 4, 2010
City of Santa Barbara v. Chevron USA, Inc., et al., Tesoro Refining and Marketing Company
Superior Court of California, County of Contra Costa
April 6, 2010

We received a NOV from the California State Water Quality Control Board in November 2011, alleging violations of the California Health and Safety Code as a result of a release of naphtha from a tank at our Los Angeles refinery. The Board proposed a penalty of $488,500 in January 2012. We are evaluating the NOV and proposed penalty but the ultimate resolution of this matter will not have a material impact on our financial position, results of operations or liquidity.
 
We settled 46 NOVs received from the Bay Area Air Quality Management District (the “District”) for $497,000 in July 2011. We had received an offer from the District to settle the NOVs issued from June 2006 to September 2009 and alleging violations of air quality regulations at our Martinez refinery in July 2010. This settlement resolves all of the NOVs received from the District through September 2009 and the resolution will not have a material impact on our financial position, results of operations or liquidity.

We received a NOV from the California Air Resources Board (“CARB”) in April 2011. The CARB alleges certain batches of fuels produced in 2009 and 2010 at our Martinez and Los Angeles refineries violated fuel standards within the California Code of Regulations. We are investigating the allegations but believe the ultimate resolution of the NOV will not have a material impact on our financial position, results of operations or liquidity.

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The EPA has alleged that we have violated the Clean Air Act, regulations under the Clean Air Act and/or Clean Air Act permits at our Alaska, Washington, Martinez, Hawaii and Utah refineries. We are continuing discussions of the EPA's claims with the EPA and the U.S. Department of Justice (“DOJ”). We previously received a NOV in March 2011, from the EPA alleging violations of Title V of the Clean Air Act at our Alaska refinery. The alleged violations in the NOV arise from a 2007 state of Alaska inspection and inspections by the EPA in 2008 and 2010. We also previously received NOVs in 2005 and 2008 alleging violations of the Clean Air Act at our Washington refinery. We are evaluating all of these allegations. The ultimate resolution of these matters could require us to incur material capital expenditures and/or civil penalties. While we cannot currently estimate the amount or timing of the resolution of these matters, and currently believe that the outcome of these matters will not have a material impact on our liquidity or financial position, the ultimate resolution could have a material impact on our interim or annual results of operations.

The naphtha hydrotreater unit at our Washington refinery was involved in a fire in April 2010, which fatally injured seven employees and rendered the unit inoperable. The Washington State Department of Labor & Industries (“L&I”), the U.S. Chemical Safety and Hazard Investigation Board (“CSB”) and the EPA initiated separate investigations of the incident. L&I completed its investigation in October 2010, issued citations and assessed a $2.4 million fine, which we appealed. L&I reassumed jurisdiction of the citation and affirmed the allegations in December 2010. We disagree with L&I's characterizations of operations at our Washington refinery and believe, based on available evidence and scientific reviews, that many of the agency's conclusions are mistaken. We filed an appeal of the citation in January 2011. The EPA and CSB investigations are ongoing. While we cannot currently estimate the amount or timing of the resolution of the remaining matters, we believe that the outcome will not have a material impact on our financial position, results of operations or liquidity.

In February 2011, Tesoro Corporation, Tesoro Refining and Marketing Company and other defendants were named in a lawsuit brought by the estates and families of the seven fatally injured employees arising from the April 2010 incident at our Washington refinery. In addition, a third-party truck driver has alleged damages in the lawsuit. The lawsuit includes allegations of negligence, premises liability, strict liability, product liability and seeks unspecified compensatory and punitive damages. This case, Donald and Peggy Zimmerman et al. v. Tesoro Corporation and Tesoro Refining and Marketing et al., is proceeding in the Superior Court of the State of Washington, Skagit County. The Company believes that it has defenses to the allegations contained in the lawsuit. While we cannot currently estimate the amount or timing of the resolution of this matter, and currently believe that the outcome of this matter will not have a material impact on our liquidity or financial position, the ultimate resolution could have a material impact on our interim or annual results of operations.

During 2009, Chevron filed a lawsuit against us claiming they are entitled to a share of the refunds we received in 2008 from the owners of the Trans Alaska Pipeline System (“TAPS”). We received $50 million in 2008, net of contingent legal fees, for excessive intrastate rates charged by TAPS during 1997 through 2000, and the period of 2001 through June 2003. Chevron is asserting that it is entitled to a share of its portion of the refunds for retroactive price adjustments under our previous crude oil contracts with them. The trial court judge granted Chevron's motion for summary judgment and awarded them $16 million, including interest in September 2010. We disagree with the trial court and have appealed the decision to the Alaska Supreme Court in which the proceeding is now pending. We have established an accrual for this matter and believe that the outcome will not have a material impact on our financial position, results of operations or liquidity.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Performance Graph
The following performance graph and related information will not be deemed “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor will 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 (a) the cumulative total return of the S&P 500 Composite Index, (b) a composite new peer group (the “New Peer Group”) of four companies selected by Tesoro and (c) a composite peer group previously used by Tesoro (the “Old Peer Group”). The composite New Peer Group includes HollyFrontier Corporation, Marathon Petroleum, Sunoco, Inc. and Valero Energy Corporation. The graph below is for the five year period commencing December 31, 2006 and ending December 31, 2011.
The New Peer Group was selected by the Company and contains four domestic refining companies believed by the Company to follow a similar business model to that of Tesoro’s including refining, transporting, storing and marketing transportation fuels and related products. The New Peer Group is representative of companies that we internally benchmark against. The change in Peer Group from 2010 is the addition of Marathon Petroleum and HollyFrontier Corporation as a result of the merger of Holly Corporation and Frontier Oil Corporation during 2011.
Comparison of Five Year Cumulative Total Return*
Among the Company, the S&P Composite 500 Index and Composite Peer Groups
 
 
12/31/2006
 
12/31/2007
 
12/31/2008
 
12/31/2009
 
12/31/2010
 
12/31/2011
Tesoro
 
$
100

 
$
146.06

 
$
41.26

 
$
43.47

 
$
59.48

 
$
74.93

S&P 500
 
100

 
105.50

 
66.45

 
84.03

 
96.68

 
98.72

Old Peer Group
 
100

 
133.92

 
49.41

 
36.80

 
52.96

 
50.42

New Peer Group
 
100

 
116.82

 
57.82

 
58.51

 
66.57

 
50.30

* Assumes that the value of the investments in common stock and each index was $100 on December 31, 2006, and that all dividends were reinvested. Investment is weighted on the basis of market capitalization.


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


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Stock Prices and Dividends per Common Share
Our common stock is listed under the symbol “TSO” on the New York Stock Exchange. Summarized below are high and low sales prices on our common stock on the New York Stock Exchange during 2011 and 2010. We did not declare any dividends in 2011 and 2010.

 
 
Sales Prices per Common Share
Quarter Ended
 
High
 
Low
December 31, 2011
 
$
29.61

 
$
17.43

September 30, 2011
 
25.79

 
17.82

June 30, 2011
 
28.74

 
20.38

March 31, 2011
 
27.99

 
17.60

December 31, 2010
 
18.94

 
12.79

September 30, 2010
 
13.50

 
10.40

June 30, 2010
 
14.43

 
10.76

March 31, 2010
 
15.33

 
11.48

Dividend Policy
We do not currently pay a dividend to our stockholders. At February 16, 2012, there were approximately 1,558 holders of record of our 140,800,815 outstanding shares of common stock.
Purchases of Equity Securities
Tesoro may acquire shares from employees to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to certain employees. There were no such shares acquired during the three-month period ended December 31, 2011.
On August 3, 2011, our Board of Directors approved a program designed to offset the dilutive effect of 2011 and future stock-based compensation awards. The Board authorized the purchase of approximately 0.7 million shares related to 2011 awards granted to offset their potential dilutive effect. The Board also authorized a program to purchase additional shares in subsequent years to offset the dilutive effect of future stock-based compensation programs. On September 26, 2011, the Board of Directors authorized the purchase of an additional 4.0 million shares of common stock intended to offset the dilutive effect of shares issued for stock-based compensation awards granted in fiscal years prior to 2011. In total, we purchased the 4.7 million authorized shares of common stock in the third quarter of 2011 for $95 million pursuant to the Board's approval.
2012 Annual Meeting of Stockholders
The 2012 Annual Meeting of Stockholders will be held at 8:30 A.M. Central Time on Thursday, May 3, 2012, at Tesoro Corporate Headquarters, 19100 Ridgewood Parkway, San Antonio, Texas. Holders of common stock of record at the close of business on March 13, 2012 are entitled to notice of and to vote at the annual meeting.


















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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth certain selected consolidated financial data of Tesoro as of and for each of the five years in the period ended December 31, 2011. The selected consolidated financial information presented below has been derived from our historical financial statements. 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.
 
 
Years Ended December 31,
 
 
2011
 
2010
 
2009
 
2008
 
2007 (a)(b)
 
 
(Dollars in millions except per share amounts)
Statement of Operations Data
 
 
 
 
 
 
 
 
 
 
Total Revenues
 
$
30,303

 
$
20,583

 
$
16,872

 
$
28,416

 
$
21,976

Net Earnings (Loss) (c)
 
563

 
(29
)
 
(140
)
 
278

 
566

Less net income attributable to noncontrolling interest
 
17

 

 

 

 

Net Earnings (Loss) Attributable to Tesoro Corporation
 
$
546

 
$
(29
)
 
$
(140
)
 
$
278

 
$
566

Net Earnings (Loss) Per Share:
 
 
 
 
 
 
 
 
 
 
Basic
 
$
3.86

 
$
(0.21
)
 
$
(1.01
)
 
$
2.03

 
$
4.17

Diluted (d)
 
$
3.81

 
$
(0.21
)
 
$
(1.01
)
 
$
2.00

 
$
4.06

Weighted Shares Outstanding (millions):
 
 
 

 

 

 

Basic
 
141.4

 
140.6

 
138.2

 
136.8

 
135.7

Diluted (d)
 
143.3

 
140.6

 
138.2

 
139.2

 
139.5

Dividends per share
 
$

 
$

 
$
0.35

 
$
0.40

 
$
0.35

Balance Sheet Data
 
 
 
 
 
 
 
 
 
 
Current Assets
 
$
4,151

 
$
2,928

 
$
2,223

 
$
1,646

 
$
2,600

Property, Plant and Equipment, Net
 
5,148

 
5,170

 
5,190

 
5,081

 
4,780

Total Assets
 
9,892

 
8,732

 
8,070

 
7,433

 
8,128

Current Liabilities
 
3,249

 
2,496

 
1,889

 
1,441

 
2,494

Total Debt (e)
 
1,701

 
1,995

 
1,841

 
1,611

 
1,659

Total Equity
 
3,978

 
3,215

 
3,087

 
3,218

 
3,052

Current Ratio
 
1.3:1

 
1.2:1

 
1.2:1

 
1.1:1

 
1.0:1

Working Capital
 
902

 
432

 
334

 
205

 
106

Total Debt to Capitalization (e)
 
30
%
 
38
%
 
37
%
 
33
%
 
35
%
Tesoro Stockholders' Equity (f)
 
3,668

 
3,215

 
3,087

 
3,218

 
3,052

Common Stock Outstanding (millions of shares)
 
140.0

 
143.2

 
140.4

 
138.4

 
137.0

Tesoro Stockholders' Equity per Outstanding Share (f)
 
$
26.20

 
$
22.45

 
$
21.99

 
$
23.25

 
$
22.28

Cash Flows From (Used In)
 
 
 
 
 
 
 
 
 
 
Operating Activities
 
$
689

 
$
385

 
$
663

 
$
716

 
$
1,322

Investing Activities
 
(291
)
 
(295
)
 
(436
)
 
(610
)
 
(2,838
)
Financing Activities (e)
 
(146
)
 
145

 
166

 
(109
)
 
553

Increase (Decrease) in Cash and Cash Equivalents
 
252

 
235

 
393

 
(3
)
 
(963
)
Capital Expenditures
 
$
320

 
$
287

 
$
401

 
$
619

 
$
789


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___________________
(a)
Our financial results include the results of our Los Angeles refinery and Shell and USA Gasoline retail stations since acquisition in May 2007.
(b)
Share and per share amounts have been adjusted to reflect our May 2007 two-for-one stock split.
(c)
Net earnings (loss) included the following pre-tax items that affect the comparability of the periods presented. During 2011, we recorded approximately $37 million from insurance recoveries and incurred a $51 million loss related to the change in scope of a capital project at our Los Angeles refinery. During 2010, we recorded approximately $67 million from insurance recoveries and $27 million in charges directly related to the April 2, 2010 incident at our Washington refinery and a $48 million gain from the elimination of postretirement life insurance benefits for current and future retirees. During 2009, we incurred a $43 million goodwill write-off in our refining segment and reduced inventories resulting in a last-in-first-out (“LIFO”) liquidation or reduction in cost of sales of $69 million. During 2008, we incurred a $91 million charge to write-off a receivable, reduced inventories resulting in a LIFO liquidation or reduction in cost of sales of $138 million and received net refunds of $50 million from the Trans Alaska Pipeline System associated with our protest of prior year intrastate rates.
(d)
The assumed conversion of common stock equivalents produced anti-dilutive results for the years ended December 31, 2010 and 2009, and was not included in the dilutive calculation.
(e)
During 2011, we borrowed $50 million on the TLLP Revolving Credit Facility, repurchased approximately $178 million of our senior notes and redeemed our $150 million Junior Subordinated Notes. During 2009, we issued $300 million in senior notes for general corporate purposes and during 2007 we issued $500 million in senior notes primarily to fund the acquisition of the Los Angeles refinery. Total debt includes capital lease obligations.
(f)
Tesoro Stockholders' Equity excludes $310 million of equity related to noncontrolling interest for the year ended December 31, 2011. There was no equity related to noncontrolling interest for the years ended December 31, 2007 through 2010.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following information concerning our results of operations and financial condition should be read in conjunction with Business and Properties in Items 1 and 2 in our consolidated financial statements in Item 8.

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (including information incorporated by reference) includes and references “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These statements relate to, among other things, expectations regarding refining margins, revenues, cash flows, capital expenditures, turnaround expenses, and other financial items. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins and profitability. We have used the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar terms and phrases to identify forward-looking statements in this Annual Report on Form 10-K, which speak only as of the date the statements were made.

Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect.

The matters discussed in these forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and trends to differ materially from those made, projected, or implied in or by the forward-looking statements depending on a variety of uncertainties or other factors including, but not limited to:

the constantly changing margin between the price we pay for crude oil and other refinery feedstocks, and the prices at which we are able to sell refined products;
the timing and extent of changes in commodity prices and underlying demand for our refined products;
changes in global economic conditions and the effects of the global economic downturn on our business, especially in California, and the business of our suppliers, customers, business partners and credit lenders;
the availability and costs of crude oil, other refinery feedstocks and refined products;
changes in fuel and utility costs for our facilities;
changes in the cost or availability of third-party vessels, pipelines and other means of transporting crude oil feedstocks and refined products;
actions of customers and competitors;
state and federal environmental, economic, health and safety, energy and other policies and regulations, including those related to climate change and any changes therein, and any legal or regulatory investigations, delays or other factors beyond our control;
adverse rulings, judgments, or settlements in litigation or other legal or tax matters, including unexpected environmental remediation costs in excess of any reserves;
operational hazards inherent in refining operations and in transporting and storing crude oil and refined products;
earthquakes or other natural disasters affecting operations;
changes in our cash flow from operations;
changes in capital requirements or in execution of planned capital projects;
changes in our inventory levels and carrying costs;
disruptions due to equipment interruption or failure at our facilities or third-party facilities;
direct or indirect effects on our business resulting from actual or threatened terrorist incidents or acts of war;
weather conditions affecting our operations or the areas in which our refined products are marketed; 
seasonal variations in demand for refined products;
risks related to labor relations and workplace safety; and
political developments.






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Many of these factors, as well as other factors, are described in greater detail in “Competition” on page 13 and “Risk Factors” on page 21. All future written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the previous statements. The forward-looking statements in this Annual Report on Form 10-K speak only as of the date of this Annual Report on Form 10-K. We undertake no obligation to update any information contained herein or to publicly release the results of any revisions to any forward-looking statements that may be made to reflect events or circumstances that occur, or that we become aware of, after the date of this Annual Report on Form 10-K.

BUSINESS STRATEGY AND OVERVIEW

Strategy and Goals

Our vision is to be the premier low-cost supplier of transportation fuels in the refining and marketing business within our markets, providing value for our customers while delivering industry leading returns for our shareholders and conducting ourselves responsibly in the communities in which we operate. To achieve these goals we pursue the following strategic priorities:

improve operational efficiency and effectiveness by focusing on safety and reliability, system improvements and cost leadership;
drive commercial excellence by strengthening our supply and trading activities to provide additional value to the business;
strengthen our financial position by exercising capital discipline and focusing on improving our liquidity; and
capture value-driven growth through a focus on our logistics assets and growing our marketing business.

Our goals were focused on these strategic priorities during 2011 and we accomplished the following:
 
Operational Efficiency & Effectiveness
Commercial Excellence
Financial Discipline
Value Driven Growth
Increased refinery utilization to 87%
l
 
 
 
Decreased manufacturing costs per barrel from $5.83 in 2010 to $4.98 in 2011
l
 
 
 
Leveraged our logistics operations to strategically source advantaged crude and provide market optionality for the sale of refined products
 
l
 
 
Increased exports off the West Coast and expanded trading through Tesoro Panama Company S.A. in support of our refining operations
 
l
 
 
Reduced our total debt to total capitalization ratio from 38% at the end of 2010 to 30% at the end of 2011
 
 
l
 
Purchased 4.7 million shares of common stock to offset the dilutive effects of previous stock-based compensation awards
 
 
l
 
Successfully completed the initial public offering of Tesoro Logistics LP in April 2011
 
 
l
l
Strengthened refining and marketing integration through the addition of wholesale supply contracts for 300 branded stations in 2011 and announced agreements to lease or purchase approximately 290 additional retail stations beginning in 2012
 
 
 
l
Announced plans to invest in significant high-return capital projects intended to improve yields, reduce feedstock and operating costs and expand our logistics infrastructure. These investments are expected to better position the company competitively and deliver meaningful EBITDA growth.
l
l
l
l

We plan during 2012 to continue to focus on our strategic priorities described above by:

executing a slate of capital projects focused on improving yields, reducing feedstock and operating costs, and expanding our logistics infrastructure at several of our refineries;
focusing on opportunities that will allow us to increase the integration of our refining and marketing assets in order to maximize refinery utilization;
expanding our supply and trading activities to support our refining operations and capitalize on market opportunities that allow us to maximize capture rates; and
strengthening our balance sheet by retiring the remaining $299 million of 6 1/4% Senior Notes on or before maturity.

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Tesoro Logistics LP

As part of our business strategy, we formed Tesoro Logistics LP (“TLLP”) to own, operate, develop and acquire crude oil and refined products logistics assets. In April 2011, TLLP completed the initial public offering (the “Offering”) of 14,950,000 common units at a price of $21.00 per unit, which included a 1,950,000 share over-allotment option that was exercised by the underwriters. Tesoro Logistics GP, LLC (“TLGP”), a 100% consolidated subsidiary, serves as the general partner of TLLP. Headquartered in San Antonio, Texas, TLLP's assets consist of a crude oil gathering system in the Bakken Shale/Williston Basin area, eight refined products terminals in the western United States, a crude oil and refined products storage facility and five related short-haul pipelines in Utah.

TLLP intends to expand its business through organic growth, including constructing new assets and increasing the utilization of existing assets, and by acquiring assets from us and third parties. Although we have historically operated our logistics assets primarily to support our refining and marketing business, we intend to grow our logistics operations to maximize the integrated value of our assets within the midstream and downstream value chain. We believe TLLP is well positioned to achieve its primary business objectives and execute business strategies based on its:

long-term fee-based contracts;
relationship with us;
assets positioned in the high demand Bakken Shale/Williston Basin area; and
financial flexibility.

We hold an approximate 52% interest in TLLP, including the interest of the general partner. This interest includes 304,890 common units, 15,254,890 subordinated units and 622,649 general partner units. We received net proceeds of approximately $283 million from the Offering, after deducting offering expenses (the “Offering Costs”) and debt issuance costs. TLLP retained $3 million for working capital purposes and paid $2 million in connection with entering into its revolving credit facility.

Effective on the closing date of the Offering, TLLP entered into a senior secured revolving credit agreement (“TLLP Revolving Credit Facility”) with a syndicate of banks and financial institutions, which provides for borrowings under a revolving credit facility with total loan availability of $150 million. TLLP borrowed $50 million under the TLLP Revolving Credit Facility at the closing of the Offering. TLLP distributed total proceeds to us of $333 million, which includes $283 million from the Offering and $50 million from the TLLP Revolving Credit Facility, in consideration of assets contributed and to reimburse us for certain capital expenditures incurred with respect to these assets. The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP (which is TLLP's general partner), and is guaranteed by all of TLLP's subsidiaries and secured by substantially all of TLLP's assets. For additional information regarding our credit facilities, see “Capital Resources and Liquidity.”

Reconciliation of Cash Proceeds (In millions)
 
Total proceeds from the Offering
$
314

Less: Offering Costs, net of debt issuance costs
(26
)
Proceeds from the Offering, net of Offering Costs
288

Less: Debt issuance costs
(2
)
Net proceeds from the Offering
286

Less: Cash retained by TLLP
(3
)
Net proceeds distributed to Tesoro from the Offering
283

Add: Borrowings under the TLLP Revolving Credit Facility
50

Distribution to Tesoro
$
333


Martinez Crude Oil Marine Terminal

In December 2011, we announced our intention to offer TLLP the Martinez Crude Oil Marine Terminal and are currently in negotiations with TLLP. The terminal consists of a single-berth dock, five crude oil storage tanks with a combined storage capacity of 425,000 barrels and related pipelines that receive crude oil from third-party marine vessels for delivery to our Martinez refinery and a third-party terminal. Total throughput capacity for the terminal is estimated to be approximately 145 thousand barrels per day (“Mbpd”). The transaction is expected to close in the first half of 2012. The growth of TLLP helps us capture the value of our embedded logistics assets. As we are the general partner, and hold the related incentive distribution rights, we receive an increasing share in the incremental distributable cash flow the partnership generates.

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Unit Train Unloading Facility

In July 2011, we announced that we expect to offer the unit train unloading facility at our Washington refinery to TLLP upon completion of construction, which is expected to be in the fourth quarter of 2012. The project includes unloading facilities for trains of rail cars ("unit trains") and is expected to deliver up to 30 Mbpd of Bakken crude oil to our Washington refinery.

Retail Acquisitions

During 2011, we entered into agreements to expand our network of retail stations with the addition of 290 stations between 2012 and 2014, as part of our commitment to enhancing integration and growing our marketing business.

We entered into an agreement with SUPERVALU, Inc. in September 2011, to acquire approximately 50 retail stations located primarily in Washington, Oregon, California, Nevada, Idaho, Utah and Wyoming. In January 2012, we completed the acquisition for a total purchase price of approximately $36 million, including inventories of approximately $3 million. We assumed the obligations under the seller's leases and other agreements arising after the closing date. SUPERVALU, Inc. retained certain pre-closing liabilities, including environmental matters. We intend to invest approximately $5 million to rebrand these stations from which we expect fuels sales of approximately 5 Mbpd.

We entered into an agreement with Thrifty Oil Co. and certain of its affiliates effective August 2011, to lease approximately 240 retail stations located primarily in southern California, for an aggregate amount of approximately $25 million annually. We estimate that these stations will provide an additional 20-25 Mbpd of ratable off-take for our refining system after we invest approximately $30 million to rebrand the network. Each retail station lease is for an initial term of 10 years, with the option to renew for two additional five-year terms. We are scheduled to take possession of the retail stations in a phased transition, with approximately 190 stations taken during the course of 2012 and the balance to come during 2014.

Hawaii Operations

We announced in January 2012 that we intend to sell our Hawaii operations as part of a previously announced strategy to focus on the Mid-Continent and West Coast markets.  The assets for sale include the 94 Mbpd Kapolei refinery, 32 retail stations and the associated logistical assets.


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Industry Overview

Our profitability is heavily influenced by the cost of crude oil and the aggregate value of the products we make from that crude oil and is affected by changes in economic conditions. Product values and crude oil costs are set by the market and are outside of the control of independent refiners.

Average Key Commodity Prices and Differentials
(Dollars per barrel)


Crude Oil and Product Price Analysis

The U.S. economy continued to grow in 2011, although at a slower pace than in 2010. This slower pace of domestic growth is attributable to a number of factors, including continued high unemployment rates. The nationwide unemployment rate decreased from 9.4% at the end of 2010 to 8.5% at the end of 2011. In California, a key market area for Tesoro, the state's unemployment rate fell by 1.2%, to 11.3%, from December 2010 to November 2011. Global factors include increased geo-political tensions in Libya and the Middle East as well as the effect of heightened European solvency concerns on the already slow-paced recovery from the global 2008 financial collapse.

Developing markets in Asia and Latin America continue to show stronger growth than OECD (the “Organization for Economic Co-operation and Development”) member countries, although their market growth rates tempered toward year end. This strong growth rate combined with refinery issues, primarily in Latin America, have provided an export opportunity for U.S. light products, particularly diesel exports. As of November 2011, net U.S. exports of the three principle light products (gasoline, jet, diesel) exceeded 700 Mbpd. As a result, these historically high exports have provided an outlet for U.S. refining capacity, which has supported margins during this time.

These exports have been led primarily by distillates as the recovery in Asian markets has improved global middle distillate values. Strong Asian refining crack spreads, high demand in Latin America and continued strength in U.S. light product exports provided additional support during the year. During 2011, U.S. West Coast benchmark diesel fuel margins were up nearly 39% from 2010, while U.S. West Coast benchmark gasoline margins fell approximately 18% as compared to 2010. Higher consumer gasoline prices combined with the slow economic recovery continued to keep gasoline demand growth from recovering and continued to weaken gasoline margins.


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The price differential between Mid-Continent crudes and waterborne crudes increased during the year, contributing to strong refining margins in the Mid-Continent region. The West Texas Intermediate (“WTI”) to Brent differential averaged about $16.15 per barrel in 2011, compared to an average of $(0.11) per barrel in 2010. This differential was the result of Mid-Continent crude oil logistics constraints combined with geo-political and global supply issues. The discount of WTI to Brent during the fourth quarter narrowed by $18 per barrel, dropping from $26 per barrel at the end of September 2011 to $8 per barrel at the end of December 2011. This differential has averaged around $12 per barrel during the first quarter of 2012.

Outlook

The slow rate of economic recovery and the accompanying high unemployment continue to hinder the rate of recovery of transportation fuel demand. The growing economies in the developing world are expected to continue to provide positive pressure on distillate margins, though gasoline margins, which are more driven by U.S. consumers, are expected to remain in seasonal ranges. Internationally, recent events, both natural and geopolitical, have created interruptions in the supply chain for oil and other industries, which are causing readjustments in the market place. The lingering effects of the earthquake in Japan during 2011 are continuing to impact low sulfur fuel oil and heavy low sulfur crude oil prices in the Pacific Basin markets. The Libyan oil export disruption in 2011 increased uncertainty related to the supply of crude oil despite increased production by certain OPEC member countries and the release of about 31 million barrels of crude oil from the U.S. Strategic Petroleum Reserve during the year. More recently, concerns about closure of the Strait of Hormuz in the Persian Gulf have increased concerns about crude oil supply from the Middle East. Additionally, the European debt crisis continues to add pressure to financial markets. These international issues continue to impact crude oil and refined product prices and drive concerns about global and regional demand.

In addition to current market conditions, there are long-term factors that may impact the supply and demand of refined products in the U.S. including:

world crude oil prices;
increased federal fuel efficiency standards for motor vehicles;
increased volumes of renewable fuels, mandated by the Federal Clean Air Act;
various regulations of greenhouse gas emissions from stationary and mobile sources by the U.S. Environmental Protection Agency (“EPA”) pursuant to the Federal Clean Air Act and by the State of California pursuant to AB32;
potential enactment of federal climate change legislation; and
possible promulgation of national regulations relative to gasoline composition and ozone standards under the Federal Clean Air Act.


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RESULTS OF OPERATIONS

A discussion and analysis of the factors contributing to our results of operations is presented below. The accompanying consolidated financial statements in Item 8, together with the following information, are intended to provide investors with a reasonable basis for assessing our historical operations, but should not serve as the only criteria for predicting our future performance.

Summary

Our net earnings in 2011 were $546 million ($3.81 per diluted share) compared with a net loss of $29 million ($0.21 per diluted share) in 2010. The increase in net earnings of $4.02 per diluted share was primarily due to the following:

significant increases in gross refining margins in the Pacific Northwest and Mid-Continent regions of $326 million and $531 million, respectively, driven by feedstock advantages from local crude discounts, and lower manufacturing cost per barrel;
considerably higher refining throughput primarily as a result of increased utilization of 87%, and the temporary shut-down of processing at the Washington refinery in 2010; and
growth in refining and marketing integration from the increased number of retail stations and wholesale supply contracts.

The increase in net earnings during 2011 relative to 2010 was partially offset by the following:

a $48 million gain recognized in 2010 from the elimination of postretirement life insurance benefits for current and future retirees as part of our strategy to reduce overhead and benefit expenses;
a $31 million higher loss in 2011 as compared to 2010, related to write-downs due to a change in scope of a capital project at our Los Angeles refinery;
the receipt of $67 million of business interruption and property insurance recoveries in 2010, compared to the receipt of $37 million of business interruption and property insurance recoveries in 2011, related to the April 2, 2010 incident at our Washington refinery; and
a $20 million increase in interest and financing costs in 2011 due to the write-off of the remaining unamortized discount associated with the early redemption of our Junior Subordinated Notes due 2012 and premiums paid in connection with the repurchase of a portion of our Senior Notes.

Our net loss in 2010 was $29 million ($0.21 per diluted share) compared with a net loss of $140 million ($1.01 per diluted share) in 2009. The increase in net earnings of $0.80 per diluted share was primarily due to the following:

contribution from our capital and non-capital initiative program during 2010 which increased our overall margin through reduced transportation and feedstock costs, increased product margins, and improved refinery yields;
increased gross refining margins due to local crude discounts and improved distillate margins partially offset by weaker gasoline margins;
a $48 million gain from the elimination of postretirement life insurance benefits for current and future retirees as part of our strategy to reduce overhead and benefit expenses;
a $39 million decrease in losses on our derivative instruments;
improved contribution of $14 million from our retail marketing segment; and
a goodwill write-off of $10 million in 2010 compared to $43 million in 2009.

The decrease in net loss during 2010 relative to 2009 was partially offset by the following:

lower throughput primarily from the temporary shut-down of processing at our Washington refinery and completion of scheduled refinery turnarounds at several of our other refineries. The gross margin impact of the temporary shut-down at the Washington refinery was partially offset by the receipt of $55 million in business interruption insurance recoveries;
a $51 million increase in incentive and stock-based compensation expense, primarily as a result of increases in Tesoro stock prices during 2010 as compared to 2009; and
a reduction in cost of sales of $69 million resulting from a last-in, first-out ("LIFO") liquidation benefit during 2009.


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Refining Segment
 
 
2011
 
2010
 
2009
 
 
(Dollars in millions except per
barrel amounts)
Revenues 
 
 

 
 

 
 

Refined products (a)
 
$
29,058

 
$
19,038

 
$
15,674

Crude oil resales and other (b)
 
747

 
1,039

 
691

Total Revenues
 
$
29,805

 
$
20,077

 
$
16,365

Throughput (thousand barrels per day)
 
 
 
 

 
 

Heavy crude (c)
 
171

 
181

 
177

Light crude
 
373

 
270

 
335

Other feedstocks
 
35

 
29

 
37

Total Throughput
 
579

 
480

 
549

% Heavy Crude Oil of Total Refining Throughput 
 
30
%
 
38
%
 
32
%
Yield (thousand barrels per day)
 
 
 
 

 
 

Gasoline and gasoline blendstocks
 
285

 
232

 
268

Jet Fuel
 
79

 
68

 
70

Diesel Fuel
 
135

 
103

 
114

Heavy fuel oils, residual products, internally produced fuel and other
 
112

 
106

 
127

Total Yield
 
611

 
509

 
579

Gross refining margin ($/throughput bbl) (d)
 
$
13.94

 
$
11.26

 
$
8.90

Manufacturing cost ($/throughput bbl) (d)
 
$
4.98

 
$
5.83

 
$
5.01

_______________________________________
(a)
Refined products sales include intersegment sales to our retail segment, at prices which approximate market of $4.8 billion, $3.3 billion and $2.7 billion in 2011, 2010 and 2009, respectively.
(b)
Crude oil resales and other includes third-party revenues earned by TLLP. Consolidated revenues for the refining segment include $4 million from TLLP for the year ended December 31, 2011, and $4 million and $3 million from TLLP's predecessor for the years ended December 31, 2010 and 2009, respectively.
(c)
We define heavy crude oil as crude oil with an American Petroleum Institute gravity of 24 degrees or less.
(d)
Management uses gross refining margin per barrel to evaluate performance and compare profitability to other companies in the industry. There are a variety of ways to calculate gross refining margin per barrel; different companies may calculate it in different ways. We calculate gross refining margin per barrel by dividing gross refining margin (revenue less costs of feedstocks, purchased refined products, transportation and distribution) by total refining throughput. Management uses manufacturing costs per barrel to evaluate the efficiency of refinery operations. There are a variety of ways to calculate manufacturing cost per barrel; different companies may calculate it in different ways. We calculate manufacturing costs per barrel by dividing manufacturing costs by total refining throughput. Investors and analysts use these financial measures to help analyze and compare companies in the industry on the basis of operating performance. These financial measures should not be considered alternatives to segment operating income, revenues, cost of sales, operating expenses or any other measure of financial performance presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).

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Refining Segment
 
 
2011
 
2010
 
2009
 
 
(Dollars in millions except per
barrel amounts)
Segment Operating Income
 
 

 
 

 
 

Gross refining margin (e)
 
$
2,944

 
$
1,974

 
$
1,783

Expenses
 
 
 
 

 
 

Manufacturing costs
 
1,052

 
1,022

 
1,004

Other operating expenses
 
241

 
254

 
262

Selling, general and administrative expenses
 
43

 
30

 
32

Depreciation and amortization expense (f)
 
369

 
365

 
359

Loss on asset disposals and impairments
 
60

 
48

 
71

Segment Operating Income (g)
 
$
1,179

 
$
255

 
$
55

Refined Product Sales (Mbpd) (h)
 
 
 
 

 
 

Gasoline and gasoline blendstocks
 
341

 
288

 
306

Jet fuel
 
91

 
92

 
84

Diesel fuel
 
143

 
116

 
121

Heavy fuel oils, residual products and other
 
85

 
76

 
85

Total Refined Product Sales
 
660