10-K 1 tso201610-k.htm 10-K Document

 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_________________________
FORM 10‑K
(Mark One)
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ______________ to __________

Commission File Number 1‑3473
TESORO CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
tesoroa01.jpg
95-0862768
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
19100 Ridgewood Pkwy, 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 þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Indicate by check mark 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. þ
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
þ
 
Accelerated filer
o
 
 
Non-accelerated filer
o  (Do not check if a smaller reporting company)
 
Smaller reporting company
o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
At June 30, 2016, the aggregate market value of the voting common stock held by non-affiliates of the registrant was approximately $8.8 billion based upon the closing price of its common stock on the New York Stock Exchange Composite tape. At February 15, 2017, there were 116,986,291 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 2016 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

 




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.”


IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
 

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

This Annual Report on Form 10-K (including information incorporated by reference) contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than statements of historical fact, including without limitation statements regarding expectations regarding refining margins, revenues, cash flows, capital expenditures, turnaround expenses and other financial items, our business strategy, goals and expectations concerning our market position, future operations, margins and profitability, are forward-looking statements. Forward-looking statements may be identified by use of the words “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “predict,” “project,” “will,” “would” and similar terms and phrases. Although we believe our assumptions concerning future events are reasonable, a number of risks, uncertainties and other factors could cause actual results and trends to differ materially from those projected, including, but not limited to:

the constantly changing margin between the price we pay for crude oil and other refinery feedstocks as well as renewable identification numbers (“RINs”) and environmental credits, and the prices at which we are able to sell refined products;
changes in the expected value of and benefits derived from acquisitions and capital projects;
changes in global economic conditions on our business, especially in California, and the business of our suppliers, customers, business partners and credit lenders;
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;
regulatory and other requirements concerning the transportation of crude oil, particularly from the Bakken area;
changes in the carrying costs of our inventory;
the timing and extent of changes in commodity prices and underlying demand for our refined products, natural gas and natural gas liquids;
the availability and costs of crude oil, other refinery feedstocks, refined products and RINs;
changes in our cash flow from operations;
earthquakes or other natural disasters affecting operations;
direct or indirect effects on our business resulting from actual or threatened terrorist incidents, cyber-security breaches or acts of war;
weather conditions affecting our operations or the areas in which our refined products are marketed;
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, compliance costs or other factors beyond our control;
delays in obtaining necessary approvals and permits;
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;
changes in our credit profile;
changes in capital requirements or in execution of planned capital projects;
disruptions due to equipment interruption or failure at our facilities or third-party facilities;
seasonal variations in demand for refined products and natural gas;
risks related to labor relations and workplace safety;
political developments; and
the factors described in greater detail under “Competition” and “Risk Factors” in Items 1 and 1A, and our other filings with the SEC.

All forward-looking statements included in this report are based on information available to us on the date of this report. We undertake no obligation to revise or update any forward-looking statements as a result of new information, future events or otherwise.


 
 
December 31, 2016 | 1

GLOSSARY OF TERMS
 
 

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 oil 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.

Blendstocks - Components used for blending or compounding into finished jet or gasoline (e.g., straight-run gasoline, alkylate, reformulate, benzene, toluene, and xylene). Excludes oxygenates (alcohols, ethers), butane and pentanes.

Calcining - A process whereby green or raw petroleum coke from the refining process is converted to a high grade coke by thermally treating it to remove moisture and volatile combustible matter. The upgraded high grade calcined coke is typically used by the aluminum industry.

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.

D&A - Depreciation and amortization expenses.

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.

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

FERC - Federal Energy Regulatory Commission.

 
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 and is used 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.

Fractionation - The process of separating natural gas liquids into its component parts by heating the natural gas liquid stream and boiling off the various fractions in sequence from the lighter to the heavier hydrocarbon.

Fuel Margin - The margin on fuel products sold through our Marketing 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.

Gas Processing - A complex industrial process designed to remove the heavier and more valuable natural gas liquids components from raw natural gas allowing the residue gas remaining after extraction to meet the quality specifications for long-haul pipeline transportation or commercial use.

Gross Refining Margin - The margin on products manufactured and purchased, including those sold to our Marketing segment. Gross refining margin is the difference between the prices of all manufactured refined products sold and the cost of crude oil and other feedstocks used to produce refined products, including the cost of transportation and distribution.

Heavy Crude Oil - Crude oil with an API gravity of 24 degrees or less. Heavy crude oil is typically sold at a discount to lighter crude oil.

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 distillates, 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.


2 | Tesoro Corporation
 
 

 
 
GLOSSARY OF TERMS

Jobber/Dealer - Retail station owned by a third party that sells products purchased from or through us.

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

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

Mbpd - Thousand barrels per day.

MMBtu - Million British thermal units.

MMMBtu - Billion British thermal units.

MMcf - Million cubic feet.

Multi-Site Operator (“MSO”) - Companies licensed to operate retail stations in which we have a fee or leasehold interest in the property and title to the fuel until sold to the consumer. MSOs operate the non-fuel business at the location and employ the operating personnel.

Naphtha - Refined product used as a gasoline blending component, a feedstock for reforming and as a petrochemical feedstock.

NGLs - Natural gas liquids.

OPEC - Organization of the Petroleum Exporting Countries

Other Feedstocks - Any non-crude raw or semi-finished material, which is further processed in various units of a refinery.

Refined Products - Hydrocarbon compounds, such as gasoline, diesel fuel, jet fuel and residual fuel that are produced by a refinery.

Refining Yield - Volumes of product produced from crude oil 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.

Residual crude oil - The remainder of the crude oil after gasoline and distillate fuel oils have been extracted through distillation.

SG&A - Selling, general and administrative expenses.

Sweet crude oil - Crude oil containing less than 0.45% sulfur.

Sour crude oil - Crude oil containing greater than 0.45% sulfur.
 
Tesoro Index - A performance benchmark that uses several crude oils and approximately 8 to 10 products to provide a potentially closer representation of the trends in the available margin. Our actual gross refining margins differ from the Tesoro Index based on the actual slate of crude oil that is run at our refineries and the products we produce or yield. The published Tesoro Index, including a reconciliation of the included components, is available on our website at www.tsocorp.com.

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.

Unit Train - A train consisting of approximately one hundred rail cars containing a single material (such as crude oil) that is transported by the railroad as a single unit from its origin point to the destination, enabling decreased transportation costs and faster deliveries.

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


 
 
December 31, 2016 | 3

BUSINESS
 
 

As used in this Annual Report on Form 10-K, the terms “Tesoro,” the “Company,” “we,” “us” or “our” may refer to Tesoro Corporation, one or more of its consolidated subsidiaries or all of them taken as a whole. The words “we,” “us” or “our” generally include Tesoro Logistics LP (“TLLP”), a publicly traded limited partnership, and its subsidiaries as consolidated subsidiaries of Tesoro Corporation with certain exceptions where there are transactions or obligations between TLLP and Tesoro Corporation or its other subsidiaries. When used in descriptions of agreements and transactions, “TLLP” or the “Partnership” refers to TLLP and its consolidated subsidiaries.

PART I

ITEM 1. BUSINESS

Tesoro was incorporated in Delaware in 1968. Headquartered in San Antonio, Texas, we are one of the largest independent petroleum refining, logistics and marketing companies in the United States. Our common stock trades on the New York Stock Exchange under the symbol “TSO.”

Our business is organized into three operating segments:

REFINING. Our refining operating segment 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 and petroleum coke for sale in bulk markets to a wide variety of customers within our markets.

TLLP. Our logistics operating segment, which is comprised of TLLP’s assets and operations, includes certain crude oil and natural gas gathering assets, natural gas and
 
NGLs processing assets, and crude oil and refined products terminalling, transportation and storage assets acquired from Tesoro and third parties. The TLLP financial and operational data presented include the historical results of all assets acquired from Tesoro prior to the dates they were acquired by TLLP. The historical results of operations of these assets have been retrospectively adjusted to conform to the current presentation.

MARKETING. Our marketing segment sells transportation fuels through branded and unbranded channels. The branded business sells transportation fuels using a unique brand portfolio with the ARCO®, Shell®, Exxon®, Mobil®, USA GasolineTM, RebelTM, ThriftyTM and Tesoro® brands across a network of 2,492 retail stations.

See Notes 15 and 19 to our consolidated financial statements in Item 8 for additional information on our operating segments and properties.



 
 
 

refininga01.jpg REFINING

OVERVIEW. We currently own and operate seven petroleum refineries located in the western United States with a combined crude oil capacity of 895 Mbpd. Our Refining segment buys and refines crude oil and other feedstocks into transportation fuels that we sell to a wide variety of customers. 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 vehicle miles traveled. As a result, our operating results for both the Refining and Marketing segments for the first and fourth quarters are typically lower than the second and third quarters.

REGIONS. We currently operate the Refining segment in three separate regions: California, Pacific Northwest and Mid-Continent. Our geographic footprint and integrated logistics and marketing businesses enable our refineries to interact across these regions providing higher asset utilization and lower operating costs while maintaining well-balanced product supplies to better serve our customers.
 

CALIFORNIA REFINERIES
californiarefineriesv4a01.jpg

Crude Oil Capacity / 2016 Throughput (in Mbpd)
Los Angeles: 380 / 364
Martinez: 166 / 143



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BUSINESS

LOS ANGELES. Our Los Angeles refinery is located on approximately 930 acres in the Carson-Wilmington area of California about 20 miles south of Los Angeles. The refinery’s major processing units include crude distillation, vacuum distillation, delayed coking, hydrocracking, naphtha reforming, hydrotreating, fluid catalytic cracking, butane isomerization and alkylation. The refinery produces a high proportion of transportation fuels, including CARB gasoline and CARB diesel fuel, conventional gasoline, diesel fuel and jet fuel. The refinery also produces heavy fuel oils, liquefied petroleum gas, petroleum coke, calcined coke and electricity.

MARTINEZ. Our Martinez refinery is located on approximately 2,200 acres in Martinez, California about 30 miles east of San Francisco. 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 CARB gasoline and CARB diesel fuel, conventional gasoline and diesel fuel. The refinery also produces liquefied petroleum gas and petroleum coke.

PACIFIC NORTHWEST REFINERIES

pnwrefineriesv4.jpg

Crude Oil Capacity / 2016 Throughput (in Mbpd)
Anacortes: 120 / 124 (a)
Kenai: 72 / 57

(a) Throughput can exceed crude oil capacity due to the processing of other feedstocks in addition to crude oil.

ANACORTES. Our Anacortes refinery is located on approximately 950 acres in northwest Washington about 70 miles north of Seattle. 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 conventional gasoline, diesel fuel and jet fuel. The refinery also produces heavy fuel oils and liquefied petroleum gas.

 
KENAI. Our Kenai refinery is located on approximately 450 acres on the Cook Inlet near Kenai, Alaska about 60 miles southwest of Anchorage. The refinery’s major processing units include crude distillation, vacuum distillation, 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.

MID-CONTINENT REFINERIES

mcrefineriesv4.jpg

Crude Oil Capacity / 2016 Throughput (in Mbpd)
Salt Lake City: 63 / 58
Mandan: 74 / 71
Dickinson: 20 / 14 (b)

(b)
Throughput for the 2016 period for Dickinson measured since our acquisition of the refinery on June 28, 2016.

SALT LAKE CITY. Our Salt Lake City refinery is located on approximately 150 acres in Salt Lake City, Utah. 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.

MANDAN. Our Mandan refinery is located on approximately 950 acres along the Missouri River near Mandan, North Dakota. 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.

DICKINSON. Acquired during 2016, our Dickinson refinery is located on 318 acres approximately 100 miles west of the Mandan refinery near Dickinson, North Dakota. The refinery produces ultra-low sulfur diesel, naphtha and residuals.





 
 
December 31, 2016 | 5

BUSINESS
 
 

FEEDSTOCK PURCHASES.  We purchase crude oil and other feedstocks from domestic and foreign sources either through the spot market or term agreements with renewal provisions and volume commitments. We purchase domestic crude oil produced primarily in North Dakota, Alaska, California, Utah and Wyoming. We purchase foreign crude oil produced in South America, the Middle East, Canada, western Africa and other locations. We lease access to the Trans-Panama pipeline (the “Panama Pipeline”) and several tanks in Panama through agreements expiring in April 2017 that allow us to deliver the crude oil acquired in Africa and the Atlantic region of South America to refineries on the West Coast. We also transport crude oil across the Panama Pipeline for third parties. At December 31, 2016, we held title to approximately 5.2 million barrels of crude oil in transit or in Panama for delivery to our refineries on the West Coast or to third parties.





 
SOURCES OF OUR CRUDE OIL PURCHASES BASED ON VOLUMES PURCHASED

tso201610-k_chartx26171.jpg
Our refineries process both heavy and light crude oil. Light crude oil, when refined, produces a greater proportion of higher value transportation fuels such as gasoline, diesel and jet fuel, and as a result is typically more expensive than heavy crude oil. In contrast, heavy crude oil produces 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.


PRIMARY CRUDE OIL CHARACTERISTICS AND SOURCES OF CRUDE OIL FOR OUR REFINERIES

 
 
Characteristics
 
 
 
 
Sources
 
 
Sweet
Sour
Residual
Other Feedstocks
Blendstocks
 
 
United States
Canada
South & Central America
Asia
Middle East & Africa
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Los Angeles
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Martinez
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Anacortes
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Kenai
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mandan
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Salt Lake City
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Dickinson
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

REFINED PRODUCTS.  The total products produced in the refining process 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 may also include other products such as heavy fuel oils, liquefied petroleum gas, petroleum coke, calcined coke and asphalt.


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BUSINESS

2016 THROUGHPUT VOLUMES AND REFINING YIELDS

 
California
 
Pacific Northwest
 
Mid-Continent
 
Total Refining
 
Volume
 
%
 
Volume
 
%
 
Volume
 
%
 
Volume
 
%
Throughput
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Heavy crude
170

 
34
 
6

 
3
 

 

 
176

 
21
Light crude
304

 
60
 
162

 
90
 
132

 
96

 
598

 
73
Other feedstocks
33

 
6
 
13

 
7
 
5

 
4

 
51

 
6
Total
507

 
100
 
181

 
100
 
137

 
100

 
825

 
100
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Yield
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
294

 
53
 
80

 
42
 
77

 
55

 
451

 
51
Diesel fuel
113

 
21
 
35

 
19
 
41

 
29

 
189

 
22
Jet fuel
71

 
13
 
35

 
19
 
12

 
8

 
118

 
13
Heavy fuel oils, residual products, internally produced fuel and other (a)
74

 
13
 
37

 
20
 
11

 
8

 
122

 
14
Total (b)
552

 
100
 
187

 
100
 
141

 
100

 
880

 
100

(a)
The majority of internally produced fuel is consumed during the refining process.
(b)
Refined product sales may exceed our yield due to purchased refined products.
 
LOGISTICS ASSETS
logistics.jpg
 
TERMINAL AND PIPELINES. We transport, store and distribute crude oil, feedstocks and refined products through our terminals and pipelines or terminals and pipelines owned by TLLP and third-parties in our market areas as well as through purchases and exchange arrangements with other refining and marketing companies. Our refineries are integrated with each other via pipelines, terminals and barges. The transportation links that connect our refineries allow for movement of intermediate and finished products, which permit us to optimize our value chain and maximize utilization.

MARINE. We charter tankers to optimize the transportation of crude oil, feedstocks, and refined products to support our refinery system and ensure adequate shipping capacity. Our current U.S.-flag and foreign-flag tanker time charters will expire with varying dates between 2017 and 2021, unless we exercise renewal options. We also time charter tug and barge units and a ship assist tug with varying expiration dates between 2017 through 2018, unless we exercise renewal options. We continually look to optimize our marine fleet and minimize costs, and from time to time we sub-charter vessels in our fleet to third-parties to maintain high utilization. All of our chartered tankers and barges are double-hulled.

RAIL. We maintain a fleet of leased rail cars to transport crude and refined products in support of our refining
 
operations. In 2016, Tesoro placed an order for 525 additional tank cars for crude oil service that exceed the U.S. Department of Transportation’s 117 standards that were announced in 2015 (“DOT120J200”). These cars started delivering in the second half of 2016 and will complement the 210 DOT120J200 tank cars currently in our fleet. We intend to continue ordering new rail cars that are among the safest available at the time of order and to comply with all relevant regulatory requirements.

REFINED PRODUCT SALES
retail.jpg

Our Marketing segment provides a committed outlet for the majority of gasoline produced by our refineries; however, we also sell gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils and residual products in bulk markets in the western U.S. We also opportunistically export gasoline and diesel fuel to certain foreign markets. Our bulk sales are primarily to independent unbranded distributors, other refining and marketing companies, utilities, railroads, airlines and marine and industrial end-users. Our sales include refined products that we manufacture, purchase or receive through exchange arrangements.

SALES OF PURCHASED PRODUCTS.  In the normal course of business, we purchase refined products manufactured by others for resale through our marketing and bulk operations to our customers to meet local market demands and fulfill supply commitments. We purchase these refined products, primarily gasoline, jet fuel, diesel fuel and industrial and marine fuel blendstocks, mainly in the spot market.

 
 
 
 

 
 
December 31, 2016 | 7

BUSINESS
 
 

pipelinea01.jpggasprocessinga02.jpgtruckandmarinea02.jpgcruderaila04.jpg TLLP

OVERVIEW. TLLP is a fee-based, growth-oriented Delaware limited partnership formed by us to own, operate, develop and acquire logistics assets. TLLP is a publicly traded limited partnership that is traded on the New York Stock Exchange under the symbol “TLLP.” TLLP’s operations are organized into three businesses: Gathering, Processing, and Terminalling and Transportation. TLLP owns and operates a network of crude oil, refined products and natural gas pipelines, terminals with dedicated and non-dedicated storage capacity for crude oil and refined products, rail facilities with loading and off-loading capabilities, marine terminals and trucking fleets. In addition, TLLP owns and operates natural gas processing and fractionation complexes. TLLP generates revenues by charging fees for gathering crude oil and natural gas, for processing natural gas, and for terminalling, transporting and storing crude oil and refined products. TLLP’s customers experience modest seasonality due to regulatory restrictions, weather conditions and seasonal refined product demand, resulting in higher volumes during the summer months and lower volumes during the winter months. Many of the effects of
 
seasonality on TLLP’s operating results are mitigated through fee-based commercial agreements that include minimum volume commitments. On January 1, 2017, TLLP acquired crude oil, natural gas and produced water gathering systems and two natural gas processing facilities (“North Dakota Gathering and Processing Assets”). The North Dakota Gathering and Processing Assets include over 650 miles of crude oil, natural gas, and produced water gathering pipelines, 170 MMcf per day of natural gas processing capacity and 18,700 bpd of fractionation capacity in the Sanish and Pronghorn fields of the Williston Basin in North Dakota.

TLLP intends to continue expanding its business through organic growth, including the construction of new assets and increasing the utilization of existing assets, and by acquiring assets from us and third parties. TLLP’s continued expansion of the logistics business is expected to allow us to optimize the value of our assets within the midstream and downstream value chain. Below is a map of TLLP’s strategic assets in relation to our refineries.


tllpmap.jpg


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BUSINESS

GATHERING. TLLP’s Gathering business consists of crude oil, natural gas and produced water gathering systems in the North Dakota Williston Basin/Bakken Shale area (the “Bakken Region”) and the Uinta, Vermillion and greater Green River basins. TLLP’s High Plains System, located in the Bakken Region, gathers and transports crude oil from various production locations in this area for transportation to Tesoro’s North Dakota refinery and other destinations in the Bakken Region, including export rail terminals and pipelines. In addition in the High Plains System, we own and operate a truck-based crude oil gathering operation and a pipeline regulated by the FERC. TLLP’s natural gas gathering systems include the Uinta Basin, Vermillion, Williston, Green River, and Three Rivers gathering systems, its equity method investments in Rendezvous Gas Services, L.L.C., Uintah Basin Field Services, L.L.C. and Three Rivers Gathering, LLC, and two pipelines regulated by the FERC through which it provides natural gas and crude oil transportation services.

TLLP GATHERING - VOLUMES TRANSPORTED IN 2016

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(a)
Also includes barrels that were gathered and delivered into TLLP’s High Plains System by truck.

PROCESSING. TLLP’s Processing business consists of natural gas processing and fractionation complexes with a combined processing throughput capacity of approximately 1,600 MMcf/d and fractionation throughput capacity of approximately 34 Mbpd. TLLP processes gas for certain producers under keep-whole processing agreements. Under a keep-whole agreement, a producer transfers title to the NGLs produced during gas processing and the processor, in exchange, delivers to the producer natural gas with a BTU content equivalent to the NGLs removed. The operating margin for these agreements is determined by the spread between NGLs sales prices and the price paid to purchase the replacement natural gas (“Shrink Gas”). We are party to a five-year agreement, entered into in December 2014 and amended in February 2016, with TLLP that substantially transfers the commodity risk exposure associated with these keep-whole processing agreements from TLLP to us (the “Keep-Whole Commodity Agreement”). Under the Keep-Whole Commodity Agreement, we pay TLLP a fee to process NGLs related to keep-whole agreements and deliver Shrink Gas to the producers on behalf of TLLP. TLLP pays us a marketing fee in exchange for assuming the commodity risk.
 
As of 2016, pricing under this agreement is subject to a tiered pricing structure with pricing for a base level of NGLs production and pricing for incremental volumes over 315,000 gallons per day. The pricing for both the base and incremental volumes are subject to revision each year.

TERMINALLING AND TRANSPORTATION. TLLP’s Terminalling and Transportation business consists of: crude oil and refined products terminals and storage facilities in the western and midwestern U.S. that are supplied by Tesoro-owned and third-party pipelines, trucks and barges; marine terminals in California that load and unload vessels; pipelines that transport products and crude oil from our refineries to nearby facilities in Salt Lake City and Los Angeles; a 50% fee interest in a pipeline that transports jet fuel from our Los Angeles refinery to the Los Angeles International Airport; a regulated common carrier products pipeline running from Salt Lake City, Utah to Spokane, Washington and a jet fuel pipeline to the Salt Lake City International Airport (the “Northwest Products Pipeline”); a rail-car unloading facility in Washington that receives crude oil transported on unit trains we lease; a petroleum coke handling and storage facility in Los Angeles that handles and stores petroleum coke from our Los Angeles refinery; and a regulated common carrier refined products pipeline system connecting our Kenai refinery to Anchorage, Alaska.

TLLP TRANSPORTATION VOLUME (in Mbpd)

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TLLP TERMINALLING THROUGHPUT (in Mbpd)

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December 31, 2016 | 9

BUSINESS
 
 

marketing.jpg MARKETING

Our Marketing segment sells gasoline and diesel fuel in the western U.S. through branded and unbranded channels. Our branded operations include transportation fuel sales through retail stations and agreements with third-party dealers and distributors. Our unbranded business includes volumes sold through agreements with third-party distributors/operators. Our branded and unbranded
 
channels provide a committed outlet for the majority of the gasoline produced by our refineries. The map below shows the approximate number of retail outlets by region included in our Marketing segment’s branded network of retail stations under the ARCO®, Shell®, Exxon®, Mobil®, USA GasolineTM, RebelTM, ThriftyTM and Tesoro® brands as of December 31, 2016.


marketingmap.jpg

 
 
 

COMPETITION

The refining industry is highly competitive and includes a diverse set of competitors. Our primary competitors are typically the other local refining, marketing and logistics companies within the regions we operate, but may include companies from across the globe depending on the market environment. The competitors range from small independently owned businesses to some of the largest integrated multi-national oil companies in the world.
 

We obtain all of our crude oil from third-party sources and compete in the world market for the crude oil and feedstocks we process, and for the customers who purchase 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.



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BUSINESS

We compete with other refiners and with importers for customers in most of our market areas including sales of our distillate production through wholesale and bulk channels. Competition and concentrations specific to each of our refineries are:

Our Martinez, Los Angeles and Anacortes refineries compete with several refiners in the U.S., Canada and throughout the Pacific Rim;
Our Kenai refinery competes with two other in-state refineries along with refineries on the West Coast and in Asia. Our jet fuel sales in Alaska are concentrated in Anchorage, where we are one of the principal suppliers at the Anchorage International Airport; and
Our mid-continent refineries in Mandan, Dickinson, and Salt Lake City compete with supplies provided from refineries in surrounding states and pipeline supply from the Midwest and Gulf Coast regions.

We sell gasoline through our network of branded retail stations as well as on an unbranded, or wholesale, and bulk basis. Our marketing operations compete with other independent marketers, integrated oil companies and high-volume retailers. Competitive factors that affect Marketing include product price, location, convenience and brand appeal.
 

TLLP’s gathering business competes with a number of transportation, midstream, and trucking companies for the gathering and transportation of crude oil and natural gas, as applicable, in the areas in which they operate. TLLP’s gathering business competes for opportunities to build gathering lines from producers or other pipeline companies, to provide accessible and flexible service to producers, and facilitate the transportation of crude oil and natural gas to applicable markets. In processing, TLLP competes with midstream companies and producers primarily based on reputation, commercial terms, reliability, service levels, flexibility, access to markets, location, available capacity, capital expenditures and fuel efficiencies. TLLP’s terminalling and transportation business competes predominately with independent terminal and pipeline companies, integrated petroleum companies, refining and marketing companies and distribution companies with marketing and trading arms. Competition in particular geographic areas is affected primarily by the volumes of refined products produced by refineries located in those areas, the availability of refined products and the cost of transportation to those areas from refineries located in other areas.



 
 
 

HEALTH & SAFETY

Improving personal and process safety is a core value at Tesoro. We are committed to operating our refineries, pipelines, retail stations and other facilities in a manner that promotes the health and safety of our employees, our customers and the communities where we do business.

Our Environmental, Health & Safety (EH&S) policy in conjunction with our Operational Excellence Management System establish metrics, expectations and responsibilities for achieving our goals for these key areas:

PERSONAL SAFETY.  At Tesoro, we consider the health and safety of our people a core value and an essential area of focus of our leadership. We strive to instill a culture of personal responsibility among our employees and contractors by setting clear expectations around our safety standards and policies. We conduct regular audits, assessments and program reviews to ensure these practices are being followed and to identify improvements to enhance our workplace safety.

 
PROCESS SAFETY. Our facilities are designed, constructed, operated and maintained to ensure safe work environments. To maintain the integrity of our operating systems, we enforce a disciplined framework that includes comprehensive design, engineering, operating and maintenance practices. We use industry-recognized methodologies to assure process safety and asset integrity and reduce the risk of incidents.

TRANSPORTATION SAFETY. We are committed to conducting business in a manner that promotes the safety of our employees and those living around us. This includes the operations of our pipelines, storage facilities, rail cars and trucking fleet, which transports crude oil and other feedstock, as well as fuel and other products. We proactively led the industry in the safe transport of crude oil via rail by working collaboratively with tank car manufacturers to develop enhanced rail cars (120J) that surpass regulatory standards.


 
 
 


 
 
December 31, 2016 | 11

BUSINESS
 
 

GOVERNMENT REGULATION AND LEGISLATION

REGULATORY CONTROLS AND EXPENDITURES. Like other companies engaged in similar businesses, we are subject to extensive and frequently changing federal, state, regional and local laws, regulations and ordinances relating to the environment, including those governing emissions or discharges to 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 promulgated multiple regulations to control greenhouse gas emissions under the Federal Clean Air Act. The first of these regulations, finalized on April 1, 2010, set standards for the control of greenhouse gas emissions from light trucks and cars. The U.S. Congress may also consider legislation regarding greenhouse gas emissions in the future.
The Energy Independence and Security Act of 2007 mandates the blending of increasing amounts of renewable fuels in the supply of transportation fuels used domestically. This use of renewable fuels is required of all manufacturers and importers of transportation fuels sold domestically. The EPA implemented the second renewable fuel standard (“RFS2”) through regulation and RFS2 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 EPA finalized amendments to the Clean Air Act Risk Management Planning regulations in 2016 significantly expanding the regulatory requirements.
The Department of Transportation (“DOT”) issued new regulations in 2015 governing the design of rail cars used to transport petroleum and other materials.
In California, Senate Bill 32 (“SB 32”) set a new greenhouse gas emission reduction requirement of 40% below 1990 levels by 2030. Assembly Bill (“AB 197”) mandated direct emission reductions of greenhouse gases from large stationary sources such as our refineries. Assembly Bill 32 (“AB 32”), previously created a statewide cap on greenhouse gas emissions now replaced by SB 32 but also created a low carbon fuel standard, which requires a 10% reduction in the carbon intensity of fuels by 2020.
 
In California, the Board for the South Coast Air Quality Management District passed amendments to the Regional Clean Air Incentives Market (“RECLAIM”) on December 4, 2015. The RECLAIM Amendments became effective in 2016 and required a staged reduction of Nitrogen Oxides through 2022.
In California, new and expanded Process Safety Management and Refinery Safety and Prevention regulations were proposed in 2016 in response to recommendations made in 2014 by the Governor’s Interagency Refinery Safety Working Group.

The impact of these and other regulatory and legislative developments 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 may 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 Item 7.

OIL SPILL PREVENTION AND RESPONSE. We operate in environmentally sensitive coastal waters, where tanker, pipeline, rail cars 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 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. Our spill prevention plans and procedures are frequently reviewed and modified to prevent releases and to minimize potential impacts to land and water should a release occur. 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. At our facilities adjacent to water, federally certified Oil Spill Response Organizations (“OSROs”) are available to respond to a spill on water from above ground storage tanks or pipelines. We have contracts in place to ensure support from the respective OSROs for spills in both open and inland waters, as well as on land.

We currently charter tankers to ship crude oil from foreign and domestic sources to our California, Washington and Alaska refineries. The tanker owners contract with 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 to two million barrels.



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BUSINESS

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 also have entered into contracts with Marine Spill Response Corporation for 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 one spill-response organization 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 we contract with have the highest available rating and certification from the U.S. Coast Guard and are required to annually demonstrate their response capability to the U.S. Coast Guard and state agencies. 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 U.S. 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.

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.

RAIL CAR SAFETY. Tesoro maintains a fleet of leased rail cars to transport crude and support our refining operations. Generally, rail operations are subject to federal, state and local regulations. Over the last year, Tesoro has added over 700 new DOT120J200 tank cars to its crude oil fleet. These cars exceed the new federal standards issued by the DOT during 2015. The new DOT regulations allow for an orderly phase out or retrofit of previous generation rail cars. In 2016, Tesoro retrofit 250 cars while phasing out 500 older CPC-1232 tank cars. Tesoro will continue to comply with all regulatory requirements and order only new rail cars that are among the safest and most robust available at the time of order. TLLP rail operations are limited to loading and unloading rail cars at its facilities. TLLP believes its entire rail car loading and unloading operations meet or exceed all applicable regulations.

PIPELINE SAFETY. Our pipelines, gathering systems and terminal operations, including those owned by TLLP, are subject to increasingly strict safety laws and regulations. The transportation and storage of refined products, natural gas and crude oil involve a risk that hazardous liquids may be released into the environment, potentially causing harm to the public or the environment. The DOT, through the Pipeline and Hazardous Materials Safety Administration and state agencies, enforce safety regulations with respect to the design, construction, operation, maintenance, inspection and management of our pipeline and storage facilities.

REGULATION OF PIPELINES. Operations on portions of our pipelines are regulated by state agencies in Alaska and California. In addition, TLLP owns and operates crude oil, refined product and natural gas pipelines, which are common carriers regulated by various federal, state and local agencies. The FERC regulates interstate transportation on TLLP’s High Plains System, Northwest Products Pipeline and natural gas pipeline under the Interstate Commerce Act, the Energy Policy Act of 1992 and the rules and regulations promulgated under those laws.

Federal regulation of interstate pipelines extends to such matters as rates, services, and terms and conditions of service; the types of services offered to customers; the certification and construction of new facilities; the acquisition, extension, disposition or abandonment of facilities; the maintenance of accounts and records; relationships between affiliated companies; the initiation and continuation of services; market manipulation in connection with interstate sales, purchases or transportation of commodities; and participation by interstate pipelines in cash management arrangements.



 
 
December 31, 2016 | 13

BUSINESS
 
 

The intrastate operation of TLLP’s Alaska pipeline is regulated 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 existing intrastate rates are permitted by complaint of an interested person or by independent action of the appropriate regulatory authority. The intrastate operations of TLLP’s High
 
Plains System in North Dakota are regulated by the North Dakota Public Service Commission. Applicable state law requires that pipelines operate as common carriers, that access to transportation services and pipeline rates be non-discriminatory, that if more crude oil is offered for transportation than can be transported immediately the crude oil volumes transported be apportioned equitably and that pipeline rates be just and reasonable.


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 “Capital Resources and Liquidity” in Item 7.

 
EMPLOYEES

We had more than 6,300 full-time employees at December 31, 2016, approximately 2,090 of whom are full-time represented union employees covered by collective bargaining agreements. The agreements for approximately 1,750 of these employees will expire on February 1, 2019, the agreements for approximately 80 of these employees will expire on March 1, 2017, and the agreements for the remaining represented employees expire on May 1, 2019.


EXECUTIVE OFFICERS

The following is a list of our executive officers, their ages and their positions at Tesoro, effective as of February 21, 2017.

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 (the “Board”) in conjunction with the annual meeting of stockholders. The term of each office runs until the corresponding meeting of the Board 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, 60, was named President and Chief Executive Officer in May 2010 and Chairman of our Board of Directors in December 2014. Mr. Goff also serves as Chief Executive Officer and Chairman of the Board of Directors of Tesoro Logistics GP, LLC (“TLGP”), the general partner of TLLP. Since March 2015, Mr. Goff has served as Chairman of the Board of the American Fuel & Petrochemical Manufacturers. Before joining Tesoro, he served as Senior Vice President, Commercial for ConocoPhillips Corporation (“ConocoPhillips”), an international, integrated energy company, from 2008 to 2010. Mr. Goff held various positions at ConocoPhillips from 1981 to 2008, including Managing Director and CEO of Conoco JET Nordic from 1998 to 2000; Chairman and Managing Director of Conoco Limited, a UK-based refining and marketing affiliate, from 2000 to 2002; President of ConocoPhillips Europe and Asia Pacific downstream operations from 2002 to 2004; President of ConocoPhillips specialty businesses and business development from 2006 to 2008; and President of ConocoPhillips specialty businesses and business development from 2006 to 2008. Mr. Goff serves as Chairman of the Board of the American Fuel and Petrochemical Manufacturers trade association and on the National Advisory Board of the University of Utah Business School. Previously, Mr. Goff served on the board of Chevron Phillips Chemical Company and was a member of the upstream and downstream committees of the American Petroleum Institute. In addition, Mr. Goff has public company experience from his prior service on the board of directors of DCP Midstream GP, LLC. Mr. Goff received a Bachelor’s degree in Science and Master’s degree in Business Administration from the University of Utah.

Keith M. Casey, 50, was named Executive Vice President, Marketing and Commercial in August 2016. Prior to his current role, Mr. Casey served as Executive Vice President, Operations, since May 2014. Prior to that, he served as Senior Vice President, Strategy and Business Development beginning in April 2013. Prior to joining Tesoro, Mr. Casey served as Vice President, BP Products North America, Texas City Refinery beginning in September 2006.


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BUSINESS

Kim K.W. Rucker, 50, joined Tesoro in March 2016 as Executive Vice President, General Counsel and Secretary. Ms. Rucker also serves as Executive Vice President and General Counsel for TLGP. Before joining Tesoro, Ms. Rucker served as Executive Vice President, Corporate and Legal Affairs, General Counsel and Corporate Secretary of Kraft Food Groups, Inc., a food and beverage company (now The Kraft-Heinz Company), from October 2012 to July 2015. She joined Mondelēz International as Executive Vice President, Corporate & Legal Affairs, Kraft Foods North America in September 2012. Prior to that, she served as Senior Vice President, General Counsel and Chief Compliance Officer of Avon Products, Inc., a global manufacturer of beauty and related products, beginning in March 2008 and as Corporate Secretary in February 2009. Ms. Rucker also served as Senior Vice President, Secretary and Chief Governance Officer of Energy Future Holdings Corp. (formerly TXU Corp.), an energy company, from 2004 to 2008. She was Corporate Counsel for Kimberly-Clark Corporation and a Partner in the Corporate & Securities group at Sidley Austin LLP in Chicago. Ms. Rucker serves on the board of directors of Lennox International Inc. She holds a bachelor of business administration degree in economics from the University of Iowa, a law degree from the Harvard Law School and a master’s in public policy from the John F. Kennedy School of Government at Harvard University.

Steven M. Sterin, 45, was named Executive Vice President and Chief Financial Officer in August 2014. In August 2016, he also assumed leadership of corporate development in support of our growth plans. Mr. Sterin also serves as Executive Vice President and Chief Financial Officer of TLGP. Prior to joining Tesoro, Mr. Sterin served as the Senior Vice President and Chief Financial Officer of Celanese Corporation, a global technology and specialty material company, from July 2007 until May 2014 and continued to serve as an employee until August 2014. From December 2010 through January 2013, he was president of Celanese’s Advanced Fuel Technologies business. Mr. Sterin joined Celanese in 2003 as Director of Finance and Controller for the company’s chemical business and also served as Corporate Controller and Principal Accounting Officer before being appointed CFO. Before Celanese, Mr. Sterin spent six years with global chemicals company Reichhold, Inc. in a variety of financial positions, including Director of Tax and Treasury in the Netherlands, Global Treasurer and Vice President of Finance for one of the company’s divisions in North Carolina. Mr. Sterin holds a Master of Professional Accounting degree and a Bachelor of Business Administration degree in accounting, which he earned concurrently at the University of Texas at Austin. He is also a certified public accountant in Texas.

Cynthia J. Warner, 58, was named Executive Vice President, Operations in August 2016. Prior to her current role, Mrs. Warner served as Executive Vice President, Strategy and Business Development since October 2014. Before joining Tesoro, Mrs. Warner served as President, Chief Executive Officer, and Chairman of the Board of Sapphire Energy beginning in 2009.

Blane W. Peery, 50, was named Vice President and Controller of both Tesoro and TLGP in November 2016. Prior to that, he served as Vice President, Process Excellence and Chief Information Officer from February 2015 through October 2016. Mr. Peery has experience leading global accounting organizations, business planning and analysis functions, supply chain groups, global shared services including finance, human resources, information technology, and mergers and acquisitions integration. From March 2014 to February 2015, Mr. Peery served as VP, Global Business Services at Mylan N.V., a leading global pharmaceutical company. Prior to that he worked for Celanese Corporation, a global technology and specialty materials company, for over 20 years in roles with increasing responsibility, including positions as its Vice President, Global Business Services from October 2012 to March 2014, its Vice President, Supply Chain from October 2011 to October 2012 and its first-ever Global Accounting Director. Mr. Peery began his career as an auditor for PricewaterhouseCoopers and is a Certified Public Accountant (CPA). Mr. Peery holds a Bachelor of Business Administration degree in accounting, which he earned at the University of Texas at Austin.

Stephan E. Tompsett, 40, was named Vice President, Treasurer and Credit in August 2016. From May 2015 through August 2016, he served as Chief Financial Officer, Logistics of Tesoro Companies, Inc. Prior to joining Tesoro, Mr. Tompsett served in a variety of finance roles at Energy Transfer Partners from February 2011 to May 2015. From September 2008 to January 2011, he was Vice President, Corporate Development at Synthesis Energy Systems. He was an associate at JPMorgan from July 2005 to August 2008. Mr. Tompsett holds a Master of Business Administration degree from the University of Texas at Austin - Red McCombs School of Business and a Bachelors of Science degree in biology and mathematics from the University of Texas at Austin.

WEBSITE ACCESS TO REPORTS AND OTHER INFORMATION

Our Internet website address is http://www.tsocorp.com. Information contained on our Internet website is not part of this Annual Report on Form 10-K.

Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and other public filings with the Securities and Exchange Commission (“SEC”) are available, free of charge, on our website as soon as reasonably practicable after we file them with, or furnish them to, the SEC. You may also access these reports on the SEC’s website at http://www.sec.gov.


 
 
December 31, 2016 | 15

RISK FACTORS
 
 

ITEM 1A. RISK FACTORS

Our proposed acquisition of Western Refining is subject to significant risks and uncertainties.

As described elsewhere in this Annual Report on Form 10-K, we have entered into a merger agreement, dated as of November 16, 2016, with Western Refining, Inc. (“Western Refining”) pursuant to which, on the terms and subject to the conditions included therein, we have agreed to acquire Western Refining. Our ability to complete the proposed acquisition on a timely basis or at all is subject to numerous risks and uncertainties, including, but not limited to, the following:

we may not obtain required shareholder approval;
we may not obtain required regulatory approvals or receipt of regulatory approvals may take longer than expected or may impose conditions to the proposed acquisition that are not presently anticipated or cannot be met;
conditions to the proposed acquisition may not be fulfilled in a timely manner or at all; or
unforeseen events and those beyond our control.

The proposed acquisition also subjects us to business uncertainties while it is pending and places other restrictions on our business, including, without limitation:

our ability to attract, retain and motivate key personnel until the proposed acquisition is completed and for a period of time thereafter;
our ability to maintain our relationships with our customers and other third parties we transact with, who may seek to change their existing business relationships with us as a result of the proposed acquisition; and
restrictions imposed on us under the merger agreement that prohibit us from entering into certain corporate transactions and taking other specified actions without the consent of Western Refining, which may prevent us from pursuing attractive business opportunities that may arise prior to the completion of the acquisition.

We have incurred and expect to continue to incur significant transaction and acquisition-related costs associated with the proposed acquisition. These, as well as other unanticipated costs and expenses could have a material adverse effect on our financial condition and operating results. Combining our businesses may be more difficult, costly or time consuming than expected. Integration involves numerous challenges, including our ability to integrate our businesses in an efficient and timely manner, integrate our systems and controls as well as integrate our relationships with our customers, suppliers, employees and other third parties. The integration process may, for us and Western Refining, result in the loss of key employees, the disruption of ongoing businesses or inconsistencies in standards, controls, procedures and policies.

The success of the proposed acquisition will depend on, among other things, our ability to realize the anticipated benefits and cost savings from combining our and Western Refining’s businesses in a manner that facilitates growth opportunities and realizes anticipated synergies and costs savings. These anticipated benefits and cost savings may not be realized fully or at all, or may take longer to realize than expected or could have other adverse effects that we do not currently foresee.

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

Our refining margins are influenced by the price of our refining feedstocks-crude oil and other feedstocks-and the price of our refined products. These prices often move independently of each other, which can negatively impact our margins, earnings or cash flows. In recent years, prices have fluctuated significantly due to global and local factors that are beyond our control, including:

production and availability of foreign and domestic crude oil and refined products;
production controls set and maintained by the members of the Organization of the Petroleum Exporting Countries;
transportation infrastructure availability, local market conditions, operation levels of other refineries in our markets, and the import or export of crude and refined products;
political instability, threatened or actual terrorist incidents, acts of war, and other global political conditions;
domestic and foreign governmental regulations and taxes;
the price, availability and efficiency of competing energy sources;
local, regional, national and worldwide economic conditions; and
weather conditions, hurricanes or other natural disasters.


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RISK FACTORS

Some of these factors can vary by region and may change quickly, adding to market volatility, while others may have longer-term effects. The long-term effects of these and other factors on prices for crude oil, refinery feedstocks and refined products are uncertain and could negatively impact our margins, earnings or financial condition.

The short-term effects of these fluctuations could affect our margins, earnings and cash flows. 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 refined products could affect our margins, earnings or cash flows. In addition, we purchase refined products manufactured by others to sell to our customers. If we are unable to manage our commodity exposure risk, it could affect our business, financial condition and results of operations. Lower refining margins may reduce the amount of refined products we produce, which may reduce our revenues, income from operations or cash flows. Significant reductions in margins could require us to reduce our capital expenditures or impair the carrying value of our assets.

Volatile prices for natural gas and electricity 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. In addition, the volume of crude oil, refined products, natural gas and NGLs that TLLP distributes and stores at its terminals, transports and processes depends substantially on our and other customers’ profit margins, the market price of crude oil, natural gas, NGLs and other refinery feedstocks, and product demand.

A substantial change to fiscal or tax policies may adversely affect our business.

Recent events have given rise to a heightened possibility of a substantial change to fiscal and tax policies, which may include comprehensive tax reform. We cannot predict the impact these changes will have on our business; however, it is possible that these changes could adversely affect our business, our cash flows, our profitability, and our ability to compete domestically and internationally. Until we know what changes are enacted, we will not know the type or extent of the effects on our business.

We may be unsuccessful in integrating the operations of the assets we have acquired or may acquire in the future, or in realizing all or any part of the anticipated benefits of any such acquisition.

If we are unable to successfully integrate our acquisitions into our business, we may never realize their expected benefits. With each acquisition, we may discover unexpected costs, environmental liabilities, delays, or lower than expected cost savings or synergies. In addition, we may be unable to successfully integrate the diverse company cultures, retain key personnel, apply our expertise to new competencies, or react to adverse changes in commodity prices or industry conditions.

We cannot predict with certainty the benefits of these acquisitions, which often constitute multi-year endeavors. For example, our proposed acquisition of Western Refining is uncertain and, if completed, will require substantial capital during 2017 and later years. If we are unable to realize all or part of the projected benefits from this or other acquisitions within our expected timeframes, our business, results of operations and financial condition may suffer.

We are subject to interruptions of supply and increased costs as a result of our reliance on logistics assets for the transportation of crude oil, feedstocks and refined products within our business.

Our subsidiaries own and operate seven refineries in the western United States, which refine crude oil and other feedstocks into refined products for sale to a wide variety of markets. We rely on a variety of logistics assets to transport crude oil, feedstocks and refined products, including, but not limited to, marine vessels, marine terminals, rail, pipelines, product terminals, storage tanks and trucks. Some of these assets are owned and operated by third-parties. In particular, losing access to certain assets owned by TLLP could halt production at some of our refineries. Accidents, natural disasters, government regulation, third-party actions or other events outside of our control could impede our use or increase the cost of using these assets, which could have a material adverse effect on our financial condition and results of operations.

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.

Our business is affected by the strength of the U.S. and global economies, and the risk of global economic downturn continues. Prolonged downturns could result in declines in consumer and business confidence and spending as well as increased unemployment and reduced demand for transportation fuels. These conditions may decrease the creditworthiness of our suppliers, customers and business partners, which could interrupt or delay our suppliers’ performance of our contracts, reduce or delay customer purchases, delay or prevent customers from obtaining financing to purchase our products, or result in bankruptcy of customers or business partners. Any of these events may adversely affect our cash flow, profitability and financial condition.

 
 
December 31, 2016 | 17

RISK FACTORS
 
 


Our business includes selling products in international markets, and we are subject to risks of doing business on a global level.

We sell some of our products internationally, primarily to markets in Mexico, South America and Asia. Our operating results or financial condition could be negatively impacted by disruptions in any of these markets, including economic instability, restrictions on the transfer of funds, duties and tariffs, transportation delays, import and export controls, changes in governmental policies, labor unrest and changing regulatory and political environments. In addition, if trade relationships deteriorate with these countries, if existing trade agreements are modified or terminated, or if taxes, border adjustments or tariffs make trading with these countries more costly, it could have a material adverse effect on our business.

The availability and cost of renewable identification numbers could have an adverse effect on our financial condition and results of operations.

The RFS2 requires refiners to add annually increasing amounts of “renewable fuels” to their petroleum products or to purchase credits, known as renewable identification numbers (“RINs”), in lieu of such blending. Due to regulatory uncertainty and in part due to the nation’s fuel supply approaching the “blend wall” (the 10% ethanol limit prescribed by most automobile warranties), the price and availability of RINs has been volatile.

While we generate RINs by blending renewable fuels manufactured by third parties, we purchase RINs on the open market to comply with the RFS2. We cannot predict the future prices of RINs, and the costs to obtain the necessary RINs could be material. Our financial condition and results of operations could be adversely affected if we are unable to pass the cost of compliance on to our customers, pay significantly higher prices for RINs, and generate or purchase RINs to meet RFS2 mandated standards.

Meeting the requirements of, including the cost to comply with evolving environmental, health and safety laws and regulations including those related to climate change could materially affect our performance, financial condition and results of operations.

Environmental, health and safety laws and regulations may continue to raise our operating costs and require significant capital investments. If we discover new conditions at our facilities that require remediation, or if environmental, health and safety, and energy requirements change materially, we could be required to increase our capital expenditures, which could negatively impact our financial condition. We cannot predict developments in federal or state laws or regulations governing environmental, health and safety or energy matters, or how these changes may affect our business or financial condition.

Currently, multiple legislative and regulatory measures to address greenhouse gas (including carbon dioxide, methane and nitrous oxides) and other emissions are in various phases of consideration, promulgation or implementation. These include actions to develop national, statewide or regional programs, each of which could require reductions in our greenhouse gas or other emissions and decrease the demand for our refined products. Requiring reductions in these 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 emissions programs, including acquiring emission credits or allotments. For example:

In California, the state legislature adopted SB 32 in 2016. SB 32 set a cap on emissions of 40% below 1990 levels by 2030 but did not establish a particular mechanism to achieve that target. The legislature also adopted a companion bill -AB 197 that most significantly directs the California Air Resources Board to prioritize direct emission reductions on large stationary sources. While AB 197 does not specifically preclude a market mechanism, it is expected to result in future regulations that will target greenhouse gas reductions at refineries, in addition to the mandates imposed by the existing cap and trade and low carbon fuel standard programs created by AB 32. AB 32 requires the state to reduce its greenhouse gas (“GHG”) emissions to 1990 levels by 2020. Two regulations implemented to achieve this goal are Cap-and-Trade and the Low Carbon Fuel Standard (“LCFS”). In 2012, the California Air Resource Board implemented Cap-and-Trade. This program currently places a cap on GHGs and we are required to acquire a sufficient number of credits to cover emissions from our refineries and our in-state sales of gasoline, diesel, and some LPGs. In 2009, CARB adopted the LCFS, which requires a 10% reduction in the carbon intensity of gasoline and diesel by 2020. Compliance is demonstrated by blending lower carbon intensity biofuels into gasoline and diesel or by purchasing credits. Compliance with each of these programs is demonstrated through a market-based credit system. If we are unable to pass the costs of compliance on to our customers, sufficient credits are unavailable for purchase, we have to pay a significantly higher price for credits, or if we are otherwise unable to meet our compliance obligation, our financial condition and results of operations could be adversely affected.
In California, the Board for the South Coast Air Quality Management District passed amendments to the RECLAIM on December 4, 2015. The RECLAIM Amendments became effective in 2016 and require a staged reduction of NOx through 2022.

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RISK FACTORS

The EPA adopted a new rule in 2015 requiring further reductions in the National Ambient Air Quality Standard for ozone.

In addition, pre-rulemaking is underway in California to implement the recommendations made in 2014 by the Governor’s Interagency Refinery Safety Working Group to significantly expand the scope and requirements of California’s process safety management regulations. The final requirements could have a material impact on our cash flows, profitability and financial condition.

Regulatory and other requirements concerning the transportation of crude oil and other commodities by rail may cause increases in transportation costs or limit the amount of crude that we can transport by rail.

We rely on a variety of systems to transport crude oil, including rail. In 2012, we completed the construction of a 50 Mbpd crude oil rail car unloading facility in Anacortes, Washington (the “Anacortes Rail Facility”), which TLLP subsequently acquired from us. The Anacortes Rail Facility allows us to receive crude oil into our Anacortes refinery. We have also entered into a joint venture with Savage Companies to construct, own and operate a unit train unloading and marine loading terminal at the Port of Vancouver, USA. The construction of the terminal is subject to approval by regulatory agencies and will have a capacity up to 360 Mbpd.

In 2015 the U.S. Department of Transportation issued new standards and regulations applicable to crude-by-rail transportation (Enhanced Tank Car Standards and Operational Controls for High-Hazard Flammable Trains). These or other regulations could increase the time required to move crude oil from production areas to our refineries, increase the cost of rail transportation and decrease the efficiency of shipments of crude oil by rail within our operations. Any of these outcomes could have a material adverse effect on our business and results of operations.

We rely upon certain critical information systems for the operation of our business, and the failure of any critical information system, including a cyber-security breach, may result in harm to our reputation and business.

We depend heavily on our technology infrastructure and critical information systems, including data networks, telecommunications, remote connectivity, cloud-based information controls, software applications and hardware, including those that are critical to operating our refineries, pipelines, terminals, retail stations and other business operations. In addition, we collect sensitive data, including personally identifiable information of our customers using credit cards at our retail outlets.

We are in the process of completing the enterprise resource planning project (see further discussion in Item 7) which aims to simplify business processes by implementing a standardized and scalable technology platform. Large information systems and business process transformations such as this one are complex and require significant investments in system software, business process development and employee resources. Our business and results of operations may be adversely affected if we experience operating problems, scheduling delays, cost overages or service limitations. Additionally, we may not achieve all of the expected synergies with this project which may impact our ability to achieve the project’s objectives.

Our technology infrastructure and 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, employee error or malfeasance, and other events. Although we have experienced actual or attempted breaches of our cybersecurity, none of these breaches have had a material effect on our business, operations or reputation (or compromised any customer data). However, no cybersecurity or emergency recovery processes is failsafe, and if our safeguards fail or our data or technology infrastructure is compromised, the safety and efficiency of our operations could be materially harmed, our reputation could suffer, and we could be subject us to additional costs, liabilities, and costly legal challenges, including those involving privacy of customer data. Any of these outcomes could materially harm our business and operations. Finally, state and federal legislation relating to cybersecurity could impose new requirements, which could increase our costs or reduce our efficiency.

Disruption of our ability to obtain crude oil could adversely affect our operations, revenue and cash flow.

To maintain or increase production levels at our refineries, we must continually contract for crude oil supplies from third parties. A material decrease in crude oil production from the fields that supply our refineries as a result of decreased exploration and production activity, natural production declines or otherwise, could result in a decline in the volume of crude oil available to our refineries. Such an event could result in an overall decline in volumes of refined products processed at our refineries and a corresponding reduction in our revenue and cash flow.

In addition, many of our logistics agreements contain minimum volume commitments. If we do not satisfy the minimum volume commitments, we will still be responsible for payment for transportation and storage services as if we had utilized such minimum volumes.


 
 
December 31, 2016 | 19

RISK FACTORS
 
 

Terrorist attacks aimed at our facilities or that impact our customers or the markets we serve could adversely affect our business.

The U.S. government has issued warnings that energy assets in general, including the nation’s refining, pipeline and terminal infrastructure, may be future targets of terrorist organizations. Any future terrorist attacks on our facilities, those of our customers, or on any transportation networks, including pipelines, could have a material adverse effect on our business. Similarly, any future terrorist attacks that severely disrupt the markets we serve could materially and adversely affect our results of operations, financial position and cash flows.

Our inventory risk management activities may result in substantial derivative variability or losses.

We enter into derivative transactions to manage the risks from changes in the prices of crude oil, refined products, natural gas, and other feedstocks associated with our physical inventories and future production, and these may result in substantial derivatives variability or losses, which could increase the volatility of our earnings. We manage 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 results may fluctuate significantly from one reporting period to the next depending on commodity price fluctuations and our relative physical inventory positions. These transactions may also expose us to risks for financial losses; for example, if our production is less than we anticipated at the time we entered into a hedge agreement or if a counterparty to our hedge agreement fails to perform its obligations under the agreements. See Item 7A.

Competition in the refining, logistics and marketing industry is intense, and an increase in competition in the markets in which we sell our products could adversely affect our earnings and profitability.

We compete with a broad range of refining and marketing companies, including certain multinational oil companies. Competitors with greater geographic diversity, larger or more complex refineries, integrated operations with exploration and productions resources and broader access to resources, may be better able to withstand volatile market conditions and to bear the risks inherent in the refining industry. For example, competitors that engage in exploration and production of crude oil may be better positioned to withstand periods of depressed refining margins or feedstock shortages. Our competitors’ recent consolidations and acquisitions and their plans for projects that could increase refining capacity or efficiency could increase competition in our markets, reduce our margins and affect our cash flow.

In addition, we compete with alternative energy and fuel producers for some industrial, commercial and individual consumers. There is significant governmental and consumer pressure to increase the use of alternative fuels and vehicles in the United States. If these alternative energy sources gain support as a result of governmental regulations and subsidies, technological advances, consumer demand, or other causes, they could impact demand for our products and our financial condition.

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

Refineries, gas processing plants, pipelines, rail cars, terminals and other components of our business are subject to potential operational hazards and risks inherent in refining operations and in transporting and storing crude oil, natural gas, refined products and waste. Operational hazards, such as fires, floods, earthquakes, explosions, third-party accidents, maritime disasters, security breaches, pipeline ruptures and spills, mechanical failure of equipment, severe weather and other 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. These events could create significant liabilities that are outside the limits or scope or our insurance policies, and could expose us to penalties under federal, state and local laws. The costs that we could have to pay in penalties or for clean-up, remediation and damages could have a material adverse effect on our business, financial condition and operations. Any such unplanned event or shutdown could have a material adverse effect on our business, financial condition and results of operations.

In addition, we operate in and adjacent to environmentally sensitive coastal waters where tanker, pipeline, rail car and refined product transportation and storage operations are closely regulated by federal, state and local agencies and monitored by environmental interest groups. Our coastal refineries receive crude oil and other feedstocks by tanker. In addition, our refineries receive crude oil and other feedstocks by rail car and truck. Transportation and storage of crude oil, other feedstocks 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, Washington and Alaska. If we are unable to promptly and adequately contain any accident or discharge involving tankers, pipelines, rail cars or above ground storage tanks transporting or storing crude oil, other feedstocks or refined products, we may be subject to substantial liability. In addition, the service providers we have contracted to aid us in a discharge response may be unavailable due to weather conditions, governmental regulations or other local or global events. State or federal rulings could divert our response resources to other global events.


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RISK FACTORS

We are also required to ensure the quality and purity of the products loaded at our loading racks and pipeline connections. If our quality control measures were to fail or be compromised, we may have contaminated or off-specification products commingled in our pipelines and storage tanks that could be sent to customers and other end users. These types of incidents could result in product liability claims from our customers or other pipelines to which our pipelines connect. These product liability claims may have a material adverse effect on our business or results or operations or our ability to maintain existing customers or retain new customers.

We do not maintain insurance coverage against all potential losses. Marine vessel charter agreements may not provide complete indemnity for oil spills, and any marine charterer’s liability insurance we carry may not cover all losses. If a loss event is not fully covered by insurance or if our insurers fail to honor their coverage commitments for an insured event or if our counterparties fail to honor any indemnification agreements, it could have a material adverse effect on our business, financial condition and results of operations.

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. We may become involved in further litigation or other civil or criminal proceedings, or we may be held responsible in any existing or future litigation or proceedings, the costs of which could be material.

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.

Large capital projects can take several years to complete, and if we are unable to complete capital projects at their expected costs or in a timely manner, or if market conditions deteriorate significantly between the project approval date and the project startup date, our results of operations, cash flows or project returns could be adversely impacted.

We are constructing several new projects and expanding existing ones, such as the construction of the Vancouver Energy Project and the Clean Product Upgrade Project. The construction process involves numerous regulatory, environmental, political and legal uncertainties, most of which are not fully within our control. If we are unable to complete capital projects at their expected costs or in a timely manner our results of operations or cash flows could be adversely affected. In addition, our revenues may not increase immediately upon the expenditure of funds because construction or expansion may occur over an extended period of time, and we may not receive any material increases in revenues until after substantial completion of the project.

To approve a large-scale capital project, the project must meet an acceptable level of return on the capital to be employed in the project. We base these economic projections on our best estimate of future market conditions that are not within our control. Most large-scale projects take many years to complete and during this multi-year period, market conditions can change from those we forecast due to changes in general economic conditions, available alternative supply and changes in customer demand. Accordingly, we may not be able to realize our expected returns from a large investment in a capital project, and this could negatively impact our results of operations, cash flows and return on capital employed.

Because of our debt obligations, our business, financial condition, results of operations and cash flows could be negatively impacted by a deterioration of our credit profile, a decrease in debt capacity or unsecured commercial credit available to us, or by factors adversely affecting credit markets generally.

At December 31, 2016, our total debt obligations for borrowed money and capital lease obligations were $7.0 billion. We may incur substantial additional debt obligations in the future.

Our indebtedness may impose various restrictions and covenants on us that could have material adverse consequences, including:

increasing our vulnerability to changing economic, regulatory and industry conditions;
limiting our ability to compete and our flexibility in planning for, or reacting to, changes in our business and the industry;
limiting our ability to pay dividends to our stockholders;
limiting our ability to borrow additional funds; and

 
 
December 31, 2016 | 21

RISK FACTORS
 
 

requiring us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby reducing funds available for working capital, capital expenditures, acquisitions and other purposes.

Refining optimization requires precise inventory management, which we perform through combinations of working capital and debt. A decrease in our debt or commercial credit capacity, including unsecured credit extended by third-party suppliers, or a deterioration in our credit profile, could increase our costs of borrowing money or limit our access to the capital markets and commercial credit, which could affect our ability to manage our inventory or otherwise materially and adversely affect our business, financial condition, results of operations and cash flows.

Our business may be negatively affected by work stoppages, slowdowns or strikes by our employees, as well as new labor requirements.

As of December 31, 2016, approximately 2,090 of our employees are covered by collective bargaining agreements at our Anacortes, Mandan, Martinez, Los Angeles and Salt Lake City refineries. The agreements for approximately 1,750 of these employees will expire on February 1, 2019, agreements for approximately 80 others will expire on March 1, 2017, and agreements for the remaining represented employees expire on May 1, 2019. A strike, work stoppage or other labor action could have an adverse effect on our financial condition or results of operations.

In addition, California requires refinery owners to pay prevailing wages to contract craft workers and restricts refiners’ ability to hire qualified employees to a limited pool of applicants. Legislation or changes in regulations (e.g. the U.S. Department of Labor’s recent interpretation regarding joint employers/independent contractors) could result in labor shortages higher labor costs, and an increased risk that contract employees become joint employees of Tesoro, which could trigger bargaining issues, employment discrimination liability issues as well as wage and benefit consequences, especially during critical maintenance and construction periods.

Ownership of the general partner of TLLP may involve a greater exposure to legal liability than our historic business operations.

One of our subsidiaries acts as the general partner of TLLP. Our control of the general partner may increase the possibility of claims of breach of fiduciary duties including claims of conflicts of interest related to TLLP. Any liability resulting from such claims could have a material adverse effect on our future business, financial condition, results of operations and cash flows.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Our principal properties are described in Item 1 under “Refining,” “TLLP” and “Marketing.” We believe that our properties and facilities are adequate for our operations and are adequately maintained. We, along with TLLP, 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 marketing business through a network of 2,492 retail stations. Our unbranded business includes volumes sold through agreements with third-party distributors/operators at terminals supporting our refineries. See Note 12 and 15 to our consolidated financial statements in Item 8 for additional information on our leased properties.

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 liquidity, financial position, or results of operations.

UNRESOLVED MATTERS

MERGER-RELATED LITIGATION. On February 7, 2017, a Tesoro stockholder filed a purported class action complaint in the Court of Chancery of the State of Delaware, captioned Carl Arias v. Gregory J Goff, et al., Case No. 2017-0094-, on behalf of himself and all other Tesoro stockholders against the current members of our board of directors. The complaint alleges that our directors breached their fiduciary duties of care, loyalty, good faith and/or disclosure by failing to disclose to our stockholders all material

22 | Tesoro Corporation
 
 

 
 
LEGAL PROCEEDINGS

information necessary to make an informed decision regarding whether to approve the issuance of Tesoro common stock in connection with our proposed acquisition of Western Refining. Among other remedies, the plaintiff seeks to enjoin the merger and to hold our directors liable for allegedly breaching their fiduciary duties. The action also seeks to recover costs and disbursements from the defendants, including attorneys’ fees and experts’ fees. The defendants intend to defend the action vigorously.

WASHINGTON REFINERY FIRE. 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”) initiated an investigation of the incident. L&I completed its investigation in October 2010, issued a citation and assessed approximately a $2 million fine, which we appealed. 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. In separate September 2013, November 2013 and February 2015 orders, the Board of Industrial Insurance Appeals (“BIIA”) granted partial summary judgment in our favor rejecting 33 of the original 44 allegations in the citation as lacking legal or evidentiary support. The hearing on the remaining 11 allegations concluded in July 2016, and we expect the judge to issue a recommended decision for the BIIA’s review in 2017. While we cannot currently estimate the final amount or timing of the resolution of this matter, we have established an accrual based on our best estimate at the time.

AIR QUALITY REGULATIONS. On February 12, 2016, we received an offer to settle 35 Notice of Violations (“NOV”) received from the Bay Area Air Quality Management District (“BAAQMD”). The NOVs were issued from May 2011 to November 2015 and allege violations of air quality regulations for ground level monitors located at our Martinez refinery. While we are negotiating a settlement of the allegations with the BAAQMD, we cannot currently estimate the amount or timing of the resolution of this matter, and we believe the outcome will not have a material impact on our liquidity, financial position, or results of operations.

Also, on January 31, 2017, we received an offer to settle 51 NOVs received from the BAAQMD. The NOVs were issued from July 2011 to July 2015 and allege violations of various air quality regulations at our Martinez refinery. While we are evaluating the allegations and cannot currently estimate the amount or timing of the resolution of this matter, we believe the outcome will not have a material impact on our liquidity, financial position, or results of operations.

FUEL STANDARDS. On April 19, 2016, we received an offer to settle two NOVs received from CARB. The NOVs were issued in February 2016 and allege certain batches of fuels produced in June and July 2015 at our Martinez and Los Angeles refineries violated fuel standards within the California Code of Regulations. While we are actively discussing a settlement of the allegations with CARB, we cannot currently estimate the amount or timing of the resolution of this matter.

RESOLVED MATTERS

In December 2016, we settled allegations from CARB related to reports filed by our Los Angeles refinery in 2013 and 2014 under California’s Greenhouse Gas Mandatory Reporting Program. The amount paid to settle this matter did not have a material impact on our liquidity, financial positions or results of operations. Also in December 2016, we agreed to settle three NOVs from the County of San Diego, Department of Environmental Health. The NOVs were issued after the inspection of three marketing sites between December 2014 and June 2015 and alleged improper operation of underground storage tank leak detection equipment as required by the California Health and Safety Code. The amount we have agreed to pay to settle this matter will not have a material impact on our liquidity, financial position or results of operations.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 
 
December 31, 2016 | 23

MARKET FOR EQUITY, STOCKHOLDER MATTERS AND PURCHASES OF EQUITY SECURITIES

 
 

PART II

ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

PERFORMANCE GRAPH

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 and (b) a composite peer group (“Peer Group”) comprised of HollyFrontier Corporation, Marathon Petroleum, Phillips 66 and Valero Energy Corporation. The graph below is for the five year period commencing December 31, 2011 and ending December 31, 2016.

We selected the Peer Group to include four domestic refining companies we believe follow a similar business model to ours, including refining, transporting, storing and marketing transportation fuels and related products. The Peer Group is representative of companies that we internally benchmark against.

COMPARISON OF FIVE YEAR CUMULATIVE TOTAL RETURN
AMONG THE COMPANY, THE S&P COMPOSITE 500 INDEX AND COMPOSITE PEER GROUPS (a)

 
12/31/2011
 
12/31/2012
 
12/31/2013
 
12/31/2014
 
12/31/2015
 
12/31/2016
Tesoro
$
100.00

 
$
189.79

 
$
256.32

 
$
331.66

 
$
479.25

 
$
408.45

S&P 500
100.00

 
116.00

 
153.57

 
174.60

 
177.01

 
198.18

Peer Group
100.00

 
173.58

 
258.76

 
250.29

 
315.43

 
328.51


(a)
Assumes that the value of the investments in common stock and each index was $100 on December 31, 2011, and that all dividends were reinvested. Investment is weighted on the basis of market capitalization.
a20141231-ts_chartx58737a01.jpg
Note: The stock price performance shown on the graph is not necessarily indicative of future performance.


24 | Tesoro Corporation
 
 

 
 
MARKET FOR EQUITY, STOCKHOLDER MATTERS AND PURCHASES OF EQUITY SECURITIES


STOCK PRICES AND DIVIDENDS PER COMMON SHARE

Our common stock is listed under the symbol “TSO” on the New York Stock Exchange.

HIGH AND LOW SALES PRICES AND DIVIDENDS DECLARED AND PAID ON OUR COMMON STOCK

 
Sales Prices per Common Share
 
Dividends per Common Share
Quarter Ended
High
 
Low
 
December 31, 2016
$
93.06

 
$
78.32

 
$
0.55

September 30, 2016
84.89

 
69.49

 
0.55

June 30, 2016
87.85

 
70.78

 
0.50

March 31, 2016
109.24

 
67.80

 
0.50

December 31, 2015
119.67

 
95.37

 
0.50

September 30, 2015
110.74

 
83.75

 
0.50

June 30, 2015
93.14

 
81.77

 
0.425

March 31, 2015
94.83

 
64.16

 
0.425


DIVIDEND DECLARATION

Our Board of Directors (the “Board”) declared a quarterly cash dividend on common stock of $0.55 per share on February 3, 2017. The dividend is payable on March 15, 2017 to holders of record at the close of business on February 28, 2017. There were approximately 916 holders of record of our 116,986,291 outstanding shares of common stock on February 15, 2017. For information regarding restrictions on future dividend payments and stock purchases, see Item 7 and Note 16 to our consolidated financial statements in Item 8.

PURCHASES OF EQUITY SECURITIES

We are authorized by our Board to purchase shares of our common stock in open market transactions at our discretion. The Board’s authorization has no time limit and may be suspended or discontinued at any time. Purchases of our common stock can also be made to offset the dilutive effect of stock-based compensation awards and to meet our obligations under employee benefit and compensation plans, including the exercise of stock options and vesting of restricted stock and to fulfill other stock compensation requirements. Our Board authorized a $1.0 billion share repurchase program on July 30, 2014. On October 28, 2015, our Board approved a new $1.0 billion share repurchase program to become effective upon the full completion of the previous $1.0 billion share repurchase authorized. On November 16, 2016 the Board approved an additional $1.0 billion of share repurchases. We purchased approximately 3.2 million and 6.9 million shares of our common stock in the years ended December 31, 2016 and 2015 for approximately $250 million and $644 million, respectively. We have $2.1 billion remaining under our authorized programs as of December 31, 2016.

PURCHASES BY TESORO OF ITS COMMON STOCK

Period
Total Number of Shares Purchased (a)
 
Average Price Paid
per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (in millions)
October 2016
94,074

 
$
81.53

 
94,074

 
$
1,106

November 2016
221

 
$
86.56

 

 
$
2,106

December 2016

 
$

 

 
$
2,106

Total
94,295

 
 
 
94,074

 
 

(a)
Includes 221 shares acquired from employees during the fourth quarter of 2016 to satisfy tax withholding obligations in connection with the vesting of restricted stock issued to them.


 
 
December 31, 2016 | 25

SELECTED FINANCIAL DATA
 

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth certain selected consolidated financial data of Tesoro as of and for each year in the five-year period ended December 31, 2016. The selected consolidated financial information presented below has been derived from our historical financial statements. The following table should be read in conjunction with Item 7 and our consolidated financial statements in Item 8.
 
Years Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(in millions except per share amounts)
Statement of Consolidated Operations Data
 
 
 
 
 
 
 
 
 
Revenues
$
24,582

 
$
28,711

 
$
40,633

 
$
37,601

 
$
29,809

Net Earnings from Continuing Operations
850

 
1,694

 
917

 
434

 
903

Net Earnings from Continuing Operations Attributable to Tesoro Corporation
724

 
1,544

 
872

 
392

 
876

Net Earnings from Continuing Operations per Share:
 
 
 
 
 
 
 
 
 
Basic
6.11

 
12.53

 
6.79

 
2.90

 
6.28

Diluted
6.04

 
12.39

 
6.67

 
2.85

 
6.20

Dividends per Share
2.10

 
1.85

 
1.10

 
0.90

 
0.27

 
 
 
 
 
 
 
 
 
 
 
As of December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In millions)
Consolidated Balance Sheet Data
 
 
 
 
 
 
 
 
 
Total Current Assets
$
7,414

 
$
4,307

 
$
5,074

 
$
5,262

 
$
4,522

Total Assets
20,398

 
16,332

 
16,491

 
13,252

 
10,538

Total Debt, Net of Unamortized Issuance Costs
6,933

 
4,073

 
4,167

 
2,756

 
1,538

Total Liabilities
12,271

 
8,592

 
9,515

 
7,767

 
5,801

Tesoro Corporation Stockholders’ Equity
5,465

 
5,213

 
4,454

 
4,302

 
4,251

Total Equity
8,127

 
7,740

 
6,976

 
5,485

 
4,737



26 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

ITEM 7. MANAGEMENTS 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 Items 1 and 2 and our consolidated financial statements in Item 8.

Management’s Discussion and Analysis is our analysis of our financial performance, financial condition and significant trends that may affect future performance. All statements in this section, other than statements of historical fact, are forward-looking statements that are inherently uncertain. See “Important Information Regarding Forward-Looking Statements” for a discussion of the factors that could cause actual results to differ materially from those projected in these statements.

BUSINESS STRATEGY AND OVERVIEW

In recent years, we have implemented strategies to transform the composition of our portfolio of refining, logistics and marketing assets. In 2010, the majority of our operating income was generated through our Refining segment with only a small portion attributable to our previous retail segment and we did not have commercial logistics operations. As of 2016, Tesoro Logistics, LP (“TLLP”) has grown significantly and our Marketing segment continues to expand at a steady rate as a percentage of contribution to our consolidated operating income. We are committed to further integrating our business model, improving our value chain optimization and continuing to diversify our portfolio amongst our segments and be a leader among our independent refining peers. To help us achieve this strategy, organic growth and growth by acquisition are key contributors. See our Capital Expenditures discussion within the Capital Resources and Liquidity section for more on our organic growth strategy.

On November 16, 2016, Tesoro entered into an Agreement and Plan of Merger with Western Refining, Inc. (“Western Refining”) and other Tesoro wholly-owned subsidiaries (the “Merger”). Western Refining has

three refineries in Texas, New Mexico and Minnesota with a total refining capacity of approximately 254 Mbpd, which would expand the combined company’s operational capabilities and improve our access to advantaged crude oil and extended product regions;
three premium and value retail and convenience store brands to better serve a broader customer base and regional preferences; and
an extensive and complementary logistics network with access to advantaged crude oil basins, including the Permian.

The completion of the Merger is expected in the first half of 2017, subject to certain customary mutual conditions and regulatory approval. We believe the Merger aligns with the strategic objectives for our refining, marketing and logistics businesses, which are discussed below. Per the registration statement on Form S-4, which was declared effective February 16, 2017, the transaction was valued at approximately $4.1 billion consisting of stock and cash consideration. See Note 2 in Part II, Item 8 for more details about the Merger.

STRATEGY AND GOALS

As the leading integrated refining, marketing and logistics company in our strategic foot print, we are driven to create value by driving significant business improvements to provide for sustainable earnings growth, utilizing a disciplined approach to capital allocation to create significant long-term shareholder value and consistently executing on our goals in the delivery of results. Our diversified and integrated portfolio of assets and operations provides us with strong growth opportunities across the refining, marketing and logistics value chain. The following discussion outlines how we create value in each of our business segments.

REFINING. In our Refining segment, our strategy focuses on our ability to access regionally advantaged crude oil, optimize our system-wide value chain to drive strong gross refining margin capture, drive operational excellence enabling asset availability in excess of 97% and deliver other annual improvement objectives discussed in the Market Conditions and Performance Objectives section below. To meet our strategic objectives, we invest in high return capital projects designed to enhance our feedstock flexibility, improve our yields and lower our costs. See the Capital Expenditures section for discussion of major capital projects in development or in process.
 
TLLP. Through our ownership of TLLP and TLLP’s continued growth, we expect our logistics assets and in-region placement to minimize our transportation costs and maximize our overall performance by focusing on a stable, fee-based business, optimizing its existing asset base, pursuing organic expansion opportunities and growing through strategic acquisitions. Additionally, our ownership in TLLP creates value to our shareholders through the lower cost of capital available to TLLP as a limited partnership and our receipt of TLLP’s quarterly distributions. As the distributions per unit increase, our proportion of the total distributions grow at an accelerated rate due to our incentive distribution rights. For example, we received $245 million in distributions from TLLP during 2016 compared to $148 million and $87 million in 2015 and 2014, respectively. We believe TLLP is well positioned

 
 
December 31, 2016 | 27

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

to achieve its primary business objectives and execute business strategies based on its long-term fee-based contracts, relationship with us, strategically positioned assets and financial flexibility provided by its balanced capital structure, revolving credit facility capacity, dropdown credit facility, ability to access equity capital markets through its continuous issuance program and financial support from us.

MARKETING. Our marketing assets provide a secure and ratable offtake of high value gasoline and diesel production from our refineries. We are driving growth and improvements in our Marketing segment by focusing on higher value, branded distribution channels, adding new retail sites to our network, and implementing store improvements, to enhance our convenience store position.

Underpinning our strategy and goals for all of our businesses is a high performing culture where every employee leads according to our guiding principles and has the opportunity to make a difference. These guiding principles are as follows:

CORE VALUES – We act individually and collectively with the highest level of integrity and we are steadfast in our commitment to safety, health and the environment.
EXCEPTIONAL PEOPLE – We employ the best people and develop our capabilities and leadership to realize our objectives.
SHARED PURPOSE – Everyone clearly understands and owns our vision, strategy, how they fit and what they are expected to contribute.
POWERFUL COLLABORATION – We leverage the power of collaboration and our individual and collective expertise to create value and competitive advantage.
SUPERIOR EXECUTION – We pursue and deliver our objectives with energy, passion and a sense of urgency to deliver industry-leading results.
 
By following our guiding principles, we aim to achieve strategic priorities that are focused on the delivery of operational efficiency and effectiveness, value chain optimization, financial discipline, and value-driven growth. In addition, we take a principles-based approach to conducting our business, seeking to create shared value for key stakeholders including employees, communities, business partners, government and the environment.

STRATEGIC PRIORITIES
 
 
 
 
 
 
 
 
 
 
OPERATIONAL EFFICIENCY & EFFECTIVENESS
continuously improving safety, compliance, reliability, system improvements and cost leadership
 
 
 
 
 
 
 
 
 
 
 
 
 
HIGH PERFORMING CULTURE

fostering a culture that is committed to building leadership at all levels of the organization and across our value chain with employees from diverse backgrounds and experiences while being firmly
 grounded in our guiding principles
 
 
 
 
 
 
 
 
 
 
VALUE CHAIN OPTIMIZATION
enhancing margin capture through our supply and trading activities, optimization of our integrated businesses and customer focus
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
FINANCIAL DISCIPLINE
maintaining a strong financial position by exercising capital discipline and focusing on a balanced use of free cash flow
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
VALUE-DRIVEN GROWTH
extending our capabilities and growing earnings through growth in our logistics and marketing businesses and other strategic opportunities accretive to shareholder value
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


28 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

The following table outlines how significant accomplishments during 2016 align with our strategic priorities:

SIGNIFICANT ACCOMPLISHMENTS DURING 2016
 
Operational
Efficiency &
Effectiveness
Value Chain Optimization
Financial
Discipline
Value
Driven
Growth
High Performing Culture
Tesoro announced on November 17, 2016 it entered into a definitive agreement to acquire Western Refining. The transaction will result in a highly integrated and geographically diversified refining, marketing and logistics company. In conjunction with the acquisition, Tesoro:
-    completed an offering of $1.6 billion aggregate principal amount senior notes due 2023 and 2026 with the proceeds to be used to refinance certain Western Refining debt; and
-    amended its revolving credit agreement to provide an incremental $1.0 billion revolving facility.
-    filed a registration statement on Form S-4, which was declared effective February 16, 2017, to issue up to approximately 47.8 million shares to complete the Merger.
 
TLLP announced it had entered into a purchase and sale agreement on November 21, 2016 to buy crude oil, natural gas and produced water gathering pipelines and two processing facilities in the Bakken Region of North Dakota for $700 million that closed on January 1, 2017.
 
 
Tesoro completed the following acquisitions:
-    Virent, Inc., an innovative renewable fuels and chemicals company that supports Tesoro’s renewable fuels strategy of developing high-quality, lower carbon, renewable feedstocks and blendstocks that can either be co-processed in existing refineries or blended seamlessly with traditional fuels;
-    Dakota Prairie Refining, LLC, including its refinery (“Dickinson Refinery”) with crude oil capacity of 20 Mbpd and produces ultra-low sulfur diesel, naphtha and atmospheric residuals;
-    crude oil pipeline and gathering system as well as transportation, storage and rail loading facilities in the Williston Basin; and
-    refined product terminals, truck racks, storage and rail loading facilities in Alaska along with wholesale fuel marketing contracts.
 
Anacortes refinery achieved one year of operations without an OSHA recordable injury and received the Elite Silver Award from AFPM as part of their Distinguished Safety Awards process.
 
 
 
TLLP’s Colton Clean Products fleet reached 10 years and 8 million miles without an on-road preventable accident.
 
 
 
TLLP completed its acquisition of:
-    the Alaska Storage and Terminalling Assets from Tesoro; and
-    the Northern California Terminalling and Storage Assets from Tesoro.
 
 
Tesoro entered into a new senior revolving credit agreement which provides a total capacity of $2.0 billion which is free from borrowing base redeterminations, becomes unsecured if investment grade credit rating is achieved, and matures in September 2020.
 
 
 
 
During 2016, TLLP:
-    amended its credit agreement and entering into a new dropdown credit facility providing additional resources for organic expansion opportunities and strategic acquisitions;
-    completed a $700 million registered senior notes offering with the proceeds used to repay amounts then borrowed on its credit facilities; and
-    completed an offering of $750 million aggregate principal amount of senior notes with the proceeds used to repay amounts outstanding due to the dropdown acquisitions.
 
 
 
 


 
 
December 31, 2016 | 29

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

MARKET CONDITIONS AND PERFORMANCE OBJECTIVES

Our year-over-year operating performance and results are impacted significantly by prevailing market conditions and our ability to drive value creation across our businesses through high utilization, operational effectiveness and other annual improvements to our base business model. The following sections outline the general market conditions impacting our business throughout 2016 and our delivery on previously established performance objectives designed to maximize utilization, operate effectively and improve our core operations through other annual improvements. These sections should be read in conjunction with the Results of Operations discussion in the following pages of this Management’s Discussion and Analysis.

MARKET CONDITIONS

2015 SUMMARY. During most of 2015, we experienced above average margin environments in our regions due to various events and factors impacting supply and demand. We saw crude oil price volatility continue in the fourth quarter of 2015 due to multiple factors including weak global demand, continued supply growth outside the U.S. and political factors within the U.S., namely the lifting of the crude export ban. All of these events resulted in narrowing of U.S. domestic crude differentials compared to similar world markets. Weaker seasonal product demand in the fourth quarter resulted in lower margins than previous quarters, but continued growth in West Coast gasoline demand and local supply disruptions brought about higher than normal margins in our West Coast regions for the fourth quarter. Gasoline margins were better than typically seen in the fourth quarter on growth in U.S. demand, while distillate margins were lower due to global oversupply and slowing growth in both domestic and emerging economies.

2016 DOMESTIC. Domestic markets have continued to experience volatility, with the price of Brent crude oil increasing over 50% in 2016 and nearly 12% in the fourth quarter. Supply growth in the Middle East and Russia in conjunction with declines in US crude production resulted in narrow domestic crude differentials relative to other global regions in a post export ban environment. Supply outages, changing logistical infrastructure, political aftereffects as well as improving domestic macroeconomic conditions have influenced all portions of our business.

In the markets in which we operate, product margins continue to reflect both global and regional fundamentals. Strong regional gasoline production was offset by demand growth which kept West Coast gasoline cracks near seasonal norms.  In the 4th quarter, weaker seasonal demand resulted in lower gasoline cracks than the 3rd quarter, but increased exports to Mexico and Latin America provided support with West Coast margins averaging slightly below the five-year fourth quarter average. During the first three quarters of the year, slower global economic growth with the associated slower global diesel demand growth resulted in a surplus of global inventory which weighed heavily on diesel product cracks. However, West Coast distillate margins improved in the last quarter of 2016 due to seasonal turnaround maintenance which resulted in lower production and inventory declines. While U.S. product stocks ended the year at the top of the five year historical range, West Coast inventories of both gasoline and distillate were below the five year average reflecting a stronger fundamental environment compared to the other domestic regions. We continue to monitor the impact of changes on prices and fundamentals on our business.

2016 GLOBAL. The global energy markets have also experienced volatility due to uncertainty for growth in the developing regions of the world, the OPEC/non-OPEC crude production agreement, and fluctuations in the financial markets. The market for crude oil, natural gas and refined products is affected by changes in economic conditions and the associated supply and demand balance changes. Product values and crude oil prices are set by the market and are outside our control. We expect global market conditions to drive continued volatility in our markets.


30 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

PERFORMANCE OBJECTIVES

UTILIZATION AND OPERATIONAL EFFECTIVENESS. In December 2015, we laid out plans to deliver $500 to $600 million of improvements to operating income in 2016 resulting from improved utilization and operational effectiveness as compared to our 2015 operating performance. In 2015, we experienced lower than normal utilization and operational effectiveness primarily due to the work stoppage and an extended turnaround at our Utah refinery, both of which negatively impacted our operating results during those times. As a result, we set forth these improvement objectives to provide a way to compare our operating results in 2016 to 2015, exclusive of market impacts and the annual improvements to operating income discussed below. Our expectations for 2016 were a Tesoro Index (as defined in our Glossary of Terms) of $12 to $14 per throughput barrel in our Refining segment, fuel margins of 11 to 14 cents per gallon in our Marketing segment and crude oil differentials reflecting transportation costs which impact our Refining segment results. For the full year 2016, the Tesoro Index was at the low end of the range and Marketing fuel margins were in line with expectations. Crude oil differentials were significantly narrower than expectations and resulted in lower year-over-year capture rates and refining profitability. For the full year 2016, we delivered an estimated $485 million of year-over-year improvements compared to 2015 from higher utilization and operational efficiencies versus our original commitment of $500 to $600 million, which was revised to $400 to $500 million in the second quarter of 2016. Given the results in 2016 and the expectations about the Tesoro Index and marketing fuel margins remain the same as experienced in 2016 along with the crude oil differentials existing in the market at the end of 2016, no separate improvement goal for utilization and operational effectiveness is being established for 2017.

OTHER ANNUAL IMPROVEMENTS. In December 2015, we also committed to delivering $400 to $500 million of annual improvements to operating income in 2016, consisting of $200 to $250 million in Refining, $175 to $200 million in TLLP and $25 to $50 million in Marketing. For the full year 2016, we estimate that we delivered approximately $420 million of annual improvements to operating income, including Refining segment improvements of approximately $245 million, TLLP segment improvements of approximately $130 million and Marketing segment improvements of approximately $45 million. Estimated TLLP operating income improvements were below the range primarily due to the weak commodity price environment, which impacted crude oil and natural gas volumes and organic growth. Our 2016 achievements include the following in our Refining segment:

Renegotiated a legacy product supply contract at our Los Angeles refinery, which will allow for greater yield flexibility and increased alternatives for sale and distribution of specialty products;
Installed a new preflash tower at our Los Angeles refinery, which allows for greater yield flexibility and energy savings;
Sourced new types of crude oils resulting in crude optimizations;
Shared new crude oil cargos between the Los Angeles refinery and our Martinez refinery;
Improved crude blending capabilities at the Carson crude terminal that resulted in higher throughput volumes;
Improved pipeline connectivity between the Los Angeles refinery sites;
Integrated naphtha and gasoline blendstocks on the West Coast;
Re-distributed in-bound crude oil to our Kenai refinery during maintenance and turnaround activities at our Anacortes refinery to optimize our west coast system;
Transported intermediates from our Dickinson refinery to our Anacortes and Salt Lake City refineries for additional upgrading;
Operated our Salt Lake City refinery’s fluid catalytic cracker during the third quarter turnaround by running intermediates from our Dickinson refinery and waxy crude oil; and
Completed the second phase of the Salt Lake City Refinery Expansion project.

Additionally, in our TLLP segment, operating income was positively impacted by the strategic acquisition of assets from Tesoro during 2016, optimization of existing terminalling and transportation assets and the completion of the second phase of gathering systems connecting additional wells located in the North Dakota Williston Basin/Bakken Shale area (the “High Plains System”). Further, our Marketing segment experienced continued growth in its retail station network with the addition of 95 sites during the year.

As announced in November 2016, we plan to deliver $475 to $575 million of annual improvements to operating income during 2017 in addition to the improvements delivered in 2016.


 
 
December 31, 2016 | 31

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

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.

ITEMS IMPACTING COMPARABILITY

The TLLP financial and operational data presented include the historical results of all assets acquired from Tesoro prior to the acquisition dates. The acquisitions from Tesoro were transfers between entities under common control. Accordingly, the financial information of TLLP contained herein has been retrospectively adjusted to include the historical results of the assets acquired from Tesoro prior to the effective date of each acquisition for all periods presented and do not include revenue for transactions with Tesoro with the exception of regulatory tariffs on its pipeline assets. The TLLP financial data is derived from the combined financial results of the TLLP predecessor (the “TLLP Predecessor”). We refer to the TLLP Predecessor and, prior to each acquisition date, the acquisitions from Tesoro collectively, as “TLLP’s Predecessors.”

NON-GAAP MEASURES

Our management uses certain “non-GAAP” performance measures to analyze operating segment performance and non-GAAP financial measures to evaluate past performance and prospects for the future to supplement our GAAP financial information presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). These financial non-GAAP measures are important factors in assessing our operating results and profitability and include:

EBITDA-U.S. GAAP-based net earnings before interest, income taxes, and depreciation and amortization expenses
Debt to capitalization ratio excluding TLLP-the ratio achieved by dividing the net result of our consolidated debt less all debt owed by TLLP (both net of unamortized issuance costs) by the sum of our consolidated debt less TLLP’s total debt (both net of unamortized issuance costs) and our total equity less noncontrolling interest associated with the public ownership of TLLP

We present these measures because we believe they may help investors, analysts, lenders and ratings agencies analyze our results of operations and liquidity in conjunction with our U.S. GAAP results, including but not limited to:

our operating performance as compared to other publicly traded companies in the refining, logistics and marketing industries, without regard to historical cost basis or financing methods;
our ability to incur and service debt and fund capital expenditures; and
the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.

Management also uses these measures to assess internal performance, and we believe they may provide meaningful supplemental information to the users of our financial statements. Non-GAAP measures have important limitations as analytical tools, because they exclude some, but not all, items that affect net earnings and operating income. These measures should not be considered substitutes for their most directly comparable U.S. GAAP financial measures.


32 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

HIGHLIGHTS (in millions)

tso201610-k_chartx26067.jpgtso201610-k_chartx27121.jpgtso201610-k_chartx28064.jpg
RECONCILIATION OF NET EARNINGS TO EBITDA (in millions)

tso201610-k_chartx28946.jpg

2016 COMPARED TO 2015

OVERVIEW. Our net earnings in 2016 of $860 million decreased from net earnings of $1.7 billion in 2015 primarily due to the weaker margin environment within our Refining segment. Similarly, EBITDA of $2.4 billion in 2016 declined $1.2 billion, or 33%, from $3.6 billion in 2015 as a result of the weaker margin environment.

GROSS MARGINS. Our gross refining margin decreased $1.2 billion during 2016 compared to 2015 primarily driven by a weaker margin environment across all the regions in which we operate. The $4.70 decrease in our gross refining margin per barrel included the benefits of higher throughput in the year due to continued demand growth and the positive impact of the net lower of cost or market inventory adjustment of $359 million reversing in 2016 compared to an additional charge of $317 million in 2015. With a continued volatile price environment, the impact of our lower of cost of market adjustment can vary and may increase in the future. TLLP revenues, net of operating expenses, increased $92 million due to higher storage fees as well as terminalling and pipeline transportation throughput volumes driven by assets acquired in the year and continued organic expansion. Our gross marketing margin decreased $68 million primarily due to lower fuel margins in 2016 partially offset by increased fuel sales in the year.

OPERATING AND OTHER EXPENSES. Operating expenses remained relatively flat at $2.5 billion in 2016 compared to 2015. Depreciation and amortization expenses increased $95 million to $851 million in 2016 compared to 2015 primarily due to depreciation and amortization associated with the Great Northern Midstream acquisition along with new assets and turnarounds placed into service during the year.

INTEREST AND FINANCING COSTS, NET. Interest and financing costs increased approximately $57 million to $274 million during 2016 from $217 million in 2015. The increase was attributable to the write-off of deferred financing costs related to revolver amendments, bridge facility fees in anticipation of the Western Refining acquisition and new debt issuances in the year, primarily the $250 million aggregate principal amount of TLLP’s 6.125% Senior Notes due in 2021 and the $450 million aggregate principal amount of TLLP’s 6.375% Senior Notes due in 2024 issued in May 2016.


 
 
December 31, 2016 | 33

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

OTHER INCOME. Other income during 2016 included gains of $15 million related to pipeline tariff refunds received in California, $13 million proceeds related to an insurance settlement on contaminated crude oil shipment we received in 2013 and $9 million gain related to an adjustment permitted in the agreement from the 2013 acquisition of the ARCO® brand. In 2015, other income included a gain for an insurance settlement of $11 million related to the Washington Refinery Fire.

INCOME TAX EXPENSE. Our income tax expense from continuing operations totaled $427 million in 2016 versus $936 million in 2015. The decreased income tax expense is attributable to the decrease in earnings before income taxes. The combined federal and state effective income tax rate was 33.4% and 35.6% during 2016 and 2015, respectively. Compared to 2015, the income from non-taxable noncontrolling interests attributable to TLLP was a higher percentage of earnings before income taxes. The 2016 rate also benefited from a $16 million decrease in expense related to the early adoption of Accounting Standards Updated (“ASU”) 2016-09, “Improvements to Employee Share-Based Payment Accounting.” See Note 1 to our consolidated financial statements in Item 8 for additional information on ASU 2016-09.

EARNINGS (LOSS) FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX. Earnings from discontinued operations related to the Hawaii Business, net of tax, were $10 million in 2016, compared to a $4 million loss in 2015. The earnings in 2016 primarily related to proceeds from the calendar year 2015 earn-out owed to the Company. The loss in 2015 was related to a change in estimate for the regulatory improvements we are required to make.

2015 COMPARED TO 2014

OVERVIEW. Our net earnings in 2015 were $1.7 billion compared with $888 million in 2014 due primarily to the stronger margin environment in our Refining segment and lower operating expenses. Similarly, EBITDA of $3.6 billion in 2015 increased $1.4 billion, or 61%, from $2.2 billion in 2014 driven by the margin environment.

GROSS MARGINS. Our gross refining margin increased $691 million during 2015 compared to 2014 primarily driven by a stronger margin environment across the California and Pacific Northwest regions. The increase in our gross refining margin was driven by an increase of $2.99 in our gross margin per barrel partially offset by the impact of the work stoppage and three refinery turnarounds on our refinery utilization during 2015 as well as the net lower of cost or market inventory adjustments of $317 million for 2015 compared to $42 million for 2014. With a continued volatile price environment, the impact of our lower of cost of market adjustments can vary and may increase in the future. TLLP revenues, net of operating expenses, increased $365 million due to higher throughput volumes driven by a full year of operating from the Rockies Natural Gas Business (defined in Item 8, Note 2), and additional operations from other acquired assets as well as continued expansion of its crude oil gathering assets. Our Marketing gross margin increased $296 million primarily driven by favorable fuel margins and strong demand.

OTHER COSTS AND EXPENSES. Operating expenses were largely in line at $2.5 billion in 2015 compared to 2014 primarily due to declining natural gas costs and the conversion of company-operated retail sites to MSOs that reduced costs associated with the management of station operations partially offset by increased expenses from a full year of operations from the Rockies Natural Gas Business. Depreciation and amortization expense increased $194 million to $756 million in 2015 compared to 2014 primarily due to depreciation and amortization associated with the Rockies Natural Gas Business and new assets placed into service. Loss on asset disposals and impairments for 2015 include various projects that were discontinued due to their lack of economic viability given the current market environment.

INTEREST AND FINANCING COSTS, NET. Interest and financing costs decreased approximately $18 million to $217 million during 2015 from $235 million during 2014. The decrease consisted primarily of financing transactions that occurred in 2014 that did not have a comparable transaction in 2015. These transactions include a $39 million charge for premiums paid, unamortized debt issuance costs and discounts related to the redemption of the 9.750% Senior Notes due 2019 and TLLP 5.875% Senior Notes due 2020 in 2014 as well as bridge fees in connection with TLLP’s Rockies Natural Gas Business acquisition. These decreases were partially offset by a full year of incremental interest on TLLP’s 5.500% Senior Notes due 2019 and TLLP’s 6.250% Senior Notes due 2022.

OTHER INCOME. Other income during 2015 included an insurance settlement gain of $11 million related to the Washington Refinery Fire and in 2014 included a refund and settlement from a crude pipeline network rate case settlement of $59 million.

INCOME TAX EXPENSE. Our income tax expense from continuing operations totaled $936 million in 2015 versus $547 million in 2014 with the increase attributable to the increase in earnings before income tax. The combined federal and state effective income tax rate was 35.6% and 37.4% during 2015 and 2014, respectively. Compared to 2014, the income from non-taxable noncontrolling interests attributable to TLLP was a higher percentage of earnings before income taxes.


34 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

LOSS FROM DISCONTINUED OPERATIONS, NET OF INCOME TAX. Losses from discontinued operations related to the Hawaii Business, net of tax, were $4 million in 2015, compared to $29 million in 2014. The loss in 2014 primarily related to $42 million in charges related to regulatory improvements we are obligated to make at the Hawaii refinery to resolve the Clean Air Act matters discussed in Note 4 to our consolidated financial statements in Item 8. The loss in 2015 is related to a change in estimate for the regulatory improvements we are required to make.

REFINING SEGMENT

HIGHLIGHTS (in millions)

tso201610-k_chartx27721.jpgtso201610-k_chartx28735.jpgtso201610-k_chartx29801.jpg
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 the majority of the transportation fuels that we sell. Our seven refineries have a combined crude oil capacity of 895 Mbpd. We purchase crude oil and other feedstocks from domestic and foreign sources, including the Middle East, South America, western Africa, Canada, and other locations either in the spot market or through term agreements with renewal provisions. Our Marketing segment, including its branded retail network, provides a committed outlet for the majority of the gasoline produced by our refineries; however, we also sell gasoline and gasoline blendstocks, jet fuel, diesel fuel, heavy fuel oils and residual products in bulk and opportunistically export refined products to certain foreign markets.

REFINING UTILIZATION (a)
tso201610-k_chartx30839.jpg
(a)
Tesoro had a total refining capacity of 895 Mbpd in 2016 following the acquisition of the Dickinson refinery in June, in line with our acquisition oriented growth strategy. In December 2015, we updated our capacity to 875 Mbpd after the completion of several key capital projects. For purposes of the utilization calculation above, a total refining capacity of 850 Mbpd was used for the years ended December 31, 2015 and 2014.

MARKET OVERVIEW. Results from our Refining segment are highly volatile and subject to many factors that are beyond our control. Revenue is not a good proxy for financial performance as the key driver of revenue is the underlying price per barrel of crude oil. Gross refining margin, refinery throughputs, crack spreads and crude oil differentials are better metrics to measure the performance of the Refining segment.

The gross refining margin is the difference between the prices of all manufactured refined products sold and the cost of crude oil and other feedstocks used to produce refined products, including the cost of transportation and distribution paid to TLLP and third parties at contractual rates. The market for crude oil and products is affected by changes in economic conditions and supply and demand balance. Product values and crude oil prices are set by the market and are outside of our control. When evaluating the markets in which we operate, we utilize the U.S. Energy Information Administration and other industry sources, to gather supply, demand, utilization, import and export information to forecast and monitor market conditions for our operating

 
 
December 31, 2016 | 35

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

regions. We focus on PADD V, or the West Coast of the U.S. where the majority of our operations are located. PADD V is defined by the Petroleum Administration for Defense Districts (“PADD”) as the states of Alaska, Arizona, California, Hawaii, Nevada, Oregon and Washington.

As a performance benchmark and a comparison with other industry participants, we utilize the West Coast and Mid-Continent crack spreads. The crack spread is a measure of the difference between market prices for crude oil and refined products and is a commonly used proxy within the industry to estimate or identify trends in gross refining margins. Crack spreads can fluctuate significantly over time as a result of market conditions and supply and demand balances. The West Coast 321 crack spread is calculated using 3 barrels of Alaska North Slope crude oil (“ANS”) producing 2 barrels of Los Angeles CARB gasoline and 1 barrel of Los Angeles CARB diesel. The Mid-Continent 321 crack spread is calculated using 3 barrels of West Texas Intermediate crude oil (“WTI”) producing 2 barrels of Group 3 gasoline and 1 barrel of Group 3 diesel.

Our actual gross refining margins differ from these crack spreads based on the actual slate of crude oil we run at our refineries and the products we produce. The global commodity markets for crude oil and refined products are subject to significant volatility resulting in rapidly changing prices and margin environments. Our refineries process a variety of crude oils that are sourced from around the world. The slate of crude oil we process can vary over time as a result of changes in market prices and shipping rates. Additionally, our refining gross margin is impacted by the changing crude oil price differentials, which is the difference between the benchmark crude oils, WTI and Brent crude oil (“Brent”), and the actual crude oil we run at our refineries. We may experience financial risk associated with price volatility of crude oil and refined products and we may utilize financial hedge instruments to help mitigate such risks where possible.

KEY INFORMATION USED TO MONITOR OUR BUSINESS - CRUDE OIL DIFFERENTIALS (in $/barrel)

tso201610-k_chartx32131.jpg
Source: PLATTS

WEST COAST. Average U.S. West Coast crack spreads were down approximately 35.9% in 2016 compared to 2015 but were up approximately 55.9% in 2015 compared to 2014. The decreased crack spreads in 2016 resulted from increased supply year over year, partially offset by continued growth in demand. 2015 crack spreads were up versus 2014 due to several extended unplanned refinery outages in the West Coast (PADD V) region, including our own as discussed below, which reduced West Coast refinery utilization in the year.


36 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

MID-CONTINENT. Average Mid-Continent crack spreads were down approximately 10.9% in 2016 compared to 2015 but were up approximately 10.2% in 2015 versus 2014. Margins and differentials both decreased in 2016 over 2015 resulting in lower gross refining margin. The region had experienced strong growth driven by crude oil drilling in recent years, but 2016 experienced lower crude oil prices and significantly reduced drilling activities which lowered crude oil supply, which led to decreasing differentials, and lowered product demand, which reduced margins. The WTI to Bakken differential decreased approximately $0.91 per barrel, increasing the price of Bakken, which resulted in a lower gross margin in 2016 compared to 2015. Bakken crude oil represented about 57% of the crude oil consumed by our Mid-Continent system in 2016.

OPERATIONAL DATA AND RESULTS. Management uses various operating metrics to evaluate performance and efficiency and to compare profitability to other companies in the industry. These measures include:

Gross refining margin per barrel is calculated by dividing gross refining margin (revenues less costs of feedstocks, purchased refined products, transportation and distribution) by total refining throughput; and
Manufacturing costs before depreciation and amortization expense (“Manufacturing Costs”) per barrel is calculated 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, costs of sales and operating expenses or any other measure of financial performance presented in accordance with U.S. GAAP.

REFINING THROUGHPUT (Mbpd)

tso201610-k_chartx35915.jpg


 
 
December 31, 2016 | 37

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

REFINING SEGMENT OPERATING DATA AND RESULTS (dollars in millions, except per barrel amounts)



 
Years Ended December 31,
 
2016
 
2015
Yield (Mbpd)
 
 
 
Gasoline and gasoline blendstocks
451

 
409

Diesel fuel
189

 
169

Jet fuel
118

 
119

Other
122

 
139

Total Yield
880

 
836

 
 
 
 
Refined Product Sales (Mbpd) (a)
 
 
 
Gasoline and gasoline blendstocks
523

 
510

Diesel fuel
210

 
204

Jet fuel
149

 
152

Other
102

 
92

Total Refined Product Sales
984

 
958

 
 
 
 
Revenues 
 
 
 
Refined products (b)
$
21,213

 
$
25,443

Crude oil resales and other
1,043

 
946

Total Revenues
22,256

 
26,389

Refining Cost of Sales
 
 
 
Cost of sales (excluding LCM) (c)
19,469

 
21,728

LCM
(359
)
 
317

Total Cost of Sales
19,110

 
22,045

Gross refining margin
3,146

 
4,344

Expenses
 
 
 
Operating expenses
 
 
 
Manufacturing costs
1,591

 
1,594

Other operating expenses
429

 
329

SG&A
2

 
14

D&A
588

 
504

Other
1

 
32

Segment Operating Income
$
535

 
$
1,871

Gross Refining Margin per throughput barrel
$
10.42

 
$
15.12

Manufacturing Costs per throughput barrel
$
5.27

 
$
5.55


 
2016 COMPARED TO 2015

OVERVIEW.  Operating income for our Refining segment decreased $1.3 billion, or 71%, to $535 million in 2016 compared to 2015 due to a weaker margin environment. Average U.S. West Coast and Mid-Continent crack spreads were down approximately $5.53 per barrel in 2016 at an average $16.18 per barrel compared to an average $21.71 per barrel in 2015. Total refinery utilization of 93% in 2016 was largely in line with the 93% experienced in 2015.

REFINING THROUGHPUT.  Total refining throughput increased 38 Mbpd, or 5%, to 825 Mbpd in 2016 compared to 787 Mbpd in 2015. The increase is primarily attributable to the California region where work stoppages and large planned turnarounds in 2015 negatively impacted throughput, the Anacortes refinery where a turnaround in mid-2015 decreased throughput and the Dickinson refinery, which was acquired in June 2016.

GROSS REFINING MARGIN.  Our gross refining margin per barrel decreased $4.70 per barrel, or 31%, to $10.42 per barrel in 2016 compared to 2015 given a weaker margin environment across all regions, particularly California and Mid-Continent, partially offset by the positive impact of the lower of cost or market adjustment in 2016.

Total gross refining margin decreased $1.2 billion, or 28%, to $3.1 billion in 2016 compared to 2015. Gross margins in the California, Pacific Northwest and Mid-Continent regions decreased by $824 million, $165 million and $209 million, respectively. Declining crack spreads and crude oil differentials in the regions within which we operate largely contributed to the decrease in gross refining margin in the year. Partially offsetting the regional decreases was continued demand growth for our refined products and a $359 million benefit from lower of cost or market adjustments reversing in 2016 related to our inventory compared to an additional $317 million charge in 2015. Our continued focus on realizing business improvements and synergies also contributed to our results across all regions.



38 | Tesoro Corporation
 
 

 
 
MANAGEMENT’S DISCUSSION AND ANALYSIS

REFINING SEGMENT OPERATING DATA AND RESULTS (dollars in millions, except per barrel amounts)



 
Years Ended December 31,
 
2015
 
2014
Yield (Mbpd)
 
 
 
Gasoline and gasoline blendstocks
409

 
429

Diesel fuel
169

 
191

Jet fuel
119

 
127

Other
139

 
132

Total Yield
836

 
879

 
 
 
 
Refined Product Sales (Mbpd) (a)
 
 
 
Gasoline and gasoline blendstocks
510

 
507

Diesel fuel
204

 
206

Jet fuel
152

 
149

Other
92

 
87

Total Refined Product Sales
958

 
949

 
 
 
 
Revenues 
 
 
 
Refined products (b)
$
25,443

 
$
37,365

Crude oil resales and other
946

 
1,456

Total Revenues
26,389

 
38,821

Refining Cost of Sales
 
 
 
Cost of sales (excluding LCM) (c)
21,728

 
35,126

LCM
317

 
42

Total Cost of Sales
22,045

 
35,168

Gross refining margin
4,344

 
3,653

Expenses
 
 
 
Operating expenses
 
 
 
Manufacturing costs
1,594

 
1,693

Other operating expenses
329

 
324

SG&A
14

 
19

D&A
504

 
421

Other
32

 
3

Segment Operating Income
$
1,871

 
$
1,193

Gross Refining Margin per throughput barrel 
$
15.12

 
$
12.13

Manufacturing Costs per throughput barrel
$
5.55

 
$
5.62


 
2015 COMPARED TO 2014

OVERVIEW. Operating income for our Refining segment increased $678 million, or 57%, to $1.9 billion in 2015 compared to 2014 due to a stronger margin environment. Average U.S. West Coast crack spreads margins were approximately $25 per barrel, over $9 per barrel higher, in 2015 compared to 2014. Total refinery utilization was 93% in 2015 compared to 97% in 2014 primarily as a result of the work stoppage and an increase in our stated overall refining capacity to 875 Mbpd compared to 850 Mbpd in 2014.

REFINING THROUGHPUT.  Total refining throughput decreased 38 Mbpd, or 5%, to 787 Mbpd in 2015 as compared to 825 Mbpd in 2014. The decrease is primarily due the work stoppage and large planned turnarounds at our Los Angeles and Martinez refineries and project activity at our Salt Lake City refinery. Our California region was most significantly impacted by the work stoppage at our Martinez refinery resulting in it being idled and reduced throughput in the Carson portion of our Los Angeles refinery.

GROSS REFINING MARGINS.  Our gross refining margin increased $2.99 per barrel, or 25%, to $15.12 per barrel in 2015 compared to 2014 given a stronger margin environment across the California and Pacific Northwest regions, which was offset by the impact of work stoppages and three refinery turnarounds during 2015.

Total gross refining margin increased $691 million, or 19%, to $4.3 billion in 2015 compared to 2014. Gross margins in the California and Pacific Northwest regions increased by $920 million and $97 million, respectively, while margins in the Mid-Continent decreased by $326 million. The gross margin increases in the California and the Pacific Northwest regions were due to favorable market conditions caused by strong clean product demand growth and supported by lower consumer prices as a result of falling crude oil price. The West Coast (PADD V) region also experienced several unplanned refinery outages, which impacted overall regional supply. Margins decreased in the Mid-Continent region primarily as a result of lower crude oil differentials. Our continued focus on realizing business improvements and synergies also contributed to our results across all regions. Partially offsetting the regional increases was a $317 million impact from lower of cost or market adjustments related to our inventory in 2015 compared to $42 million in 2014.





(a)
Sources of total refined product sales include refined products manufactured at our refineries and refined products purchased from third parties. Total refined product sales include sales of manufactured and purchased refined products. Refined product sales include all sales through our Marketing segment as well as in bulk markets and exports through our Refining segment.
(b)
Refined product sales include intersegment sales to our Marketing segment of $13.7 billion, $16.3 billion and $22.2 billion in 2016, 2015 and 2014, respectively.
(c)
Refining segment costs for services provided by our TLLP segment were $715 million, $615 million and $497 million for the years ended December 31, 2016, 2015 and 2014, respectively. These amounts are eliminated upon consolidation.


 
 
December 31, 2016 | 39

MANAGEMENT’S DISCUSSION AND ANALYSIS
 
 

REFINING SEGMENT OPERATING RESULTS BY REGION (in millions, except per barrel amounts)

 
Years Ended December 31,
 
2016
 
2015
 
2014
 
2016
 
2015
 
2014
 
2016
 
2015
 
2014
 
California
(Martinez and Los Angeles)
 
Pacific Northwest
 (Washington and Alaska)
 
Mid-Continent
(North Dakota and Utah)
Revenues 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Refined products
$
14,231

 
$
17,317