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

FORM 10‑Q
(Mark One)
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
or

¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_____________________to__________

Commission File Number 1‑3473

TESORO CORPORATION
(Exact name of registrant as specified in its charter)
Delaware
 
95‑0862768
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
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)

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 ¨

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 ¨

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.
 
Large accelerated filer
þ
 
Accelerated filer
¨
 
 
Non-accelerated filer
¨  (Do not check if a smaller reporting company)
 
Smaller reporting company
¨
 

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

There were 120,390,425 shares of the registrant’s Common Stock outstanding at October 26, 2015.

 


TESORO CORPORATION

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015


TABLE OF CONTENTS




PART I. FINANCIAL INFORMATION
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


2



PART I — FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS

TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
(Unaudited)
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
(In millions, except per share amounts)
Revenues (a)
$
7,743

 
$
11,151

 
$
22,438

 
$
32,188

Costs and Expenses:
 
 
 
 
 
 
 
Cost of sales (a)
5,571

 
9,594

 
17,309

 
28,409

Operating expenses
589

 
624

 
1,676

 
1,813

Selling, general and administrative expenses
95

 
86

 
247

 
209

Depreciation and amortization expense
192

 
144

 
553

 
409

(Gain) loss on asset disposals and impairments
4

 
1

 
12

 
(2
)
Operating Income
1,292

 
702

 
2,641

 
1,350

Interest and financing costs, net
(54
)
 
(50
)
 
(163
)
 
(168
)
Other income, net
19

 
11

 
21

 
13

Earnings Before Income Taxes
1,257

 
663

 
2,499

 
1,195

Income tax expense
458

 
249

 
888

 
437

Net Earnings from Continuing Operations
799

 
414

 
1,611

 
758

Loss from discontinued operations, net of tax
—

 
(1
)
 
(4
)
 
(2
)
Net Earnings
799

 
413

 
1,607

 
756

Less: Net earnings from continuing operations attributable to
   noncontrolling interest
40

 
17

 
121

 
58

Net Earnings Attributable to Tesoro Corporation
$
759

 
$
396

 
$
1,486

 
$
698

 
 
 
 
 
 
 
 
Net Earnings (Loss) Attributable to Tesoro Corporation
 
 
 
 
 
 
 
Continuing operations
$
759

 
$
397

 
$
1,490

 
$
700

Discontinued operations
—

 
(1
)
 
(4
)
 
(2
)
Total
$
759

 
$
396

 
$
1,486

 
$
698

Net Earnings (Loss) per Share - Basic:
 
 
 
 
 
 
 
Continuing operations
$
6.19

 
$
3.11

 
$
11.98

 
$
5.41

Discontinued operations
—

 
(0.01
)
 
(0.03
)
 
(0.02
)
Total
$
6.19

 
$
3.10

 
$
11.95

 
$
5.39

Weighted average common shares outstanding - Basic
122.5

 
127.9

 
124.3

 
129.5

Net Earnings (Loss) per Share - Diluted:
 
 
 
 
 
 
 
Continuing operations
$
6.13

 
$
3.06

 
$
11.85

 
$
5.32

Discontinued operations
—

 
(0.01
)
 
(0.03
)
 
(0.02
)
Total
$
6.13

 
$
3.05

 
$
11.82

 
$
5.30

Weighted average common shares outstanding - Diluted
123.8

 
129.7

 
125.7

 
131.7

 
 
 
 
 
 
 
 
Dividends per Share
$
0.50

 
$
0.30

 
$
1.35

 
$
0.80

 
 
 
 
 
 
 
 
Supplemental Information:
 
 
 
 
 
 
 
(a) Includes excise taxes collected by our marketing
        segment
$
137

 
$
148

 
$
423

 
$
441


The accompanying notes are an integral part of these condensed consolidated financial statements.

3




TESORO CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
September 30,
2015
 
December 31,
2014
 
(In millions, except share data)
ASSETS
Current Assets
 
 
 
Cash and cash equivalents (TLLP: $11 and $19, respectively)
$
959

 
$
1,000

Receivables, net of allowance for doubtful accounts
1,016

 
1,435

Inventories
2,507

 
2,439

Prepayments and other current assets
176

 
200

Total Current Assets
4,658

 
5,074

Net Property, Plant and Equipment (TLLP: $3,432 and $3,306, respectively)
9,427

 
9,045

Other Noncurrent Assets
 
 
 
Acquired intangibles, net (TLLP: $952 and $973, respectively)
1,190

 
1,222

Other, net (TLLP: $236 and $251, respectively)
1,326

 
1,150

Total Other Noncurrent Assets
2,516

 
2,372

Total Assets
$
16,601

 
$
16,491

 
 
 
 
LIABILITIES AND EQUITY
Current Liabilities
 
 
 
Accounts payable
$
1,789

 
$
2,470

Other current liabilities
1,063

 
996

Total Current Liabilities
2,852

 
3,466

Deferred Income Taxes
1,256

 
1,098

Other Noncurrent Liabilities
843

 
790

Debt, Net of Unamortized Issuance Costs (TLLP: $2,569 and $2,544, respectively)
3,791

 
4,161

Commitments and Contingencies (Note 10)


 


Equity
 
 
 
Tesoro Corporation Stockholders’ Equity
 
 
 
Common stock, par value $0.162/3; authorized 200,000,000 shares; 158,429,940 shares issued (156,627,604 in 2014)
26

 
26

Additional paid-in capital
1,392

 
1,255

Retained earnings
5,959

 
4,642

Treasury stock, 37,666,223 common shares (31,677,195 in 2014), at cost
(1,858
)
 
(1,320
)
Accumulated other comprehensive loss
(149
)
 
(149
)
Total Tesoro Corporation Stockholders’ Equity
5,370

 
4,454

Noncontrolling Interest
2,489

 
2,522

Total Equity
7,859

 
6,976

Total Liabilities and Equity
$
16,601

 
$
16,491


The accompanying notes are an integral part of these condensed consolidated financial statements.

4




TESORO CORPORATION
CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Unaudited)
 
Nine Months Ended
September 30,
 
2015
 
2014
 
(In millions)
Cash Flows From (Used In) Operating Activities
 
 
 
Net earnings
$
1,607

 
$
756

Adjustments to reconcile net earnings to net cash from operating activities:
 
 
 
Depreciation and amortization expense
553

 
409

Debt redemption charges
1

 
41

Stock-based compensation expense
57

 
20

Deferred income taxes
157

 
227

Turnaround and branding charges
(248
)
 
(119
)
Other non-cash operating activities
(33
)
 
(59
)
Changes in current assets and current liabilities
(247
)
 
(228
)
Net cash from operating activities
1,847

 
1,047

Cash Flows From (Used In) Investing Activities
 
 
 
Capital expenditures
(773
)
 
(477
)
Acquisitions
(6
)
 
(17
)
Other investing activities
(4
)
 
11

Net cash used in investing activities
(783
)
 
(483
)
Cash Flows From (Used In) Financing Activities
 
 
 
Borrowings under revolving credit agreements
346

 
295

Repayments on revolving credit agreements
(326
)
 
(52
)
Proceeds from debt offering
—

 
300

Repayments of debt
(402
)
 
(433
)
Dividend payments
(169
)
 
(104
)
Net proceeds from issuance of Tesoro Logistics LP common units
71

 
156

Distributions to noncontrolling interest
(135
)
 
(63
)
Purchases of common stock
(494
)
 
(350
)
Other financing activities
4

 
(21
)
Net cash used in financing activities
(1,105
)
 
(272
)
Increase (Decrease) in Cash and Cash Equivalents
(41
)
 
292

Cash and Cash Equivalents, Beginning of Period
1,000

 
1,238

Cash and Cash Equivalents, End of Period
$
959

 
$
1,530


The accompanying notes are an integral part of these condensed consolidated financial statements.


5



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


NOTE 1 – BASIS OF PRESENTATION

As used in this report, the terms “Tesoro,” “we,” “us” or “our” may refer to Tesoro Corporation, one or more of its consolidated subsidiaries or all of them taken as a whole. The words “we,” “us” or “our” generally include Tesoro Logistics LP (“TLLP”) 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.

The interim condensed consolidated financial statements and notes thereto of Tesoro Corporation and its subsidiaries have been prepared by management without audit according to the rules and regulations of the Securities and Exchange Commission (“SEC”) and reflect all adjustments that, in the opinion of management, are necessary for a fair presentation of results for the periods presented. Such adjustments are of a normal recurring nature, unless otherwise disclosed. The consolidated balance sheet at December 31, 2014 has been condensed from the audited consolidated financial statements at that date. Certain information and notes normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) have been condensed or omitted pursuant to the SEC’s rules and regulations. However, management believes that the disclosures presented herein are adequate to present the information fairly. The accompanying condensed consolidated financial statements and notes should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2014.

We prepare our condensed consolidated financial statements in conformity with U.S. GAAP, which requires management to make estimates and assumptions that affect the reported amounts and disclosures of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We review our estimates on an ongoing basis. Changes in facts and circumstances may result in revised estimates and actual results could differ from those estimates. The results of operations for any interim period are not necessarily indicative of results for the full year. Certain prior year balances have been aggregated or disaggregated in order to conform to the current year presentation. Due to there being no adjustments to accumulated other comprehensive income for the three and nine months ended September 30, 2015 and 2014, consolidated statements of comprehensive income have been omitted.

We changed our operating segment presentation in the second quarter of 2015 to include refining, TLLP and a new marketing segment. Comparable prior period information has been recast to reflect our revised segment presentation. See Note 13 for additional information.

Our condensed consolidated financial statements include TLLP, a variable interest entity. As the general partner of TLLP, we have the sole ability to direct the activities of TLLP that most significantly impact its economic performance. We are also considered to be the primary beneficiary for accounting purposes and are TLLP’s primary customer. Under our various long-term, fee-based commercial agreements with TLLP, transactions with us accounted for 54% and 55% of TLLP’s total revenues for the three and nine months ended September 30, 2015 and 86% and 87% for the three and nine months ended September 30, 2014. In the event TLLP incurs a loss, our operating results will reflect TLLP’s loss, net of intercompany eliminations. See Note 2 for additional information relating to TLLP.

On September 25, 2013, we completed the sale of all of our interest in Tesoro Hawaii, LLC, which operated a 94 thousand barrel per day Hawaii refinery, retail stations and associated logistics assets (the “Hawaii Business”). The results of operations for this business have been presented as discontinued operations in the condensed statements of consolidated operations for the three and nine months ended September 30, 2015 and 2014. There were no revenues for either the three and nine months ended September 30, 2015 or 2014. There were no recorded losses, before and after tax, respectively, for the three months ended September 30, 2015 and $6 million and $4 million, respectively, for the nine months ended September 30, 2015. We recorded losses, before and after tax, of $2 million and $1 million, respectively, for the three months ended September 30, 2014 and $3 million and $2 million, respectively, for the nine months ended September 30, 2014 related to the Hawaii Business. Cash flows used in operating activities were $2 million for both the nine months ended September 30, 2015 and September 30, 2014, respectively. Unless otherwise noted, the information in the notes to the condensed consolidated financial statements relates to our continuing operations.



6



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

New Accounting Standards and Disclosures

Revenue Recognition. In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which provides accounting guidance for all revenue arising from contracts to provide goods or services to customers. ASU 2014-09 is effective for interim and annual periods beginning after December 15, 2017 given the FASB’s recent deferral of ASU 2014-09’s effective date. Entities may choose to early adopt ASU 2014-09 as of the original effective date. The standard allows for either full retrospective adoption or modified retrospective adoption. At this time, we are evaluating the standard to determine the method of adoption and the impact of ASU 2014-09 on our financial statements and related disclosures.

Consolidation.  In February 2015, the FASB issued ASU 2015-02, “Amendments to the Consolidation Analysis” (“ASU 2015-02”). This standard modifies existing consolidation guidance for reporting organizations that are required to evaluate whether they should consolidate certain legal entities.  ASU 2015-02 is effective for interim and annual periods beginning after December 15, 2015, and requires either a retrospective or a modified retrospective approach to adoption. Early adoption is permitted. At this time, we are evaluating the potential impact of this standard on our financial statements, as well as the available transition methods.

Debt Issuance Costs. In April 2015, the FASB issued ASU 2015-03, “Interest - Imputation of Interest” (“ASU 2015-03”), which will simplify the presentation of debt issuance costs. Under ASU 2015-03, debt issuance costs related to a recognized debt liability will be presented in the balance sheet as a direct deduction from the carrying amount of the related debt liability. As a result, our balance sheet reflects a reclassification of unamortized debt issuance costs from other noncurrent assets to debt. ASU 2015-03 is effective for interim and annual periods beginning after December 15, 2015, and early adoption is permitted. We adopted this standard in the first quarter of 2015 and applied the changes retrospectively to prior periods presented. The adoption of this standard resulted in the reclassification of $93 million of unamortized debt issuance costs from other noncurrent assets to debt on the balance sheet at December 31, 2014. Unamortized debt issuance costs of $80 million are recorded as a reduction to debt on the balance sheet at September 30, 2015.

Business Combinations. In September 2015, the FASB issued ASU 2015-16, “Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”). The standard requires an acquirer to recognize the cumulative impact of adjustments to provisional purchase price amounts that are identified during the measurement period in the reporting period, in which the adjustment amounts are determined. The standard also requires an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. ASU 2015-16 is effective for interim and annual periods beginning after beginning after December 15, 2015 and must be applied prospectively to adjustments that occur after the effective date. Early application is permitted for financial statements that have not been issued.

NOTE 2 – TESORO LOGISTICS LP

TLLP is a publicly traded limited partnership that was formed to own, operate, develop and acquire logistics assets. Its assets are integral to the success of Tesoro’s refining and marketing operations and are used to gather crude oil and natural gas, process natural gas, and distribute, transport and store crude oil and refined products. TLLP provides us with various pipeline transportation, trucking, terminal distribution, storage and petroleum-coke handling services under long-term, fee-based commercial agreements. Each of these agreements, with the exception of the storage and transportation services agreement, contain minimum volume commitments. We do not provide financial or equity support through any liquidity arrangements or financial guarantees to TLLP.

Tesoro Logistics GP, LLC (“TLGP”), our wholly-owned subsidiary, serves as the general partner of TLLP. We held an approximate 33% and 36% interest in TLLP at September 30, 2015 and December 31, 2014, respectively, including an approximate 2% general partner interest and all of the incentive distribution rights. This interest at September 30, 2015 includes 28,181,748 common units and 1,631,448 general partner units.

TLLP acquired assets related to, and entities engaged in, natural gas gathering, transportation and processing in Wyoming, Colorado, Utah, and North Dakota (the “Rockies Natural Gas Business”) through its acquisition of QEP Field Services, LLC (“QEPFS”) from QEP Resources, Inc. on December 2, 2014 for $2.5 billion. At the acquisition date, QEPFS held an approximate 56% limited partner interest in QEP Midstream Partners, LP (“QEPM”), consisting of 3,701,750 common units and 26,705,000 subordinated units, and 100% of QEPM’s general partner, QEP Midstream Partners GP, LLC (“QEPM GP”), which itself held a 2% general partner interest and all of the incentive distribution rights in QEPM. All intercompany transactions with TLLP and QEPM are eliminated upon consolidation.


7



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

On April 6, 2015, TLLP entered into an Agreement and Plan of Merger with TLGP, QEPFS, TLLP Merger Sub LLC (“Merger Sub”), QEPM, and QEPM GP. TLLP and QEPM completed the transaction, in which the Merger Sub merged with and into QEPM, with QEPM surviving the merger as a wholly owned subsidiary of TLLP (the “Merger”). The Merger transaction was completed on July 22, 2015. Following the Merger, QEPM GP remains the general partner of QEPM, and all outstanding common units representing limited partnership interests in QEPM other than QEPM Common Units held by QEPFS (the “QEPM Common Units”) were converted into the right to receive 0.3088 common units representing limited partnership interests in TLLP (the “TLLP Common Units”). As a result of the Merger, TLLP issued approximately 7.1 million TLLP Common Units to QEPM unitholders. No fractional TLLP Common Units were issued in the Merger, and holders of QEPM Common Units other than QEPFS received cash in lieu of fractional TLLP Common Units. There was no impact to the purchase price allocation as a result of the Merger.

TLLP’s allocation of the Rockies Natural Gas Business acquisition’s $2.5 billion purchase price remains preliminary as of September 30, 2015. During the nine months ended September 30, 2015, the original purchase price was increased by $6 million for the settlement of acquisition date net working capital amounts. Finalization of the purchase price allocation is pending and adjustments can be made through the end of TLLP’s measurement period, which is not to exceed one year from the acquisition date. The table below reflects the preliminary acquisition date purchase price allocation as of September 30, 2015 (in millions):
Cash
$
32

Accounts receivable
120

Prepayments and other
8

Property, plant and equipment
1,735

Acquired intangibles
976

Other noncurrent assets (a)
228

Accounts payable
(67
)
Other current liabilities
(51
)
Other noncurrent liabilities
(33
)
Noncontrolling interest
(432
)
Total Purchase Price
$
2,516

____________________
(a)
Other noncurrent assets include $148 million of goodwill.

NOTE 3 – EARNINGS PER SHARE

We compute basic earnings per share by dividing net earnings attributable to Tesoro Corporation stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share include the effects of potentially dilutive shares outstanding during the period. Our share calculations are presented below (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Weighted average common shares outstanding
122.5
 
127.9
 
124.3

 
129.5
Common stock equivalents
1.3
 
1.8
 
1.4

 
2.2
Total Diluted Shares
123.8
 
129.7
 
125.7

 
131.7

Potentially dilutive common stock equivalents are excluded from the calculation of diluted earnings per share if the effect of including such securities in the calculation would have been anti-dilutive. Anti-dilutive securities were 0.1 million for both the three months ended September 30, 2015 and 2014, and 0.6 million and 0.1 million for the nine months ended September 30, 2015 and 2014, respectively.


8



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 4 – INVENTORIES

Components of inventories were as follows (in millions):
 
September 30,
2015
 
December 31,
2014
Domestic crude oil and refined products
$
2,125

 
$
1,930

Foreign subsidiary crude oil
190

 
351

Other inventories
192

 
158

Total Inventories
$
2,507

 
$
2,439


Due to a lower crude oil and refined product pricing environment experienced since the end of 2014, we recorded a lower of cost or market adjustment to cost of sales of $83 million at September 30, 2015 for our crude oil, refined products, oxygenates and by-product inventories. At December 31, 2014, we recorded a $42 million lower of cost or market adjustment for the same type of inventories, which was reversed in the first quarter of 2015 as the inventories associated with the adjustment at the end of 2014 were sold or used during the first quarter of 2015.

NOTE 5 - PROPERTY, PLANT AND EQUIPMENT

Property, plant and equipment, at cost, is as follows (in millions):
 
September 30,
2015
 
December 31,
2014
Refining
$
7,449

 
$
6,994

TLLP
3,789

 
3,551

Marketing
842

 
834

Corporate
261

 
254

Property, Plant and Equipment, at Cost
12,341

 
11,633

Accumulated depreciation
(2,914
)
 
(2,588
)
Net Property, Plant and Equipment
$
9,427

 
$
9,045


We capitalize interest as part of the cost of major projects during the construction period. Capitalized interest totaled $9 million and $7 million for the three months ended September 30, 2015 and 2014, respectively, and $27 million and $17 million for the nine months ended September 30, 2015 and 2014, respectively, and is recorded as a reduction to net interest and financing costs in our condensed statements of consolidated operations.

NOTE 6 - DERIVATIVE INSTRUMENTS

In the ordinary course of business, our profit margins, earnings and cash flows are impacted by the timing, direction and overall change in pricing for commodities used throughout our operations. We use non-trading derivative instruments to manage our exposure to the following:

•
price risks associated with the purchase or sale of feedstocks, refined products and energy supplies related to our refineries, terminals, marketing fuel inventory and customers;
•
price risks associated with inventories above or below our target levels;
•
future emission credit requirements; and
•
exchange rate fluctuations on our purchases of Canadian crude oil.

Our accounting for derivative instruments depends on whether the underlying commodity will be used or sold in the normal course of business. For contracts where the crude oil or refined products are expected to be used or sold in the normal course of business, we apply the normal purchase normal sale exception and follow the accrual method of accounting. All other derivative instruments are recorded at fair value using mark-to-market accounting.


9



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Our derivative instruments include forward purchase and sale contracts (“Forward Contracts”), exchange-traded futures (“Futures Contracts”), over-the-counter swaps (“OTC Swap Contracts”), options (“Options”), and over-the-counter options (“OTC Option Contracts”). Forward Contracts are agreements to buy or sell the commodity at a predetermined price at a specified future date. Futures Contracts are standardized agreements, traded on a futures exchange, to buy or sell the commodity at a predetermined price at a specified future date. Options provide the right, but not the obligation to buy or sell the commodity at a specified price in the future. OTC Swap Contracts and OTC Option Contracts require cash settlement for the commodity based on the difference between a contracted fixed or floating price and the market price on the settlement date. Certain of these contracts require cash collateral to be received or paid if our asset or liability position, respectively, exceeds specified thresholds. We believe that we have minimal credit risk with respect to our counterparties.

The following table presents the fair value (in millions) of our derivative instruments as of September 30, 2015 and December 31, 2014. The fair value amounts below are presented on a gross basis and do not reflect the netting of asset and liability positions permitted under the terms of our master netting arrangements including cash collateral on deposit with, or received from, brokers. We offset the recognized fair value amounts for multiple derivative instruments executed with the same counterparty in our financial statements when a legal right of offset exists. As a result, the asset and liability amounts below will not agree with the amounts presented in our condensed consolidated balance sheets.
 
 
 
Derivative Assets
 
Derivative Liabilities
 
Balance Sheet Location
 
September 30,
2015
 
December 31,
2014
 
September 30,
2015
 
December 31,
2014
Commodity Futures Contracts
Prepayments and other current assets
 
$
902

 
$
1,201

 
$
870

 
$
1,025

Commodity OTC Swap
   Contracts
Receivables
 
3

 
—

 
—

 
—

Commodity OTC Swap
   Contracts
Accounts payable
 
—

 
—

 
—

 
1

Commodity Forward Contracts
Receivables
 
2

 
3

 
—

 
—

Commodity Forward Contracts
Accounts payable
 
—

 
—

 
1

 
1

Total Gross Mark-to-Market
   Derivatives
 
 
907

 
1,204

 
871

 
1,027

Less: Counterparty Netting and
   Cash Collateral (a)
 
 
(859
)
 
(1,136
)
 
(870
)
 
(1,024
)
Total Net Fair Value of Derivatives
 
$
48

 
$
68

 
$
1

 
$
3

________________
(a)
Certain of our derivative contracts, under master netting arrangements, include both asset and liability positions. We offset both the fair value amounts and any related cash collateral amounts recognized for multiple derivative instruments executed with the same counterparty when there is a legally enforceable right and an intention to settle net or simultaneously. As of September 30, 2015, we had provided cash collateral amounts of $11 million related to our unrealized derivative positions. At December 31, 2014, our counterparties had provided cash collateral of $112 million related to our unrealized derivative positions. Cash collateral amounts are netted with mark-to-market derivative assets.

Gains (losses) for our mark-to market derivatives for the three and nine months ended September 30, 2015 and 2014 were as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Commodity Futures Contracts
$
145

 
$
167

 
$
102

 
$
90

Commodity OTC Swap Contracts
7

 
(2
)
 
5

 
(5
)
Commodity Forward Contracts
1

 
1

 
15

 
5

Foreign Currency Forward Contracts
(3
)
 
(3
)
 
(5
)
 
(3
)
Total Gain on Mark-to-Market Derivatives
$
150

 
$
163

 
$
117

 
$
87



10



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

The income statement location of gains (losses) for our mark-to market derivatives above were as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Revenues
$
30

 
$
6

 
$
28

 
$
7

Cost of sales
123

 
160

 
94

 
83

Other expense, net
(3
)
 
(3
)
 
(5
)
 
(3
)
Total Gain on Mark-to-Market Derivatives
$
150

 
$
163

 
$
117

 
$
87


Open Long (Short) Positions

The information below presents the net volume of outstanding commodity and other contracts by type of instrument, year of maturity and unit of measure as of September 30, 2015 (units in thousands):
 
 
Contract Volumes by Year of Maturity
 
Unit of Measure
Mark-to-Market Derivative Instrument
 
2015
 
2016
 
2017
 
Crude oil, refined products and blending products:
 
 
 
 
 
 
 
 
Futures - short
 
(5,311)
 
(1,050)
 
—
 
Barrels
OTC Swaps - long
 
1,100
 
900
 
—
 
Barrels
Forwards - long
 
250
 
—
 
—
 
Barrels
Carbon emissions credits:
 
 
 
 
 
 
 
 
Futures - long
 
175
 
1,000
 
1,000
 
Tons
Corn:
 
 
 
 
 
 
 
 
Futures - short
 
(4,270)
 
—
 
—
 
Bushels

At September 30, 2015, we had open Forward Contracts to purchase CAD $20 million that were settled on October 26, 2015.

NOTE 7 – FAIR VALUE MEASUREMENTS

We classify financial assets and liabilities according to the fair value hierarchy. Financial assets and liabilities classified as level 1 instruments are valued using quoted prices in active markets for identical assets and liabilities. Level 2 instruments are valued using quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices, such as liquidity, that are observable for the asset or liability. Our level 2 instruments include derivatives valued using market quotations from independent price reporting agencies, third-party brokers and commodity exchange price curves that are corroborated with market data. Level 3 instruments are valued using significant unobservable inputs that are not supported by sufficient market activity. We do not have any financial assets or liabilities classified as level 3 at September 30, 2015 or December 31, 2014.

Our financial assets and liabilities measured at fair value on a recurring basis include derivative instruments. Additionally, our financial liabilities include obligations for Renewable Identification Numbers (“RINs”) and cap and trade emission credits for the state of California (together with RINs, our “Environmental Credit Obligations”). See Note 6 for further information on our derivative instruments. Our Environmental Credit Obligations represent the estimated fair value amount at each balance sheet date for which we do not have sufficient RINs and California cap and trade credits to satisfy our obligations to the U.S. Environmental Protection Agency (“EPA”) and the state of California, respectively. RINs are assigned to biofuels produced or imported into the U.S. as required by the EPA, which sets annual quotas for the percentage of biofuels that must be blended into transportation fuels consumed in the U.S. As a producer of petroleum transportation fuels, we are required to blend biofuels into the products we produce at a rate that will meet the EPA’s quota. We must purchase RINs in the open market to satisfy the requirement if we are unable to blend at that rate. Our liability for cap and trade emission credits for the state of California represent the deficit of credits to satisfy emission reduction requirements mandated in California’s Assembly Bill 32 for each period which stationary or transportation fuel carbon emissions exceed the level allowed by the regulation.


11



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Financial assets and liabilities recognized at fair value in our condensed consolidated balance sheets by level within the fair value hierarchy were as follows (in millions):
 
September 30, 2015

Level 1

Level 2

Level 3
 
Netting and Collateral (a)
 
Total
Assets:





 
 
 
 
Commodity Futures Contracts
$
896

 
$
6

 
$
—

 
$
(859
)
 
$
43

Commodity OTC Swap Contracts
—

 
3

 
—

 
—

 
3

Commodity Forward Contracts
—

 
2

 
—

 
—

 
2

Total Assets
$
896

 
$
11

 
$
—

 
$
(859
)
 
$
48










 
 
 
 
Liabilities:








 
 
 
 
Commodity Futures Contracts
$
867

 
$
3

 
$
—

 
$
(870
)
 
$
—

Commodity Forward Contracts
—

 
1

 
—

 
—

 
1

Environmental Credit Obligations
—

 
17

 
—

 
—

 
17

Total Liabilities
$
867

 
$
21

 
$
—

 
$
(870
)
 
$
18


 
December 31, 2014
 
Level 1
 
Level 2
 
Level 3
 
Netting and Collateral (a)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
1,165

 
$
36

 
$
—

 
$
(1,136
)
 
$
65

Commodity Forward Contracts
—

 
3

 
—

 
—

 
3

Total Assets
$
1,165

 
$
39

 
$
—

 
$
(1,136
)
 
$
68

 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
Commodity Futures Contracts
$
1,011

 
$
14

 
$
—

 
$
(1,024
)
 
$
1

Commodity OTC Swap Contracts
—

 
1

 
—

 
—

 
1

Commodity Forward Contracts
—

 
1

 
—

 
—

 
1

Environmental Credit Obligations
—

 
20

 
—

 
—

 
20

Total Liabilities
$
1,011

 
$
36

 
$
—

 
$
(1,024
)
 
$
23

________________
(a)
Certain of our derivative contracts, under master netting arrangements, include both asset and liability positions. We offset both the fair value amounts and any related cash collateral amounts recognized for multiple derivative instruments executed with the same counterparty when there is a legally enforceable right and an intention to settle net or simultaneously. As of September 30, 2015, we had provided cash collateral amounts of $11 million related to our unrealized derivative positions. At December 31, 2014, our counterparties had provided cash collateral of $112 million related to our unrealized derivative positions. Cash collateral amounts are netted with mark-to-market derivative assets.

We believe the carrying value of our other financial instruments, including cash and cash equivalents, receivables, accounts payable and certain accrued liabilities approximate fair value. Our fair value assessment incorporates a variety of considerations, including the short-term duration of the instruments and the expected future insignificance of bad debt expense, which includes an evaluation of counterparty credit risk. The borrowings under the Tesoro Corporation revolving credit facility (the “Revolving Credit Facility”) and the TLLP senior secured revolving credit agreement (the “TLLP Revolving Credit Facility”), which include variable interest rates, approximate fair value. The fair value of our fixed rate debt is based on prices from recent trade activity and is categorized in level 2 of the fair value hierarchy. The carrying values of our debt were approximately $3.9 billion and $4.3 billion at September 30, 2015 and December 31, 2014, respectively, and the fair values of our debt were approximately $3.8 billion and $4.3 billion at September 30, 2015 and December 31, 2014, respectively. These carrying and fair values of our debt do not consider the unamortized issuance costs, which are netted against our total debt.


12



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 8 – DEBT

Our debt balance, net of unamortized issuance costs, at September 30, 2015 and December 31, 2014 was as follows (in millions):
 
September 30,
2015
 
December 31,
2014
Total debt (a)
$
3,873

 
$
4,255

Unamortized issuance costs (b) (c)
(76
)
 
(88
)
Current maturities
(6
)
 
(6
)
Debt, Net of Current Maturities and Unamortized Issuance Costs
$
3,791

 
$
4,161

________________
(a)
Total debt related to TLLP, which is non-recourse to Tesoro, except for TLGP, was $2.6 billion at both September 30, 2015 and December 31, 2014.
(b)
Includes unamortized premium associated with TLLP’s 5.875% Senior Notes due 2020 of $4 million and $5 million as of September 30, 2015 and December 31, 2014, respectively.
(c)
The Company adopted ASU 2015-03 in the first quarter of 2015 and applied the changes retrospectively to the prior period presented. See Note 1 for further discussion.

Revolving Credit Facilities

We had available capacity under our credit facilities as follows at September 30, 2015 (in millions):
 
Total
Capacity
 
Amount Borrowed as of September 30, 2015
 
Outstanding
Letters of Credit
 
Available Capacity
 
Expiration
Tesoro Corporation Revolving
Credit Facility (a)
$
3,000

 
$
—

 
$
76

 
$
2,924

 
November 18, 2019
TLLP Revolving Credit Facility
900

 
280

 
—

 
620

 
December 2, 2019
Letter of Credit Facilities
1,895

 
—

 
189

 
1,706

 
 
Total Credit Facilities
$
5,795

 
$
280

 
$
265

 
$
5,250

 
 
________________
(a)
Borrowing base is the lesser of the amount of the periodically adjusted borrowing base or the agreement’s total capacity of $3.0 billion.

Tesoro Corporation Revolving Credit Facility. Our Revolving Credit Facility provides for borrowings (including letters of credit) up to the lesser of the amount of a periodically adjusted borrowing base, which consists of Tesoro’s eligible cash and cash equivalents, receivables and petroleum inventories, net of the standard reserve as defined, or the Revolving Credit Facility’s total capacity of $3.0 billion. We had unused credit availability of approximately 97% of the eligible borrowing base at September 30, 2015. Our Revolving Credit Facility is guaranteed by substantially all of Tesoro’s active domestic subsidiaries, excluding TLGP, TLLP and its subsidiaries, and certain foreign subsidiaries, and is secured by substantially all of Tesoro’s active domestic subsidiaries’ crude oil and refined product inventories, cash and receivables.

The Revolving Credit Facility allows us to obtain letters of credit under separate letter of credit agreements for foreign crude oil purchases. Our uncommitted letter of credit agreements had $189 million outstanding as of September 30, 2015. Letters of credit outstanding under these agreements incur fees ranging from 0.40% to 1.00% and are secured by the crude oil inventories for which they are issued. Capacity under these letter of credit agreements is available on an uncommitted basis and can be terminated by either party at any time.


13



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

TLLP Revolving Credit Facility. The TLLP Revolving Credit Facility provided for total loan availability of $900 million as of September 30, 2015, and TLLP may request that the loan availability be increased up to an aggregate of $1.5 billion, subject to receiving increased commitments from the lenders. The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP, and is guaranteed by all of TLLP’s subsidiaries, with the exception of Rendezvous Gas Services L.L.C., and secured by substantially all of TLLP’s assets. Borrowings are available under the TLLP Revolving Credit Facility up to the total loan availability of the facility. There was $280 million in borrowings outstanding under the TLLP Revolving Credit Facility, which incurred interest at a weighted average interest rate of 2.69% at September 30, 2015. TLLP had unused credit availability of approximately 69% of the borrowing capacity at September 30, 2015.

Tesoro Debt Repayments

During August 2015, we voluntarily repaid our obligation of $398 million under the Term Loan Facility in its entirety with available cash on hand. The Term Loan Facility originally funded a portion of the acquisition of BP’s integrated Southern California refining, marketing and logistics business (“The Los Angeles Acquisition”) and was scheduled to mature on May 30, 2016. Amounts paid on the Term Loan Facility cannot be re-borrowed.

NOTE 9 – BENEFIT PLANS

Tesoro sponsors four defined benefit pension plans, including one funded qualified employee retirement plan and three unfunded nonqualified executive plans. Although our funded employee retirement plan fully meets all funding requirements under applicable laws and regulations, we voluntarily contributed $60 million during the nine months ended September 30, 2015 to improve the funded status of the plan. Tesoro also provides other postretirement health care benefits to retirees who met certain service requirements and were participating in our group health insurance program at retirement.

The components of pension and other postretirement benefit expense (income) for the three and nine months ended September 30, 2015 and 2014 were (in millions):
 
Pension Benefits
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2015
 
2014
 
2015
 
2014
Service cost
$
11

 
$
12

 
$
34

 
$
38

Interest cost
7

 
7

 
22

 
24

Expected return on plan assets
(7
)
 
(6
)
 
(20
)
 
(21
)
Amortization of prior service cost
1

 
—

 
1

 
1

Recognized net actuarial loss
6

 
3

 
18

 
10

Net Periodic Benefit Expense
$
18

 
$
16

 
$
55

 
$
52

 
 
 
 
 
 
 
 
 
Other Postretirement Benefits
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2015
 
2014
 
2015
 
2014
Service cost
$
—

 
$
—

 
$
2

 
$
2

Interest cost
1

 
1

 
2

 
2

Amortization of prior service credit
(8
)
 
(8
)
 
(25
)
 
(25
)
Recognized net actuarial loss
1

 
1

 
3

 
4

Net Periodic Benefit Income
$
(6
)
 
$
(6
)
 
$
(18
)
 
$
(17
)


14



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 10 - COMMITMENTS AND CONTINGENCIES

Environmental Liabilities

We are incurring and expect to continue to incur expenses for environmental remediation liabilities at a number of currently and previously owned or operated refining, pipeline, terminal and retail station properties. We have accrued liabilities for these expenses and believe these accruals are adequate based on current information and projections that can be reasonably estimated. Additionally, we have recognized environmental remediation liabilities assumed in past acquisitions from the prior owners that include amounts estimated for site cleanup and monitoring activities arising from operations at refineries, certain terminals and pipelines, and retail stations prior to the dates of our acquisitions. Our environmental accruals are based on estimates including engineering assessments, and it is possible that our projections will change and that additional costs will be recorded as more information becomes available.

Our accruals for environmental expenditures totaled $229 million and $274 million at September 30, 2015 and December 31, 2014, respectively, including $15 million and $32 million for TLLP, respectively. These accruals include $196 million and $216 million at September 30, 2015 and December 31, 2014, respectively, related to amounts estimated for site cleanup activities arising from operations at our Martinez refinery and operations of assets acquired in the Los Angeles Acquisition prior to their respective acquisition dates. We cannot reasonably determine the full extent of remedial activities that may be required at the Martinez refinery and for assets acquired in the Los Angeles Acquisition, and it is possible that we will identify additional investigation and remediation costs for site cleanup activities as more information becomes available. The environmental remediation liabilities assumed in the Los Angeles Acquisition include amounts estimated for site cleanup activities and monitoring activities arising from operations at the Carson refinery, certain terminals and pipelines, and retail stations prior to our acquisition on June 1, 2013. These estimates for environmental liabilities are based on third-party assessments and available information. Our estimates for site cleanup activities reflect amounts for which we are responsible under applicable cost-sharing arrangements.

On July 10, 2015, a federal court issued an order denying coverage pursuant to insurance policies for environmental remediation liabilities at our Martinez refinery and those liabilities are included in our accruals above. The insurer had filed a declaratory relief action challenging coverage of the primary policy assigned to us when we acquired the refinery. The policies provide for coverage up to $190 million for expenditures in excess of $50 million in self-insurance. We have not recognized possible insurance recoveries under the policies and have appealed the order.

Other Contingencies

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 a $2.4 million fine, which we appealed. L&I reassumed jurisdiction of the citation and affirmed the allegations in December 2010. We disagree with L&I’s characterizations of operations at our Washington refinery and believe, based on available evidence and scientific reviews, that many of the agency’s conclusions are mistaken. We filed an appeal of the citation in January 2011. In separate September 2013, November 2013 and February 2015 orders, the Board of Industrial Insurance Appeals (“BIIA”) Judge granted partial summary judgment in our favor rejecting 33 of the original 44 allegations in the citation as lacking legal or evidentiary support. A hearing on the remaining 11 allegations started on July 21, 2015, and we expect the Judge to issue a recommended decision for the BIIA’s review in 2016. 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 this time.

On November 20, 2013, we received a notice of violation (“NOV”) from the EPA alleging 46 violations of the Clean Air Act Risk Management Plan requirements at our Washington refinery. The EPA conducted an investigation of the refinery in 2011, following the April 2010 fire in the naphtha hydrotreater unit. We have provided a response to the NOV and additional information to the EPA. While we 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.

In January 2015, we received notice and demand for indemnity from the previous owner of our Washington refinery for the damages they incurred in the civil litigation involving us and the previous owner brought by the families of those fatally wounded in the April 2010 refinery fire. We settled our involvement in the civil litigation in 2012. Arbitration proceedings concerning the demand for indemnity were initiated in March 2015 after an unsuccessful mediation and we intend to vigorously defend ourselves against this claim.


15



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Environmental. The EPA has alleged that we have violated certain Clean Air Act regulations at our Alaska, Washington, Martinez, North Dakota and Utah refineries. We also retained the responsibility for resolving similar allegations relating to our former Hawaii refinery, which we sold in September 2013. We previously received a NOV in March 2011 from the EPA alleging violations of Title V of the Clean Air Act at our Alaska refinery, which arose from a 2007 state of Alaska inspection and inspections by the EPA in 2008 and 2010. We also previously received NOVs in 2005 and 2008 alleging violations of the Clean Air Act at our Washington refinery. We are continuing discussions of all of these claims with the EPA and the U.S. Department of Justice. We have established an accrual for this matter although we cannot currently estimate the final amount or timing of its resolution. The ultimate resolution of these matters could have a material impact on us, as we may be required to incur material capital expenditures at our operating refineries. However, we do not believe that the final outcome of this matter will have a material impact on our liquidity, results of operations or financial position.

Other Matters

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. We have not established accruals for these matters unless a loss is probable, and the amount of loss is currently estimable.

Legal. We are a defendant, along with other manufacturing, supply and marketing defendants, in a lawsuit brought by the Orange County Water District, alleging methyl tertiary butyl ether (“MTBE”) contamination in groundwater. This matter, originally filed in 2004, is proceeding in the United States District Court of the Southern District of New York. The defendants are being sued for having manufactured MTBE and having manufactured, supplied and distributed gasoline containing MTBE. The plaintiff alleges, in part, that the defendants are liable for manufacturing or distributing a defective product. The suit generally seeks individual, unquantified compensatory and punitive damages and attorney’s fees. We intend to vigorously assert our defenses against this claim. 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 this time and believe that the outcome will not have a material impact on our liquidity, financial position, or results of operations.

Environmental. Certain non-governmental organizations filed a Request for Agency Action (the “Request”) with the Utah Department of Environmental Quality (“UDEQ”) concerning our Utah refinery in October 2012. The Request challenges the UDEQ’s permitting of our refinery conversion project alleging that the permits do not conform to the requirements of the Clean Air Act. As the permittee, we are the real party in interest and are defending the permits with UDEQ. In orders issued on July 10 and September 9, 2014, the UDEQ Administrative Law Judge (“ALJ”) recommended the Executive Director of UDEQ deny Petitioners’ request for a stay of the project and dismiss their challenge to the permit. The Executive Director’s final decision approving the ALJ’s recommended order is currently under appeal. While we cannot estimate the timing or estimated amount, if any, associated with the outcome of this matter, we do not believe it will have a material adverse impact on our liquidity, financial position, or results of operations.

We have investigated conditions at certain active wastewater treatment units at our Martinez refinery pursuant to an order received in 2004 from the San Francisco Bay Regional Water Quality Control Board that named us as well as two previous owners of the Martinez refinery. We cannot currently estimate the amount of the ultimate resolution of the order, but we believe it will not have a material adverse impact on our liquidity, financial position, or results of operations.

Tax. We are subject to extensive federal, state and foreign tax laws and regulations. Newly enacted tax laws and regulations, and changes in existing tax laws and regulations, could result in increased expenditures in the future. We are also subject to audits by federal, state and foreign taxing authorities in the normal course of business. It is possible that tax audits could result in claims against us in excess of recorded liabilities. However, we believe that resolution of any such claim(s) would not have a material impact on our liquidity, financial position, or results of operations.

Unrecognized tax benefits increased by approximately $150 million in the second quarter of 2015 for tax positions taken on amended returns filed for 2006-2010. The positions taken exclude certain tax credits, for blending biofuels into refined products, from taxable income. These tax credits were received from the federal government during the years being amended. However, due to the complex and uncertain nature of the issue, we are unable to conclude that it is more likely than not that we will sustain the claims. Therefore, we have neither recognized a tax benefit, nor recorded a receivable for this item.

It is reasonably possible that unrecognized tax benefits may decrease by as much as $8 million in the next twelve months, related primarily to state apportionment matters. However, since the tax was fully paid in prior years, the unrecognized tax benefit would be eliminated without impacting expense.


16



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 11 - STOCKHOLDERS’ EQUITY

Changes to equity during the nine months ended September 30, 2015 are presented below (in millions):
 
Tesoro
Corporation
Stockholders’
Equity
 
Noncontrolling
 Interest
 
Total Equity
Balance at December 31, 2014 (a)
$
4,454

 
$
2,522

 
$
6,976

Net earnings
1,486

 
121

 
1,607

Purchases of common stock
(494
)
 
—

 
(494
)
Dividend payments
(169
)
 
—

 
(169
)
Net effect of amounts related to equity-based compensation (b)
34

 
4

 
38

Net proceeds from issuance of Tesoro Logistics LP common units
—

 
71

 
71

Distributions to noncontrolling interest
—

 
(135
)
 
(135
)
Transfers to (from) Tesoro paid-in capital related to:
 
 
 
 
 
TLLP’s issuance of common units
59

 
(94
)
 
(35
)
Balance at September 30, 2015 (a)
$
5,370

 
$
2,489

 
$
7,859

________________
(a)
We have 5.0 million shares of preferred stock authorized with no par value per share. No shares of preferred stock were outstanding as of September 30, 2015 and December 31, 2014.
(b)
We issued approximately 0.3 million shares and 0.5 million shares during the nine months ended September 30, 2015 and 2014 for proceeds of $12 million and $14 million, respectively, primarily for stock option exercises under our equity-based compensation plans. See Note 12 for more information on stock-based compensation.

Share Repurchases

We are authorized by our Board of Directors (the “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. We purchased approximately 5.5 million shares and 6.2 million shares of our common stock for approximately $494 million and $350 million during the nine months ended September 30, 2015 and 2014, respectively.

Cash Dividends

We paid cash dividends totaling $62 million and $169 million for the three and nine months ended September 30, 2015, respectively, based on a $0.50 per share and $0.425 per share quarterly cash dividend on common stock in the third and first two quarters, respectively. We paid cash dividends totaling $39 million and $104 million for the three and nine months ended September 30, 2014, respectively, based on a $0.30 per share and $0.25 per share quarterly cash dividend on common stock in the third quarter and first two quarters respectively. On October 27, 2015, our Board declared a cash dividend of $0.50 per share payable on December 15, 2015 to shareholders of record on November 30, 2015.


17



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

NOTE 12 - STOCK-BASED COMPENSATION

Stock-based compensation expense (benefit), including discontinued operations, was as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Stock appreciation rights (a)
$
10

 
$
4

 
$
20

 
$
(2
)
Performance share awards (b)
3

 
3

 
9

 
7

Market stock units (c)
7

 
4

 
19

 
12

Other stock-based awards (d)
2

 
1

 
9

 
3

Total Stock-Based Compensation Expense
$
22

 
$
12

 
$
57

 
$
20

____________________
(a)
We paid cash of $37 million and $22 million to settle 0.5 million and 0.8 million SARs that were exercised during the nine months ended September 30, 2015 and 2014, respectively. We had $43 million and $60 million recorded in accrued liabilities associated with our SARs awards at September 30, 2015 and December 31, 2014, respectively.
(b)
We granted 0.1 million market condition performance share awards at a weighted average grant date fair value of $117.96 per share under the amended and restated 2011 Long-Term Incentive Plan (“2011 Plan”) during the nine months ended September 30, 2015.
(c)
We granted 0.4 million market stock units at a weighted average grant date fair value of $114.57 per unit under the 2011 Plan during the nine months ended September 30, 2015.
(d)
We have aggregated expenses for certain award types as they are not considered significant.

The income tax effect recognized in the income statement for stock-based compensation was a benefit of $8 million and $7 million for the three months ended September 30, 2015 and 2014, respectively, and a benefit of $22 million and $9 million for the nine months ended September 30, 2015 and 2014, respectively. The reduction in current taxes payable recognized from tax deductions resulting from exercises and vestings under all of our stock-based compensation arrangements totaled $8 million and $7 million for the three months ended September 30, 2015 and 2014, respectively, and $71 million and $41 million for the nine months ended September 30, 2015 and 2014, respectively.

NOTE 13 - OPERATING SEGMENTS

Our branded operations represented the assets and operations that were previously shown as the retail segment. In previous periods, a portion of our marketing business related to sales in unbranded or wholesale channels that were presented within our refining operating segment. Upon considering the changes in our business, including the transition from company-owned retail operations to multi-site operator model, we assessed how our chief operating decision maker evaluates the business, assesses performance and allocates resources. From this analysis, we believed the presentation of a marketing segment inclusive of both unbranded and branded marketing operations was appropriate. As of the second quarter 2015, we revised our operating segments to include refining, TLLP and a realigned marketing segment. Comparable prior period information has been recast to reflect our revised segment presentation. No other changes were deemed necessary to our refining and TLLP segments.

Our refining segment owns and operates six petroleum refineries located in California, Washington, Alaska, North Dakota and Utah that manufacture gasoline and gasoline blendstocks, jet fuel, diesel fuel, residual fuel oil and other refined products. We sell these refined products, together with refined products purchased from third parties, to our marketing segment through terminal facilities and other locations and opportunistically export refined products to foreign markets. TLLP’s assets and operations include certain crude oil gathering assets, natural gas gathering and processing assets and crude oil and refined products terminalling and transportation assets acquired from Tesoro and other third parties. Revenues from the TLLP segment are generated 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. During 2014, we converted our company-operated retail locations to multi-site operators (“MSOs”) and retained the transportation fuel sales. Our marketing segment sells gasoline and diesel fuel through branded MSOs and jobber/dealers in 16 states as well as unbranded or wholesale channels through terminal facilities and other locations. Since we do not have significant operations in foreign countries, revenue generated and long-lived assets located in foreign countries are not material to our operations.

We evaluate the performance of our segments based primarily on segment operating income. Segment operating income includes those revenues and expenses that are directly attributable to management of the respective segment. TLLP and marketing revenues include intersegment transactions with our refining segment. Income taxes, other income, net, interest and financing costs, net, corporate depreciation and corporate general and administrative expenses are excluded from segment operating income.


18



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Segment information related to continuing operations is as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
 
(In millions)
Revenues
 
 
 
 
 
 
 
Refining:
 
 
 
 
 
 
 
Refined products
$
6,966

 
$
10,363

 
$
20,293

 
$
30,353

Crude oil resales and other
172

 
434

 
780

 
1,060

TLLP:
 
 
 
 
 
 
 
Gathering
87

 
32

 
253

 
84

Processing
71

 
—

 
205

 
—

Terminalling and transportation
124

 
118

 
362

 
326

Marketing:
 
 
 
 
 
 
 
Fuel (a)
5,144

 
6,501

 
14,143

 
18,814

Other non-fuel (b)
16

 
73

 
48

 
203

Intersegment sales
(4,837
)
 
(6,370
)
 
(13,646
)
 
(18,652
)
Total Revenues
$
7,743

 
$
11,151

 
$
22,438

 
$
32,188

Segment Operating Income
 
 
 
 
 
 
 
Refining (c)
$
895

 
$
536

 
$
1,831

 
$
1,074

TLLP (d)
112

 
61

 
329

 
169

Marketing (c)
379

 
180

 
724

 
292

Total Segment Operating Income
1,386

 
777

 
2,884

 
1,535

Corporate and unallocated costs (e)
(94
)
 
(75
)
 
(243
)
 
(185
)
Operating Income
1,292

 
702

 
2,641

 
1,350

Interest and financing costs, net (f)
(54
)
 
(50
)
 
(163
)
 
(168
)
Other income, net (g)
19

 
11

 
21

 
13

Earnings Before Income Taxes
$
1,257

 
$
663

 
$
2,499

 
$
1,195

Depreciation and Amortization Expense
 
 
 
 
 
 
 
Refining
$
132

 
$
112

 
$
373

 
$
317

TLLP
44

 
18

 
132

 
51

Marketing
11

 
10

 
34

 
30

Corporate
5

 
4

 
14

 
11

Total Depreciation and Amortization Expense
$
192

 
$
144

 
$
553

 
$
409

Capital Expenditures
 
 
 
 
 
 
 
Refining
$
153

 
$
118

 
$
485

 
$
280

TLLP
92

 
63

 
235

 
137

Marketing
8

 
9

 
20

 
27

Corporate
6

 
4

 
16

 
20

Total Capital Expenditures
$
259

 
$
194

 
$
756

 
$
464

______________________
(a)
Federal and state motor fuel taxes on sales by our marketing segment are included in both revenues and cost of sales in our condensed statements of consolidated operations. These taxes totaled $137 million and $148 million for the three months ended September 30, 2015 and 2014, respectively, and $423 million and $441 million for the nine months ended September 30, 2015 and 2014, respectively.
(b)
Primarily includes rental income for the three and nine months ended September 30, 2015 and primarily merchandise revenue for the three and nine months ended September 30, 2014.
(c)
Our refining segment uses RINs to satisfy its obligations under the Renewable Fuels Standard, in addition to physically blending required biofuels. Effective April 1, 2013, we changed our intersegment pricing methodology and no longer reduced the amount marketing pays for the biofuels by the market value of the RINs due to significant volatility in the value of RINs. At the end of 2014, given the price of RINs has become more transparent in the price of biofuels, we determined our intersegment pricing methodology should include the market value of RINs as a reduction to the price our marketing segment pays to our refining segment. We made this change effective January 1, 2015. We have not adjusted financial information presented for our refining and marketing segments for the three or nine month periods ended September 30, 2014. Had we made this change effective January 1, 2014, operating income in our refining segment would have been reduced by $35 million and $94 million with a corresponding increase to operating income in our marketing segment for the three and nine months ended September 30, 2014, respectively.


19



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

(d)
We present TLLP’s segment operating income net of general and administrative expenses totaling $16 million and $6 million representing TLLP’s corporate costs for the three months ended September 30, 2015 and 2014, respectively, and $43 million and $14 million for the nine months ended September 30, 2015 and 2014, respectively that are not allocated by TLLP to its operating segments.
(e)
Includes stock-based compensation expense of $22 million and $12 million for the three months ended September 30, 2015 and 2014, respectively, and $57 million and $20 million for the nine months ended September 30, 2015 and 2014, respectively. The significant impact to stock-based compensation expense during the three and nine months ended September 30, 2015 compared to the prior period is primarily a result of changes in Tesoro’s stock price.
(f)
Includes charges totaling $41 million for premiums and unamortized debt issuance costs associated with the redemption of the 5.50% Senior Notes due 2019 during the nine months ended September 30, 2014.
(g)
During the three and nine months ended September 30, 2015, we recorded a gain of $11 million as other income for insurance proceeds related to the settlement of claims associated with the Washington Refinery Fire.

The following table details our identifiable assets related to continuing operations:
 
September 30, 2015
 
December 31, 2014
Identifiable Assets Related to Continuing Operations:
(In millions)
Refining
$
9,521

 
$
9,467

TLLP
4,851

 
4,765

Marketing
1,115

 
1,048

Corporate
1,114

 
1,211

Total Assets
$
16,601

 
$
16,491


NOTE 14 - CONDENSED CONSOLIDATING FINANCIAL INFORMATION

Separate condensed consolidating financial information of Tesoro Corporation (the “Parent”), subsidiary guarantors and non-guarantors is presented below. At September 30, 2015, Tesoro and certain subsidiary guarantors have fully and unconditionally guaranteed our 4.250% Senior Notes due 2017, 5.375% Senior Notes due 2022, and 5.125% Senior Notes due 2024. TLLP, in which we had a 33% ownership interest as of September 30, 2015, and other subsidiaries have not guaranteed these obligations. As a result of these guarantee arrangements, we are required to present the following condensed consolidating financial information, which should be read in conjunction with the accompanying condensed consolidated financial statements and notes thereto. This information is provided as an alternative to providing separate financial statements for guarantor subsidiaries. Separate financial statements of Tesoro’s subsidiary guarantors are not included because the guarantees are full and unconditional and these subsidiary guarantors are 100% owned and are jointly and severally liable for Tesoro’s outstanding senior notes. The information is presented using the equity method of accounting for investments in subsidiaries. Certain intercompany and intracompany transactions between subsidiaries are presented gross and eliminated in the eliminations column. Additionally, the results of operations of the Hawaii Business have been reported as discontinued operations in these condensed consolidating statements of operations and comprehensive income for the three and nine months ended September 30, 2015 and 2014.


20



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Operations
for the Three Months Ended September 30, 2015
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$
—

$
8,574

$
1,054

$
(1,885
)
$
7,743

Costs and Expenses:
 
 
 
 
 
Cost of sales
—

6,574

748

(1,751
)
5,571

Operating, selling, general and administrative expenses
2

679

137

(134
)
684

Depreciation and amortization expense
—

147

45

—

192

Loss on asset disposals and impairments
—

4

—

—

4

Operating Income (Loss)
(2
)
1,170

124

—

1,292

Equity in earnings of subsidiaries
776

38

—

(814
)
—

Interest and financing costs, net
(11
)
(17
)
(26
)
—

(54
)
Other income, net
—

17

2

—

19

Earnings Before Income Taxes
763

1,208

100

(814
)
1,257

Income tax expense (a)
4

443

11

—

458

Net Earnings
759

765

89

(814
)
799

Less: Net earnings from continuing operations attributable
   to noncontrolling interest
—

—

40

—

40

Net Earnings Attributable to Tesoro Corporation
$
759

$
765

$
49

$
(814
)
$
759

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
759

$
765

$
89

$
(814
)
$
799

Less: Noncontrolling interest in comprehensive income
—

—

40

—

40

Comprehensive Income Attributable to Tesoro
   Corporation
$
759

$
765

$
49

$
(814
)
$
759

_________________
(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.


21



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Operations
for the Three Months Ended September 30, 2014
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$
—

$
12,528

$
1,671

$
(3,048
)
$
11,151

Costs and Expenses:
 
 
 
 
 
Cost of sales
—

11,076

1,504

(2,986
)
9,594

Operating, selling, general and administrative expenses
2

692

78

(62
)
710

Depreciation and amortization expense
—

125

19

—

144

Loss on asset disposals and impairments
—

1

—

—

1

Operating Income (Loss)
(2
)
634

70

—

702

Equity in earnings of subsidiaries
405

11

—

(416
)
—

Interest and financing costs, net
(10
)
(22
)
(18
)
—

(50
)
Other income, net
—

11

—

—

11

Earnings Before Income Taxes
393

634

52

(416
)
663

Income tax expense (benefit) (a)
(3
)
241

11

—

249

Net Earnings from Continuing Operations
396

393

41

(416
)
414

Loss from discontinued operations, net of tax
—

(1
)
—

—

(1
)
Net Earnings
396

392

41

(416
)
413

Less: Net earnings from continuing operations attributable
   to noncontrolling interest
—

—

17

—

17

Net Earnings Attributable to Tesoro Corporation
$
396

$
392

$
24

$
(416
)
$
396

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
396

$
392

$
41

$
(416
)
$
413

Less: Noncontrolling interest in comprehensive income
—

—

17

—

17

Comprehensive Income Attributable to Tesoro
   Corporation
$
396

$
392

$
24

$
(416
)
$
396

_________________
(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.


22



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Operations
for the Nine Months Ended September 30, 2015
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$
—

$
24,573

$
2,718

$
(4,853
)
$
22,438

Costs and Expenses:
 
 
 
 
 
Cost of sales
—

19,903

1,874

(4,468
)
17,309

Operating, selling, general and administrative expenses
8

1,905

395

(385
)
1,923

Depreciation and amortization expense
—

417

136

—

553

Loss on asset disposals and impairments
—

12

—

—

12

Operating Income (Loss)
(8
)
2,336

313

—

2,641

Equity in earnings of subsidiaries
1,523

102

—

(1,625
)
—

Interest and financing costs, net
(32
)
(52
)
(79
)
—

(163
)
Other income (expense), net
1

14

6

—

21

Earnings Before Income Taxes
1,484

2,400

240

(1,625
)
2,499

Income tax expense (benefit) (a)
(2
)
863

27

—

888

Net Earnings from Continuing Operations
1,486

1,537

213

(1,625
)
1,611

Loss from discontinued operations, net of tax
—

(4
)
—

—

(4
)
Net Earnings
1,486

1,533

213

(1,625
)
1,607

Less: Net earnings from continuing operations attributable
   to noncontrolling interest
—

—

121

—

121

Net Earnings Attributable to Tesoro Corporation
$
1,486

$
1,533

$
92

$
(1,625
)
$
1,486

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
1,486

$
1,533

$
213

$
(1,625
)
$
1,607

Less: Noncontrolling interest in comprehensive income
—

—

121

—

121

Comprehensive Income Attributable to Tesoro
   Corporation
$
1,486

$
1,533

$
92

$
(1,625
)
$
1,486

_________________
(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.

23



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Operations
for the Nine Months Ended September 30, 2014
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Revenues
$
—

$
36,821

$
5,110

$
(9,743
)
$
32,188

Costs and Expenses:
 
 
 
 
 
Cost of sales
—

33,312

4,668

(9,571
)
28,409

Operating, selling, general and administrative expenses
6

1,981

207

(172
)
2,022

Depreciation and amortization expense
—

355

54

—

409

(Gain) loss on asset disposals and impairments
—

3

(5
)
—

(2
)
Operating Income (Loss)
(6
)
1,170

186

—

1,350

Equity in earnings of subsidiaries
722

38

—

(760
)
—

Interest and financing costs, net
(27
)
(105
)
(36
)
—

(168
)
Other income, net
2

11

—

—

13

Earnings Before Income Taxes
691

1,114

150

(760
)
1,195

Income tax expense (benefit) (a)
(7
)
419

25

—

437

Net Earnings from Continuing Operations
698

695

125

(760
)
758

Loss from discontinued operations, net of tax
—

(2
)
—

—

(2
)
Net Earnings
698

693

125

(760
)
756

Less: Net earnings from continuing operations attributable
   to noncontrolling interest
—

—

58

—

58

Net Earnings Attributable to Tesoro Corporation
$
698

$
693

$
67

$
(760
)
$
698

 
 
 
 
 
 
Comprehensive Income
 
 
 
 
 
Total comprehensive income
$
698

$
693

$
125

$
(760
)
$
756

Less: Noncontrolling interest in comprehensive income
—

—

58

—

58

Comprehensive Income Attributable to Tesoro
   Corporation
$
698

$
693

$
67

$
(760
)
$
698

_________________
(a)
The income tax expense (benefit) reflected in each column does not include any tax effect of the equity in earnings from corporate subsidiaries, but does include the tax effect of the corporate partners’ share of partnership income.


24



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Balance Sheet as of September 30, 2015
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
ASSETS
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$
—

$
926

$
33

$
—

$
959

Receivables, net of allowance for doubtful accounts
—

802

214

—

1,016

Short-term receivables from affiliates
—

73

—

(73
)
—

Inventories
—

2,315

192

—

2,507

Prepayments and other current assets
51

107

18

—

176

Total Current Assets
51

4,223

457

(73
)
4,658

Net Property, Plant and Equipment
—

5,926

3,501

—

9,427

Investment in Subsidiaries
8,125

449

—

(8,574
)
—

Long-Term Receivables from Affiliates
1,653

—

—

(1,653
)
—

Long-Term Intercompany Note Receivable
—

—

1,376

(1,376
)
—

Other Noncurrent Assets:
 
 
 
 
 
Acquired intangibles, net
—

237

953

—

1,190

Other, net
6

1,085

235

—

1,326

Total Other Noncurrent Assets, Net
6

1,322

1,188

—

2,516

Total Assets
$
9,835

$
11,920

$
6,522

$
(11,676
)
$
16,601

 
 
 
 
 
 
LIABILITIES AND EQUITY
Current Liabilities:
 
 
 
 
 
Accounts payable
$
26

$
1,546

$
217

$
—

$
1,789

Short-term payables to affiliates
—

—

73

(73
)
—

Other current liabilities
208

705

150

—

1,063

Total Current Liabilities
234

2,251

440

(73
)
2,852

Long-Term Payables to Affiliates
—

1,587

66

(1,653
)
—

Deferred Income Taxes
1,256

—

—

—

1,256

Other Noncurrent Liabilities
411

380

52

—

843

Debt, net of unamortized issuance costs
1,188

34

2,569

—

3,791

Long-Term Intercompany Note Payable
1,376

—

—

(1,376
)
—

Equity-Tesoro Corporation
5,370

7,668

906

(8,574
)
5,370

Equity-Noncontrolling Interest
—

—

2,489

—

2,489

Total Liabilities and Equity
$
9,835

$
11,920

$
6,522

$
(11,676
)
$
16,601



25



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Balance Sheet as of December 31, 2014
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
ASSETS
Current Assets:
 
 
 
 
 
Cash and cash equivalents
$
—

$
943

$
57

$
—

$
1,000

Receivables, net of allowance for doubtful accounts
6

912

517

—

1,435

Short-term receivables from affiliates
—

84

—

(84
)
—

Inventories
—

2,088

351

—

2,439

Prepayments and other current assets
71

115

16

(2
)
200

Total Current Assets
77

4,142

941

(86
)
5,074

Net Property, Plant and Equipment
—

5,666

3,379

—

9,045

Investment in Subsidiaries
6,592

362

—

(6,954
)
—

Long-Term Receivables from Affiliates
2,427

—

—

(2,427
)
—

Long-Term Intercompany Note Receivable
—

—

1,376

(1,376
)
—

Other Noncurrent Assets:
 
 
 
 
 
Acquired intangibles, net
—

249

973

—

1,222

Other, net
6

893

251

—

1,150

Total Other Noncurrent Assets, Net
6

1,142

1,224

—

2,372

Total Assets
$
9,102

$
11,312

$
6,920

$
(10,843
)
$
16,491

 
 
 
 
 
 
LIABILITIES AND EQUITY
Current Liabilities:
 
 
 
 
 
Accounts payable
$
1

$
1,779

$
690

$
—

$
2,470

Short-term payables to affiliates
—

—

84

(84
)
—

Other current liabilities
148

717

133

(2
)
996

Total Current Liabilities
149

2,496

907

(86
)
3,466

Long-Term Payables to Affiliates
—

2,399

28

(2,427
)
—

Deferred Income Taxes
1,098

—

—

—

1,098

Other Noncurrent Liabilities
447

296

47

—

790

Debt, net of unamortized issuance costs
1,578

39

2,544

—

4,161

Long-Term Intercompany Note Payable
1,376

—

—

(1,376
)
—

Equity-Tesoro Corporation
4,454

6,082

872

(6,954
)
4,454

Equity-Noncontrolling Interest
—

—

2,522

—

2,522

Total Liabilities and Equity
$
9,102

$
11,312

$
6,920

$
(10,843
)
$
16,491



26



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Cash Flows for the Nine Months Ended September 30, 2015
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Cash Flows From (Used In) Operating Activities
 
 
 
 
 
Net cash from (used in) operating activities
$
(14
)
$
1,462

$
399

$
—

$
1,847

Cash Flows From (Used In) Investing Activities
 
 
 
 
 
Capital expenditures
—

(530
)
(243
)
—

(773
)
Acquisitions
—

—

(6
)
—

(6
)
Intercompany notes, net
1,075

—

—

(1,075
)
—

Other investing activities
—

(4
)
—

—

(4
)
Net cash from (used in) investing activities
1,075

(534
)
(249
)
(1,075
)
(783
)
Cash Flows From (Used In) Financing Activities
 
 
 
 
 
Borrowings under revolving credit agreements
—

—

346

—

346

Repayments on revolving credit agreements
—

—

(326
)
—

(326
)
Repayments of debt
(398
)
(4
)
—

—

(402
)
Dividend payments
(169
)
—

—

—

(169
)
Net proceeds from issuance of Tesoro Logistics LP
   common units
—

—

71

—

71

Distributions to noncontrolling interest
—

—

(135
)
—

(135
)
Purchases of common stock
(494
)
—

—

—

(494
)
Net intercompany repayments
—

(996
)
(79
)
1,075

—

Distributions to TLLP unitholders and general partner
33

18

(51
)
—

—

Other financing activities
(33
)
37

—

—

4

Net cash from (used in) financing activities
(1,061
)
(945
)
(174
)
1,075

(1,105
)
Decrease in Cash And Cash Equivalents
—

(17
)
(24
)
—

(41
)
Cash and Cash Equivalents, Beginning of Period
—

943

57

—

1,000

Cash and Cash Equivalents, End of Period
$
—

$
926

$
33

$
—

$
959



27



TESORO CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


Condensed Consolidating Statement of Cash Flows for the Nine Months Ended September 30, 2014
(In millions)
 
Parent
Guarantor
Subsidiaries
Non-
Guarantors
Consolidating Adjustments
Consolidated
Cash Flows From (Used In) Operating Activities
 
 
 
 
 
Net cash from (used in) operating activities
$
(31
)
$
926

$
152

$
—

$
1,047

Cash Flows From (Used In) Investing Activities
 
 
 
 
 
Capital expenditures
—

(341
)
(136
)
—

(477
)
Acquisitions
—

(17
)
—

—

(17
)
Intercompany notes, net
261

—

—

(261
)
—

Other investing activities
—

1

10

—

11

Net cash from (used in) investing activities
261

(357
)
(126
)
(261
)
(483
)
Cash Flows From (Used In) Financing Activities
 
 
 
 
 
Borrowings under revolving credit agreements
—

—

295

—

295

Proceeds from debt offering
300

—

—

—

300

Repayments on revolving credit agreements
—

—

(52
)
—

(52
)
Repayments of debt
(300
)
(2
)
(131
)
—

(433
)
Dividend payments
(104
)
—

—

—

(104
)
Net proceeds from issuance of Tesoro Logistics LP
   common units
—

—

156

—

156

Distributions to noncontrolling interest
—

—

(63
)
—

(63
)
Purchases of common stock
(350
)
—

—

—

(350
)
Net intercompany repayments
—

(324
)
63

261

—

Borrowings from general partner
243

—

(243
)
—

—

Distributions to TLLP unitholders and general partner
13

15

(28
)
—

—

Other financing activities
(32
)
19

(8
)
—

(21
)
Net cash used in financing activities
(230
)
(292
)
(11
)
261

(272
)
Increase in Cash And Cash Equivalents
—

277

15

—

292

Cash and Cash Equivalents, Beginning of Period
—

1,161

77

—

1,238

Cash and Cash Equivalents, End of Period
$
—

$
1,438

$
92

$
—

$
1,530



28




ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Those statements in this section that are not historical in nature should be deemed forward-looking statements that are inherently uncertain. See “Important Information Regarding Forward-Looking Statements” section for a discussion of the factors that could cause actual results to differ materially from those projected in these statements. This section should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, 2014.

BUSINESS STRATEGY AND OVERVIEW

Strategy and Goals

Our vision is to create a safer and cleaner future as efficient providers of reliable transportation fuel solutions. To achieve these goals we are pursuing the following strategic priorities:

•
improve operational efficiency and effectiveness by focusing on safety and reliability, system improvements and cost leadership;
•
drive commercial excellence by strengthening our supply, trading and optimization activities to provide additional value to the business;
•
maintain our financial position by exercising capital discipline and focusing on a balanced use of free cash flow;
•
capture value-driven growth through a focus on our logistics assets, growing our marketing business and other strategic opportunities accretive to shareholder value; and
•
maintain a high performing culture by building leadership at all levels of the organization with employees from diverse backgrounds and experiences who are accountable for delivering on our commitments.

Our goals were focused on these strategic priorities and, thus far, we have accomplished the following in 2015:
 
Operational
Efficiency &
Effectiveness
Commercial Excellence
Financial
Discipline
Value
Driven
Growth
High Performing Culture
Operated our Los Angeles and Anacortes refineries safely during a work stoppage in February and March 2015.
•
•
 
 
•
Completed a safe restart of the Martinez refinery in late March 2015.
•
 
 
 
•
Completed the second phase of the Salt Lake City refinery expansion and Waxy Crude Oil Project.
 
•
 
•
•
TLLP completed the merger with QEPM, furthering the integration of the Rockies Natural Gas Business assets within the midstream and downstream value chain.
 
 
 
•
 
Purchased 5.5 million shares of our common stock and paid $0.50 and $0.425 per share dividends in the third and first two quarters, respectively.
 
 
•
 
 
Continued to upgrade our crude oil rail car fleet by adding enhanced tank cars that exceed new safe transport standards issued by the Department of Transportation.
•
 
 
 
•
Modified Anacortes refinery crude tower during second quarter turnaround allowing increased throughput totaling 125 Mbpd in the third quarter.
•
•
 
•
•
Processed over 2 million barrels of additional crude oil at the Los Angeles refinery during a third quarter hydrocracker turnaround versus past events, demonstrating the synergy and integration efforts.
•
•
 
•
•
Added pipeline interconnects at the Los Angeles refinery, enabling further movements between assets and reduced dependence on third party systems.
 
•
 
 
 
Successful launch of a new ARCO Consumer Value Proposition: “ARCO has Top Tier gasoline for less” leading to solid gains in improving ARCO fuel quality perceptions and increasing fuel volumes in our key markets.
 
•
 
•
•


29




Synergy and Business Improvement Objectives

In December 2014, we laid out our plans to deliver an additional $550 to $670 million of annual improvements during 2015. These improvements are in addition to what was delivered in 2014 and include $95 to $125 million from delivering West Coast improvements, $130 to $170 million from capturing margin improvements, and $325 to $375 million by growing our logistics operations. During the first nine months of 2015, we estimate that we delivered approximately $505 million towards our ongoing initiatives around synergies and business improvement objectives, including approximately $130 million related to West Coast improvements, approximately $120 million related to enhanced gross margins, and approximately $255 million from growing our logistics operations. These initiatives focus on improving capture rates and managing our costs to drive improvements in operating income. Our 2015 achievements include the following:

•
Benefited from Los Angeles improvements including:
◦
Crude optimizations from sourcing new crudes;
◦
Crude blending capabilities at the Carson crude terminal that resulted in higher throughput volumes;
◦
New cargo sharing with our Martinez, California refinery; and
◦
Improved pipeline connectivity between the Los Angeles refinery sites.
•
Re-distributed in-bound crude oil to our Kenai, Alaska refinery during maintenance and turnaround activities at our Anacortes, Washington refinery to optimize inventory utilization.
•
Completed the second phase expansion of the waxy crude project at our Salt Lake City, Utah refinery.

Current Market Conditions

The markets in which we operate have continued to experience extreme domestic volatility, with the price of crude oil dropping more than 50% over the last twelve months. Slowing growth in domestic U.S. crude oil production, supply outages, changing logistical infrastructure as well as improving domestic macroeconomic conditions have influenced all portions of our business. Supply to the West Coast market has been impacted this year by work stoppages and several unplanned outages at refineries, including some of our facilities. During this same time period, lower gasoline and energy prices, along with improving employment have led to higher domestic demand. These factors have helped move towards an above average margin environment in our regions. During the third quarter, we saw crude oil volatility resume compared to the second quarter, as well as further declines in crude production growth, leading towards narrowing regional crude differentials. Weaker seasonal product demand and higher utilization rates resulted in a decline to a more average refining margin environment in the latter part of the third quarter and to-date in the fourth quarter. We continue to monitor the impact of these changes in market prices and fundamentals on our business including values recognized in connection with the recently acquired Rockies Natural Gas Business.

The global energy markets have also experienced volatility due to increasing demand for refined products and increasing worldwide crude oil supply. The market for crude oil, natural gas and refined 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. We expect these global demand and supply imbalances to drive continued volatility in our markets.

Tesoro Logistics LP (“TLLP”)

TLLP was formed to own, operate, develop and acquire logistics assets to gather crude oil and natural gas, to distribute, transport and store crude oil and refined products and to process and fractionate natural gas and natural gas liquids (“NGL”). Tesoro Logistics GP, LLC (“TLGP”), a wholly-owned consolidated subsidiary, serves as the general partner of TLLP. We held an approximate 33% interest in TLLP at September 30, 2015, including an approximate 2% general partner interest and all of the incentive distribution rights. In the first nine months of 2015, 55% of TLLP’s revenue was derived from us primarily under various long-term, fee-based commercial agreements that generally include minimum volume commitments.

TLLP’s strategy remains to grow earnings through four ways that have remained constant since its 2011 initial public offering:

•
Focusing on stable, fee-based business;
•
Optimizing our existing asset base;
•
Pursuing organic expansion opportunities; and
•
Continued growth through strategic acquisitions.


30




By achieving this growth and through our ownership of TLLP’s general partner, we expect the logistics operations to maximize the integrated value of assets within the midstream and downstream value chain. This includes creating shareholder value through the lower cost of capital available to TLLP as a limited partnership and receipt of TLLP’s quarterly distributions. As the distributions per unit increase, our proportion of the total distribution will grow at an accelerated rate due to our incentive distribution rights. We believe TLLP is well positioned to achieve its primary business objectives and execute business strategies based on its long-term fee-based contracts, relationship with us, assets positioned in the high demand Williston Basin, and financial flexibility.

Relative to these goals, in 2015, TLLP intends to continue to implement this strategy and have completed or announced plans to:

•
expand TLLP’s assets on its gathering and transportation system, located in the Bakken Region (the “High Plains System”) in support of growing third-party demand for transportation services and Tesoro’s increased demand for Bakken crude oil in the mid-continent and west coast refining systems, including:
◦
further expanding capacity and capability of TLLP’s common carrier pipeline in North Dakota and Montana;
◦
expanding TLLP’s gathering footprint in the Bakken region, including crude oil, natural gas and water, to enhance and improve overall basin logistic efficiencies;
◦
adding other origin and destination points on the High Plains System to increase volumes; and
◦
expanding utilization of TLLP’s proprietary truck fleet, which should generate cost and operating efficiencies.
•
increase TLLP’s terminalling volumes by expanding capacity and growing its third-party services at certain of its terminals;
•
optimize Tesoro volumes and grow third-party volumes using TLLP’s terminalling and transportation assets; and
•
expand and optimize TLLP’s acquired assets in the Rockies Natural Gas Business acquisition.

Total market value of TLLP units held by Tesoro was $1.3 billion and $1.7 billion at September 30, 2015 and December 31, 2014, respectively. At September 30, 2015, Tesoro held 28,181,748 common units at a market value of $45.00 per unit based on the closing unit price as of that date. At December 31, 2014, Tesoro held 28,181,748 common units at a market value of $58.85 per unit based on the closing unit price as of that date. For the three and nine months ended September 30, 2015 and 2014, cash distributions received from TLLP, including incentive distribution rights, is as follows (in millions):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
Cash distributions received from TLLP (a):
 
 
 
 
 
 
 
For common/subordinated units held
$
20

 
$
12

 
$
58

 
$
34

For general partner units held
18

 
8

 
48

 
21

Total Cash Distributions Received from TLLP
$
38

 
$
20

 
$
106

 
$
55

__________________
(a)
Represents distributions received from TLLP during the three and nine months ended September 30, 2015 and 2014 on common or subordinated units and general partner units held by Tesoro.

Vancouver Energy

Consistent with our strategic priorities to drive commercial excellence and capture value-driven growth, we entered into a joint venture in 2013 with Savage Companies to construct, own and operate a unit train unloading and marine loading terminal at Port of Vancouver, USA (the “Vancouver Energy” terminal) with a total capacity of 360 thousand barrels per day (“Mbpd”) allowing for the delivery of cost-advantaged North American crude oil to the U.S. West Coast. Our contribution to the project is expected to be between $95 million and $105 million. These cost estimates include the entire project scope and requirements necessary to comply with American Society of Civil Engineering and International Building Codes for seismic risks in the area. Our contributions, totaling $4 million during 2015, are considered investments in joint ventures and are presented in net cash used in investing activities in our condensed statements of consolidated cash flows.

The project is progressing through the Energy Facility Site Evaluation Council (“EFSEC”) permitting process in the state of Washington. EFSEC has begun the adjudicative phase and based on the schedule it laid out is expected to release the Draft Environmental Impact Statement in November 2015. We expect EFSEC will submit its recommendation to the governor of Washington once it completes the adjudicative phase. The joint venture expects to begin construction of the facilities upon the governor’s approval of the project and issuance of permits. Project construction is estimated to take nine to twelve months; however, initial operations are expected to begin within a few months of construction start.


31




RESULTS OF OPERATIONS

A discussion and analysis of the factors contributing to our results of operations is presented below. The accompanying condensed consolidated financial statements, 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.

Non-GAAP Measures

Our management uses a variety of financial and operating metrics to analyze operating segment performance. To supplement our financial information presented in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), our management uses additional metrics that are known as “non-GAAP” financial metrics in its evaluation of past performance and prospects for the future. These metrics are significant factors in assessing our operating results and profitability and include earnings before interest, income taxes, depreciation and amortization expenses (“EBITDA”). We define EBITDA as consolidated earnings, including earnings attributable to noncontrolling interest, excluding net earnings (loss) from discontinued operations, before depreciation and amortization expense, net interest and financing costs, income taxes and interest income. We define adjusted EBITDA as EBITDA plus or minus amounts determined to be “special items” by our management based on their unusual nature and relative significance to earnings (loss) in a certain period. We provide complete reconciliation and discussion of items identified as special items with our presentation of adjusted EBITDA.

We present EBITDA and adjusted EBITDA because we believe some investors and analysts use EBITDA and adjusted EBITDA to help analyze our cash flows including our ability to satisfy principal and interest obligations with respect to our indebtedness and use cash for other purposes, including capital expenditures. EBITDA and adjusted EBITDA are also used by some investors and analysts to analyze and compare companies on the basis of operating performance and by management for internal analysis. EBITDA and adjusted EBITDA should not be considered as alternatives to U.S. GAAP net earnings or net cash from operating activities. EBITDA and adjusted EBITDA have important limitations as analytical tools, because they exclude some, but not all, items that affect net earnings and net cash from operating activities.

Items Impacting Comparability

Our branded operations represented the assets and operations that were previously shown as the retail segment. In previous periods, a portion of our marketing business related to sales in unbranded or wholesale channels that were presented within our refining operating segment. Upon considering the changes in our business including the transition from company-owned retail operations to multi-site operator model, we assessed how our chief operating decision maker evaluates the business, assesses performance and allocates resources. From this analysis, we believed the presentation of a marketing segment inclusive of both unbranded and branded marketing operations was appropriate. As of the second quarter 2015, we revised our operating segments to include refining, TLLP and a realigned marketing segment. Comparable prior period information has been recast to reflect our revised segment presentation. No other changes were deemed necessary to our refining and TLLP segments.

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 in the acquisitions from Tesoro prior to the effective date of each acquisition for all periods presented. 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.”

TLLP acquired assets related to the Rockies Natural Gas Business through its acquisition of QEP Field Services, LLC (“QEPFS”) from QEP Resources, Inc. on December 2, 2014. At the acquisition date, QEPFS held an approximate 56% limited partner interest in QEP Midstream Partners, LP (“QEPM”) and 100% of QEPM’s general partner, QEP Midstream Partners GP, LLC, which itself held a 2% general partner interest and all of the incentive distribution rights in QEPM. In July 2015, TLLP and QEPM completed the merger, in which QEPM became a wholly owned subsidiary of TLLP. All intercompany transactions with TLLP and QEPM are eliminated upon consolidation.

Certain 2014 period EBITDA financial information has been revised to conform with EBITDA and Adjusted EBITDA presentation disclosed by TLLP on a standalone basis.


32




Summary
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
 
(In millions, except per share amounts)
Revenues
$
7,743

 
$
11,151

 
$
22,438

 
$
32,188

Costs and Expenses:
 
 
 
 
 
 
 
Cost of sales
5,571

 
9,594

 
17,309

 
28,409

Operating expenses
589

 
624

 
1,676

 
1,813

Selling, general and administrative expenses
95

 
86

 
247

 
209

Depreciation and amortization expense
192

 
144

 
553

 
409

(Gain) loss on asset disposals and impairments
4

 
1

 
12

 
(2
)
Operating Income
1,292

 
702

 
2,641

 
1,350

Interest and financing costs, net
(54
)
 
(50
)
 
(163
)
 
(168
)
Other income, net
19

 
11

 
21

 
13

Earnings Before Income Taxes
1,257

 
663

 
2,499

 
1,195

Income tax expense
458

 
249

 
888

 
437

Net Earnings from Continuing Operations
799

 
414

 
1,611

 
758

Loss from discontinued operations, net of tax
—

 
(1
)
 
(4
)
 
(2
)
Net Earnings
799

 
413

 
1,607

 
756

Less: Net earnings from continuing operations attributable to
   noncontrolling interest
40

 
17

 
121

 
58

Net Earnings Attributable to Tesoro Corporation
$
759

 
$
396

 
$
1,486

 
$
698

 
 
 
 
 
 
 
 
Net Earnings (Loss) Attributable to Tesoro Corporation
 
 
 
 
 
 
 
Continuing operations
$
759

 
$
397

 
$
1,490

 
$
700

Discontinued operations
—

 
(1
)
 
(4
)
 
(2
)
Total
$
759

 
$
396

 
$
1,486

 
$
698

 
 
 
 
 
 
 
 
Net Earnings (Loss) per Share - Basic:
 
 
 
 
 
 
 
Continuing operations
$
6.19

 
$
3.11

 
$
11.98

 
$
5.41

Discontinued operations
—

 
(0.01
)
 
(0.03
)
 
(0.02
)
Total
$
6.19

 
$
3.10

 
$
11.95

 
$
5.39

Weighted average common shares outstanding - Basic
122.5

 
127.9

 
124.3

 
129.5

 
 
 
 
 
 
 
 
Net Earnings (Loss) per Share - Diluted:
 
 
 
 
 
 
 
Continuing operations
$
6.13

 
$
3.06

 
$
11.85

 
$
5.32

Discontinued operations
—

 
(0.01
)
 
(0.03
)
 
(0.02
)
Total
$
6.13

 
$
3.05

 
$
11.82

 
$
5.30

Weighted average common shares outstanding - Diluted
123.8

 
129.7

 
125.7

 
131.7



33




 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
(In millions)
Reconciliation of Net Earnings to EBITDA and
   Adjusted EBITDA
 
 
 
 
 
 
 
Net earnings
$
799

 
$
413

 
$
1,607

 
$
756

Loss from discontinued operations, net of tax
—

 
1

 
4

 
2

Depreciation and amortization expense
192

 
144

 
553

 
409

Income tax expense
458

 
249

 
888

 
437

Interest and financing costs, net
54

 
50

 
163

 
168

EBITDA
1,503

 
857

 
3,215

 
1,772

Special items (a)
72

 
1

 
44

 
1

Adjusted EBITDA
$
1,575

 
$
858

 
$
3,259

 
$
1,773

 
 
 
 
 
 
 
 
Reconciliation of Cash Flows from Operating Activities
   to EBITDA and Adjusted EBITDA
 
 
 
 
 
 
 
Net cash from operating activities
$
940

 
$
671

 
$
1,847

 
$
1,047

Net cash used in discontinued operations
2

 
1

 
2

 
2

Debt redemption charges
(1
)
 
(10
)
 
(1
)
 
(41
)
Turnaround and branding charges
81

 
40

 
248

 
119

Changes in current assets and current liabilities
26

 
25

 
247

 
228

Income tax expense
458

 
249

 
888

 
437

Stock-based compensation expense
(22
)
 
(12
)
 
(57
)
 
(20
)
Interest and financing costs, net
54

 
50

 
163

 
168

Deferred income tax expense
(111
)
 
(203
)
 
(157
)
 
(227
)
Other
76

 
46

 
35

 
59

EBITDA
1,503

 
857

 
3,215

 
1,772

Special items (a)
72

 
1

 
44

 
1

Adjusted EBITDA
$
1,575

 
$
858

 
$
3,259

 
$
1,773

________________
(a)
Special items included in EBITDA but excluded for presentation of adjusted EBITDA consist of the following:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
(In millions)
Lower of cost or market inventory adjustment (b)
$
83

 
$
—

 
$
41

 
$
—

Throughput deficiency receivables (c)
—

 
—

 
13

 
—

Insurance settlement gain (d)
(11
)
 
—

 
(11
)
 
—

Gain on sale of Boise Terminal (e)
—

 
—

 
—

 
(5
)
Acquisition costs included in general and administrative expenses (f)
—

 
1

 
1

 
1

Inspection and maintenance expenses associated with the Northwest Products
   System (g)
—

 
—

 
—

 
5

Total Special Items Included in EBITDA
$
72

 
$
1

 
$
44

 
$
1

________________
(b)
We recorded an $83 million lower of cost or market adjustment related to our inventory for the three and nine months ended September 30, 2015. The nine months ended September 30, 2015 also include a benefit of $42 million for the reversal of a lower of cost or market inventory adjustment made in 2014.
(c)
During the nine months ended September 30, 2015, TLLP invoiced QEPFS customers for deficiency payments. TLLP did not recognize $13 million of revenue related to the billing period as it represented opening balance sheet assets for the acquisition of the Rockies Natural Gas Business; however, TLLP is entitled to the cash receipt from such billings.
(d)
During the three and nine months ended September 30, 2015, we recorded a gain of $11 million as other income for insurance proceeds related to the settlement of claims associated with the Washington Refinery Fire.
(e)
Includes a gain of $5 million for the nine months ended September 30, 2014 resulting from TLLP’s sale of its Boise terminal.
(f)
Reflects acquisition costs included in general and administrative expenses primarily related to the merger of QEPM into TLLP.
(g)
Includes costs for detailed inspection and maintenance program on the Northwest Products System Pipeline. The purchase price of
the Northwest Products System was reduced to compensate the Partnership for assuming responsibilities to perform this work.


34




Consolidated Results

Selected consolidated operating data and results are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Refined Product Sales (Mbpd) (a)
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
530

 
516

 
510

 
511

Diesel fuel
213

 
223

 
198

 
208

Jet fuel
148

 
146

 
153

 
146

Heavy fuel oils, residual products and other
101

 
87

 
91

 
85

Total Refined Product Sales
992

 
972

 
952

 
950

 
 
 
 
 
 
 
 
Refined Product Sales Margin ($/barrel) (a) (b)
 
 
 
 
 
 
 
Average sales price
$
81.92

 
$
118.75

 
$
81.84

 
$
119.04

Average costs of sales
66.35

 
106.93

 
67.92

 
107.77

Refined Product Sales Margin
$
15.57

 
$
11.82

 
$
13.92

 
$
11.27

________________
(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 margins include margins on sales of manufactured and purchased refined products.
(b)
Average refined product sales price include all sales through our marketing segment as well as in bulk markets and exports through our refining segment. Average costs of sales and related sales margins include amounts recognized for the sale of refined products manufactured at our refineries along with the sale of refined products purchased from third parties to help fulfill supply commitments.

Three Months Ended September 30, 2015 versus September 30, 2014

Overview. Our net earnings from continuing operations attributable to Tesoro Corporation were $759 million ($6.13 per diluted share) for the three months ended September 30, 2015 (“2015 Quarter”) compared to $397 million ($3.06 per diluted share) for the three months ended September 30, 2014 (“2014 Quarter”).

Gross Margins. Our gross refining margin increased $363 million during the 2015 Quarter compared to the 2014 Quarter driven by a stronger margin environment across the California and Pacific Northwest regions resulting in an overall increase of $5.57 in our gross refining margin per barrel. The increases in gross margin during the 2015 Quarter were partially offset by an $83 million lower of cost or market adjustment related to inventory given the lower price environment we experienced at the end of the third quarter of 2015. Our gross marketing margin increased $183 million primarily driven by favorable market conditions and strong demand. TLLP revenues, net of operating expenses, increased $89 million due to higher throughput volumes driven by acquired assets and continued expansion of its crude oil gathering assets,

Other Costs and Expenses. Operating expenses decreased $35 million to $589 million in the 2015 Quarter compared to the 2014 Quarter primarily due to declining natural gas costs and the conversion of company-operated retail sites to multi-site operators (“MSO”) that reduced costs associated with the management of station operations. This was partially offset by increases due to the Rockies Natural Gas Business acquisition. Our selling, general and administrative expenses were $95 million in the 2015 Quarter compared to $86 million in the 2014 Quarter primarily attributable to changes in stock-based compensation expense during the 2015 Quarter as compared to the 2014 Quarter, the majority related to our stock appreciation rights that are adjusted based on the market price of the stock each period. The stock-based compensation impact on the 2015 Quarter results include an expense of $22 million due to an increase in the stock price per share during the quarter as compared to the 2014 Quarter results, which included an expense of $12 million due to the increase in the stock price per share during that quarter.

Other income, net. The balance for the 2015 Quarter included a gain for an insurance settlement of $11 million related to the Washington Refinery Fire and $6 million related to equity in earnings of equity method investments. The balance for the 2014 Quarter included $9 million related to equity in earnings of equity method investments.

Income Taxes. Our income tax expense totaled $458 million in the 2015 Quarter versus $249 million in the 2014 Quarter. The combined federal and state effective income tax rate was 36.4% and 37.6% during the 2015 Quarter and the 2014 Quarter, respectively. The 2015 rate benefited from an increased domestic manufacturing deduction.


35




Nine Months Ended September 30, 2015 versus September 30, 2014

Overview. Our net earnings from continuing operations attributable to Tesoro Corporation were $1.5 billion ($11.85 per diluted share) for the nine months ended September 30, 2015 (“2015 Period”) compared to $700 million ($5.32 per diluted share) for the nine months ended September 30, 2014 (“2014 Period”).

Gross Margins. Our gross refining margin increased $733 million during the 2015 Period compared to the 2014 Period driven by stronger margin environment across the California and Pacific Northwest regions. The increases in gross refining margin were partially offset by the impact of the work stoppages and three refinery turnarounds during the 2015 Period resulting in an overall increase of $4.46 in our gross refining margin per barrel as well as the net effect of the lower of cost or market inventory adjustment of $41 million. Our gross marketing margin increased $390 million primarily driven by favorable market conditions and strong demand. TLLP revenues, net of operating expenses, increased $287 million due to higher throughput volumes driven by acquired assets and continued expansion of its crude oil gathering assets.

Other Costs and Expenses. Operating expenses decreased $137 million to $1.7 billion in the 2015 Period compared to the 2014 Period primarily due to declining natural gas costs and the conversion of company-operated retail sites to MSO that reduced costs associated with the management of station operations. These expenses were partially offset by increases due to the Rockies Natural Gas Business acquisition. Our selling, general and administrative expenses were $247 million in the 2015 Period compared to $209 million in the 2014 Period primarily attributable to changes in stock-based compensation expense during the 2015 Period as compared to the 2014 Period, principally related to our stock appreciation rights that are adjusted based on the market price of the stock each period. The stock-based compensation impact on the 2015 Period results include an expense of $57 million due to an increase in the stock price per share during the Period as compared to the 2014 Period results, which included an expense of $20 million due to the increase in the stock price per share during that Period.

Other income, net. The balance for the 2015 Period included a gain for an insurance settlement of $11 million related to the Washington Refinery Fire and $9 million related to equity in earnings of equity method investments. The balance for the 2014 Period included $10 million related to equity in earnings of equity method investments.

Income Taxes. Our income tax expense totaled $888 million in the 2015 Period versus $437 million in the 2014 Period. The combined federal and state effective income tax rate was 35.5% and 36.6% during the 2015 Period and the 2014 Period, respectively. The 2015 rate benefited from an increased domestic manufacturing deduction.

Refining Segment

We currently own and operate six 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 six refineries have a combined crude oil capacity of 850 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 through term agreements with renewal provisions or in the spot market. 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.

Market Overview. Results from our refining segment are heavily influenced by our gross refining margin and refinery throughputs. 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. 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 (“EIA”) and other industry sources, to gather supply, demand, utilization, import and export information to forecast and monitor market conditions for our operating regions. We focus on PADD V, or the West Coast of the US 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.


36




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 or yield. 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 of result of changes in market prices and shipping rates. Additionally, our refining gross margin is impacted by the changing crude oil 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.

The following table provides key information that can be used to monitor our business:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Crack Spreads
 
 
 
 
 
 
 
West Coast 321 (ANS) ($/barrel)
$
30.88

 
$
17.87

 
$
26.71

 
$
17.51

Mid-Continent 321 (WTI) ($/barrel)
22.10

 
16.94

 
19.53

 
17.39

Crude Oil Differentials
 
 
 
 
 
 
 
Brent to WTI
$
4.03

 
$
6.15

 
$
5.62

 
$
7.40

Brent to ANS
(1.05
)
 
1.91

 
1.25

 
1.93

WTI to Bakken (Clearbrook)
2.53

 
7.64

 
2.75

 
5.96

ANS to Bakken (Clearbrook)
7.61

 
11.87

 
7.11

 
11.44

ANS to San Joaquin Valley Heavy (CA)
8.12

 
8.03

 
8.41

 
7.39

ANS to Canadian Lt. Sweet
8.57

 
12.54

 
6.99

 
12.97


Source: PLATTS

West Coast. Average U.S. West Coast crack spreads margins were up approximately 73% in the third quarter of 2015, as compared to third quarter of 2014 and were up approximately 53% for the nine months ended September 30, 2015, as compared to the nine months ended September 30, 2014. The increased margins are a result of increased demand year over year along with several extended unplanned refinery outages, including our own as discussed below, in PADD V, which reduced West Coast refinery utilization. The EIA reports have noted an increase in PADD V clean product imports to meet the increased demand.

The first half of 2015 was impacted by work stoppages at the Anacortes, Washington and Los Angeles and Martinez, California refineries. Also during the first three quarters, planned maintenance was performed at our Los Angeles, Martinez, Anacortes and Salt Lake City refineries. Our California region was the most impacted by the work stoppage. The Martinez refinery was idled during February and March and production was impacted at the Los Angeles refinery.

Mid-Continent. Average Mid-Continent crack spreads margins were up approximately 30% in the third quarter of 2015, as compared to the third quarter of 2014 and were up approximately 12% for the nine months ended September 30, 2015, as compared to the nine months ended September 30, 2015. While margins have increased slightly year over year, the local crude oil differentials have more than offset this increase. The WTI to Bakken differential has decreased by approximately $5.11 per barrel increasing the price of Bakken, which resulted in a lower gross margin in the third quarter of 2015 compared to the third quarter of 2014. Bakken crude oil represented over 50% of the crude oil consumed by our Mid-Continent system in the third quarter of 2015.


37




Operational Data and Results. Management uses various measures 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;
•
Manufacturing costs before depreciation and amortization expense (“Manufacturing Costs”) per barrel is calculated by dividing Manufacturing Costs by total refining throughput;
•
We calculate refined product sales margin per barrel by dividing refined product sales margin by total refined product sales (in barrels); and
•
Refined product sales margin represents refined product sales less refined product cost of sales.

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.

Our refining segment operating data are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
Throughput (Mbpd)
 
 
 
 
 
 
 
Heavy crude (a)
178

 
157

 
150

 
163

Light crude
635

 
641

 
575

 
614

Other feedstocks
48

 
60

 
56

 
54

Total Throughput
861

 
858

 
781

 
831

Yield (Mbpd)
 
 
 
 
 
 
 
Gasoline and gasoline blendstocks
438

 
445

 
405

 
430

Diesel fuel
195

 
199

 
166

 
196

Jet fuel
122

 
130

 
119

 
126

Heavy fuel oils, residual products, internally produced fuel
   and other
158

 
141

 
140

 
135

Total Yield
913

 
915

 
830

 
887

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


38




Our refining segment operating results are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
 
(In millions, except per barrel amounts)
Revenues
 
 
 
 
 
 
 
Refined products (a)
$
6,966

 
$
10,363

 
$
20,293

 
$
30,353

Crude oil resales and other
172

 
434

 
780

 
1,060

Total Revenues
$
7,138

 
$
10,797

 
$
21,073

 
$
31,413

Segment Operating Income
 
 
 
 
 
 
 
Gross refining margin (b) (c)
$
1,540

 
$
1,177

 
$
3,672

 
$
2,939

Expenses
 
 
 
 
 
 
 
Manufacturing costs
384

 
428

 
1,178

 
1,280

Other operating expenses
124

 
96

 
275

 
258

Selling, general and administrative expenses
3

 
4

 
7

 
9

Depreciation and amortization expense
132

 
112

 
373

 
317

Loss on asset disposals and impairments
2

 
1

 
8

 
1

Segment Operating Income (c)
$
895

 
$
536

 
$
1,831

 
$
1,074

Gross Refining Margin ($/throughput barrel) (d)
$
20.49

 
$
14.92

 
$
17.42

 
$
12.96

Manufacturing Cost before Depreciation and Amortization
   Expense ($/throughput barrel)
$
4.84

 
$
5.42

 
$
5.53

 
$
5.65

________________
(a)
Refined product sales include intersegment sales to our marketing segment of $4.7 billion and $6.2 billion for the three months ended September 30, 2015 and 2014, respectively, and $13.2 billion and $18.3 billion for the nine months ended September 30, 2015 and 2014, respectively.
(b)
Consolidated gross refining margin combines gross refining margin for each of our regions adjusted for other amounts not directly attributable to a specific region. Other amounts included $1 million for the three months ended September 30, 2015 and $3 million and $4 million for the nine months ended September 30, 2015 and 2014, respectively. There were no amounts for the three months ended September 30, 2014. Gross refining margin includes the effect of intersegment sales to the marketing segment and services provided by TLLP. Gross refining margin approximates total refining throughput multiplied by the gross refining margin per barrel.
(c)
Our refining segment uses RINs to satisfy its obligations under the Renewable Fuels Standard, in addition to physically blending required biofuels. Effective April 1, 2013, we changed our intersegment pricing methodology and no longer reduced the amount marketing pays for the biofuels by the market value of the RINs due to significant volatility in the value of RINs. At the end of 2014, given the price of RINs has become more transparent in the price of biofuels, we determined our intersegment pricing methodology should include the market value of RINs as a reduction to the price our marketing segment pays to our refining segment. We made this change effective January 1, 2015. We have not adjusted financial information presented for our refining and marketing segments for the three or nine month periods ended September 30, 2014. Had we made this change effective January 1, 2014, operating income in our refining segment would have been reduced by $35 million and $94 million for the three and nine months ended September 30, 2014, respectively, with a corresponding increase to operating income in our marketing segment.
(d)
At September 30, 2015, we recorded an $83 million charge for a lower of cost or market adjustment to our inventories. The gross refining margin per throughput barrel does not include this charge. In addition, the gross refining margin per throughput barrel for the nine months ended September 30, 2015 excludes the impact of the $42 million benefit recognized during the first quarter of 2015 from the reversal of a lower of cost or market inventory valuation adjustment recorded in the fourth quarter of 2014 in the computation of the rate at a consolidated or regional level.


39




Our refining segment operating results by region are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
 
2015
 
2014
 
2015
 
2014
 
(Dollars in millions, except per barrel amounts)
Refining Data by Region
 
 
 
 
 
 
 
California (Martinez and Los Angeles)
 
 
 
 
 
 
 
Refining throughput (Mbpd)
534

 
538

 
494

 
528

Gross refining margin
$
1,015

 
$
637

 
$
2,408

 
$
1,616

Gross refining margin ($/throughput barrel) (a)
$
21.82

 
$
12.87

 
$
18.07

 
$
11.22

Manufacturing cost before depreciation and amortization
   expense ($/throughput barrel)
$
5.79

 
$
6.26

 
$
6.32

 
$
6.46

Pacific Northwest (Washington and Alaska)
 
 
 
 
 
 
 
Refining throughput (Mbpd)
192

 
187

 
168

 
172

Gross refining margin
$
238

 
$
248

 
$
641

 
$
506

Gross refining margin ($/throughput barrel) (a)
$
14.49

 
$
14.38

 
$
14.20

 
$
10.80

Manufacturing cost before depreciation and amortization
   expense ($/throughput barrel)
$
3.35

 
$
4.00

 
$
3.97

 
$
4.33

Mid-Continent (North Dakota and Utah)
 
 
 
 
 
 
 
Refining throughput (Mbpd)
135

 
133

 
119

 
131

Gross refining margin
$
286

 
$
292

 
$
620

 
$
813

Gross refining margin ($/throughput barrel) (a)
$
23.66

 
$
23.91

 
$
19.22

 
$
22.69

Manufacturing cost before depreciation and amortization
   expense ($/throughput barrel)
$
3.19

 
$
4.02

 
$
4.45

 
$
4.08

________________
(a)
At September 30, 2015, we recorded an $83 million charge for a lower of cost or market adjustment to our inventories. On a regional basis, gross refining margin reflects charges of $56 million, $18 million and $9 million for California, Pacific Northwest and Mid-Continent, respectively. The gross refining margin per throughput barrel on a consolidated and regional basis does not include this charge. In addition, the gross refining margin per throughput barrel for the nine months ended September 30, 2015 excludes the impact of the $42 million benefit recognized during the first quarter of 2015 from a lower of cost or market inventory valuation adjustment recorded in the fourth quarter of 2014 in the computation of the rate at a consolidated or regional level.

Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014

Overview. Operating income for our refining segment increased $359 million, or 67%, to $895 million during the 2015 Quarter as compared to the 2014 Quarter due to a stronger margin environment. Average U.S. West Coast crack spreads margins were approximately $31 per barrel, up over $13 per barrel in the 2015 Quarter as compared to the 2014 Quarter.

Refining Throughput. Total refining throughput remained steady during the 2015 Quarter as compared to the 2014 Quarter.

Gross Refining Margins. Total gross margin increased $363 million, or 31%, to $1.5 billion in the 2015 Quarter as compared to the 2014 Quarter. On a per barrel basis, our gross refining margin increased $5.57 per barrel, or 37%, to $20.49 per barrel in the 2015 Quarter as compared to the 2014 Quarter given a stronger margin environment across the California and Pacific Northwest regions. We recorded an $83 million lower of cost or market adjustment related to our inventory in the 2015 Quarter driven by the lower price environment experienced during the quarter.

Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014

Overview. Operating income for our refining segment increased $757 million, or 70%, to $1.8 billion during the 2015 Period as compared to the 2014 Period due to a stronger margin environment. Average U.S. West Coast crack spreads margins were approximately $27 per barrel up over $9 per barrel for the 2015 Period as compared to the 2014 Period.

Refining Throughput. Total refining throughput decreased 50 Mbpd, or 6%, to 781 Mbpd during the 2015 Period as compared to the 2014 Period primarily due to the work stoppage and two large planned turnarounds. Our California region was most significantly impacted with our Martinez, California refinery being idled and work stoppage affecting a portion of our Los Angeles refinery.


40




Gross Refining Margins. Total gross margin increased $733 million, or 25%, to $3.7 billion in the 2015 Period as compared to the 2014 Period. On a per barrel basis, our gross refining margin increased $4.46 per barrel, or 34%, to $17.42 per barrel in the 2015 Period as compared to the 2014 Period given a stronger margin environment across the California and Pacific Northwest regions, which was offset by the impact of the work stoppages and three refinery turnarounds during the Period as well as an $83 million lower of cost or market adjustment related to our inventory in the 2015 Period driven by the lower price environment experienced during the quarter.

TLLP Segment

TLLP is a publicly traded limited partnership that was formed to own, operate, develop and acquire logistics assets. Its assets are integral to the success of Tesoro’s refining and marketing operations and generate revenue by charging fees for gathering crude oil and natural gas, for terminalling, transporting and storing crude oil and refined products and for processing and fractionating natural gas and NGLs. On December 2, 2014, TLLP completed the Rockies Natural Gas Business acquisition transforming TLLP into a full-service logistics company with assets allowing geographic and revenue diversification in support of our strategic initiatives.

Operational Data and Results. Management uses average revenue per barrel and average revenue per million British thermal units (“MMBtu”) to evaluate performance and compare profitability to other companies in the industry. We calculate average revenue per barrel as revenue divided by total throughput or keep-whole processing volumes. We calculate average revenue per MMBtu as revenue divided by gas gathering and fee-based processing volume. 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 as an alternative to segment operating income, revenues and operating expenses or any other measure of financial performance presented in accordance with U.S. GAAP.

Our TLLP segment operating data are as follows:

Three Months Ended
September 30,
 
Nine Months Ended
September 30,

2015 (a)
 
2014 (a)
 
2015 (a)
 
2014 (a)
Gathering







Crude oil gathering pipeline throughput (Mbpd)
199


136


182


114

Average crude oil gathering pipeline revenue per barrel
$
1.71


$
1.38


$
1.77


$
1.35

Crude oil gathering trucking volume (Mbpd)
34


51


42


47

Average crude oil gathering trucking revenue per barrel
$
3.14


$
3.30


$
3.24


$
3.24

Gas gathering throughput (thousands of MMBtu/day) (b)
1,115

 
—

 
1,069

 
—

Average gas gathering revenue per MMBtu (b)
$
0.45

 
$
—

 
$
0.44

 
$
—

Processing (b)
 
 
 
 
 
 
 
NGL processing throughput (Mbpd)
8

 
—

 
8

 
—

Average keep-whole fee per barrel of NGL
$
35.75

 
$
—

 
$
34.26

 
$
—

Fee-based processing throughput
   (thousands of MMBtu/day)
767

 
—

 
742

 
—

Average fee-based processing revenue per MMBtu
$
0.39

 
$
—

 
$
0.40

 
$
—

Terminalling and Transportation







Terminalling throughput (Mbpd)
964


943


932


919

Average terminalling revenue per barrel
$
1.05


$
1.03


$
1.08


$
0.97

Pipeline transportation throughput (Mbpd)
838


843


819


824

Average pipeline transportation revenue per barrel
$
0.40


$
0.36


$
0.39


$
0.36

________________
(a)
The results of operations for TLLP’s natural gas gathering and processing operations are shown in Mbpd, per barrel, MMBtu and per MMBtu amounts.
(b)
TLLP commenced natural gas gathering and processing operations with the acquisition of Rockies Natural Gas Business on December 2, 2014.


41




Our TLLP segment operating results are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
(In millions)
Segment Operating Income
 
 
 
 
 
 
 
Revenues
 
 
 
 
 
 
 
Gathering (a)
$
87

 
$
32

 
$
253

 
$
84

Processing (a)
71

 
—

 
205

 
—

Terminalling and transportation
124

 
118

 
362

 
326

Total Revenues (b)
282

 
150

 
820

 
410

Expenses
 
 
 
 
 
 
 
Operating expenses (c)
98

 
55

 
278

 
155

General and administrative expenses (d)
28

 
16

 
81

 
39

Depreciation and amortization expense
44

 
18

 
132

 
51

Gain on asset disposals and impairments
—

 
—

 
—

 
(4
)
Segment Operating Income
$
112

 
$
61

 
$
329

 
$
169

________________
(a)
TLLP commenced natural gas gathering and processing operations with the acquisition of Rockies Natural Gas Business on December 2, 2014.
(b)
TLLP segment revenues from services provided to our refining segment were $152 million and $130 million for the three months ended September 30, 2015 and 2014, respectively, and $454 million and $358 million for the nine months ended September 30, 2015 and 2014, respectively. These amounts are eliminated upon consolidation.
(c)
TLLP segment operating expenses include amounts billed by Tesoro for services provided to TLLP under various operational contracts. Amounts billed by Tesoro totaled $28 million and $18 million for the three months ended September 30, 2015 and 2014, respectively, and $77 million and $56 million for the nine months ended September 30, 2015 and 2014, respectively. Operating expenses also include imbalance gains and reimbursements of $12 million and $17 million for the three months ended September 30, 2015 and 2014, respectively, and $31 million and $32 million for the nine months ended September 30, 2015 and 2014, respectively. These amounts are eliminated upon consolidation. TLLP segment third-party operating expenses related to the transportation of crude oil and refined products are reclassified to cost of sales in our condensed statements of consolidated operations upon consolidation.
(d)
TLLP segment general and administrative expenses include amounts charged by Tesoro for general and administrative services provided to TLLP under various operational and administrative contracts. These amounts totaled $16 million and $11 million for the three months ended September 30, 2015 and 2014, respectively, and $51 million and $28 million for the nine months ended September 30, 2015 and 2014, respectively, and are eliminated upon consolidation. TLLP segment third-party general and administrative expenses are reclassified to cost of sales in our condensed statements of consolidated operations upon consolidation.

Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014

Overview. Operating income for TLLP increased $51 million to $112 million due to the higher revenues driven by the Rockies Natural Gas Business. The Rockies Natural Gas Business contributed $46 million toward the increase in TLLP’s operating income during the 2015 Quarter.

Revenues and Throughput. Crude oil and gas gathering throughput volume increased as a result of the assets acquired in the Rockies Natural Gas Business acquisition and the continuing expansion of the High Plains System. This increase in volumes for crude oil gathering pipeline throughput includes a 67 Mbpd increase in third-party volumes. NGL processing throughput and fee-based processing throughput volumes also increased as a result of the assets acquired in the Rockies Natural Gas Business acquisition. These higher throughput volumes resulted in an increase to revenues of $132 million to $282 million during the 2015 Quarter as compared to the 2014 Quarter.

Operating and Other Expenses. Operating expenses increased $43 million during the 2015 Quarter primarily related to the operations acquired in the Rockies Natural Gas Business acquisition during 2014. General and administrative expenses increased by $12 million due to higher allocations of overhead costs associated with increased costs to support the growth of the business.


42




Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014

Overview. Operating income for TLLP increased $160 million to $329 million due to the higher revenues, offset by an increase in operating expenses of $123 million to $278 million in the 2015 Period as compared to the 2014 Period. The Rockies Natural Gas Business contributed $128 million toward the increase in TLLP’s operating income during the 2015 Period.

Revenues and Throughput. Gathering throughput volume increased as a result of the assets acquired in the Rockies Natural Gas Business acquisition and the continuing expansion of the High Plains System. This increase in volumes for crude oil gathering pipeline throughput was almost entirely due to third party volumes. NGL processing throughput and fee-based processing throughput volumes also increased as a result of the assets acquired in the Rockies Natural Gas Business acquisition. These higher throughput volumes resulted in an increase to revenues of $410 million to $820 million during the 2015 Period as compared to the 2014 Period.

Operating and Other Expenses. Operating expenses increased $123 million during the 2015 Period primarily related to the operations acquired in the Rockies Natural Gas Business acquisition during 2014. General and administrative expenses increased by $42 million due to higher allocations of overhead costs associated with increased costs to support the growth of the business.

Marketing Segment

As discussed in the “Items Impacting Comparability”, we revised our segment presentation during the second quarter of 2015 to present a marketing segment inclusive of both branded and unbranded operations. Previously, our retail segment included only branded operations and unbranded operations were included in the refining segment operating results.

We sell gasoline and diesel fuel in the western United States through branded and unbranded channels. Our branded operations include transportation fuel sales through retail stations and agreements with third-party dealers and distributors (or “Jobber/Dealers”). Our unbranded, or wholesale, operations include volumes sold through agreements with third-party dealers. Our branded and unbranded channels provide committed outlets for nearly all of the gasoline produced by our refineries. During the fourth quarter 2014, we converted our company-operated retail locations to MSOs and retained the transportation fuel sales. Under these MSO arrangements, we no longer operate the convenience stores, own the related merchandise inventory or employ the store employees as the MSO operates the stations. Our marketing segment includes a network of retail stations under the ARCO®, Shell®, Exxon®, Mobil®, USA GasolineTM and Tesoro® brands.

Operational Data and Results. Management uses fuel margin per gallon to compare fuel results to other companies in the industry. There are a variety of ways to calculate fuel margin per gallon; different companies may calculate it in different ways. We calculate fuel margin per gallon by dividing fuel gross margin by fuel sales volumes. Investors and analysts may use fuel margin per gallon to help analyze and compare companies in the industry on the basis of operating performance. This financial measure should not be considered an alternative to revenues, segment operating income or any other measure of financial performance presented in accordance with U.S. GAAP. Fuel margin and fuel margin per gallon include the effect of intersegment purchases from the refining segment.


43




Our marketing segment operating data and results are as follows:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2015
 
2014
 
2015
 
2014
 
(Dollars in millions, except per gallon amounts)
Average Number of Branded Stations (during the period)
 
 
 
 
 
 
 
Company/MSO-operated (a)
580

 
586

 
582

 
580

Jobber/Dealer operated
1,695

 
1,693

 
1,684

 
1,694

Total Average Branded Stations
2,275

 
2,279

 
2,266

 
2,274

 
 
 
 
 
 
 
 
Branded and Unbranded Fuel Sales (millions of gallons)
2,249

 
2,155

 
6,408

 
6,175

 
 
 
 
 
 
 
 
Marketing Revenues
 
 
 
 
 
 
 
Fuel
$
5,144

 
$
6,501

 
$
14,143

 
$
18,814

Other non-fuel (b)
16

 
73

 
48

 
203

Total Revenues
$
5,160

 
$
6,574

 
$
14,191

 
$
19,017

 
 
 
 
 
 
 
 
Branded and Unbranded Fuel Margin ($/gallon)
$
0.20

 
$
0.12

 
$
0.15

 
$
0.08

 
 
 
 
 
 
 
 
Segment Operating Income
 
 
 
 
 
 
 
Gross Margins
 
 
 
 
 
 
 
Fuel (c)
$
459

 
$
259

 
$
951

 
$
514

Other non-fuel (b)
16

 
33

 
45

 
92

Total Gross Margins
475

 
292

 
996

 
606

Expenses
 
 
 
 
 
 
 
Operating expenses
81

 
97

 
223

 
271

Selling, general and administrative expenses
3

 
5

 
12

 
11

Depreciation and amortization expense
11

 
10

 
34

 
30

Loss on asset disposals and impairments
1

 
—

 
3

 
2

Segment Operating Income (c)
$
379

 
$
180

 
$
724

 
$
292

________________
(a)
In December 2014, we converted our company-operated retail stations to MSO retail stations. The impact of this change was not material to our marketing segment results.
(b)
Primarily includes rental income for the three and nine months ended September 30, 2015 and primarily merchandise revenue for the three and nine months ended September 30, 2014.
(c)
Our refining segment uses RINs to satisfy its obligations under the Renewable Fuels Standard, in addition to physically blending required biofuels. Effective April 1, 2013, we changed our intersegment pricing methodology and no longer reduced the amount marketing pays for the biofuels by the market value of the RINs due to significant volatility in the value of RINs. At the end of 2014, given the price of RINs has become more transparent in the price of biofuels, we determined our intersegment pricing methodology should include the market value of RINs as a reduction to the price our marketing segment pays to our refining segment. We made this change effective January 1, 2015. We have not adjusted financial information presented for our refining and marketing segments for the three and nine month periods ended September 30, 2014. Had we made this change effective January 1, 2014, operating income in our refining segment would have been reduced by $35 million and $94 million for the three and nine months ended September 30, 2014, respectively, with a corresponding increase to operating income in our marketing segment.


44




Three Months Ended September 30, 2015 Compared with Three Months Ended September 30, 2014

Overview. Operating income increased $199 million to $379 million during the 2015 Quarter as compared to the 2014 Quarter primarily as a result of strong demand.

Gross Margin. Gross margin increased $183 million to $475 million during the 2015 Quarter as compared to the 2014 Quarter. We experienced higher branded and unbranded fuel margin driven by favorable market conditions and strong demand. Branded and unbranded fuel sales volumes increased 4% during the 2015 Quarter and 2014 Quarter, respectively from strong demand attributed to lower fuel prices and continued improvement in the markets in which we operate.

Operating and Other Expenses. The decrease of $16 million in operating expenses was primarily driven by our conversion to MSOs at retail stations that reduced costs associated with the management of station operations.

Nine Months Ended September 30, 2015 Compared with Nine Months Ended September 30, 2014

Overview. Operating income increased $432 million to $724 million during the 2015 Period as compared to the 2014 Period primarily as a result of strong demand.

Gross Margin. Gross margin increased $390 million to $996 million during the 2015 Period as compared to the 2014 Period. We experienced higher branded and unbranded fuel margin driven by favorable market conditions and strong demand. Branded and unbranded fuel sales volumes slightly increased to 6.4 billion from 6.2 billion gallons during the 2015 Period and 2014 Period, respectively from strong demand attributed to lower fuel prices and an improved economy across our markets.

Operating and Other Expenses. The decrease of $48 million in operating expenses was primarily driven by our conversion to MSOs at retail stations that reduced costs associated with the management of station operations.


45




CAPITAL RESOURCES AND LIQUIDITY

Overview

We operate in an environment where our capital resources and liquidity are impacted by changes in the price of crude oil and refined products, availability of trade credit, market uncertainty and a variety of additional factors beyond our control. These factors include the level of consumer demand for transportation fuels, weather conditions, fluctuations in seasonal demand, governmental regulations, geo-political conditions and overall market and global economic conditions. See “Important Information Regarding Forward-Looking Statements” for further information related to risks and other factors. Future capital expenditures, as well as borrowings under our credit agreements and other sources of capital, may be affected by these conditions.

Capitalization

Our capital structure at September 30, 2015 was comprised of the following (in millions):
Debt, including current maturities:
September 30, 2015
Tesoro Corporation Revolving Credit Facility
$
—

4.250% Senior Notes due 2017
450

5.375% Senior Notes due 2022
475

5.125% Senior Notes due 2024
300

Capital lease obligations and other
40

Tesoro Debt
1,265

TLLP Revolving Credit Facility
280

TLLP 5.500% Senior Notes due 2019
500

TLLP 5.875% Senior Notes due 2020
470

TLLP 6.125% Senior Notes due 2021
550

TLLP 6.250% Senior Notes due 2022
800

TLLP Capital lease obligations and other
8

TLLP Debt
2,608

Total Debt
3,873

Unamortized Issuance Costs (a)
(76
)
Debt, Net of Unamortized Issuance Costs
3,797

Total Equity
7,859

Total Capitalization
$
11,656

________________
(a)
The unamortized issuance costs for TLLP were $39 million, including an unamortized premium of $4 million as of September 30, 2015.

Our debt, net of unamortized issuance costs, to capitalization ratio was 33% and 37% at September 30, 2015 and December 31, 2014, respectively. Our debt, net of unamortized issuance costs, to capitalization ratio, excluding TLLP, was 19% and 27% at September 30, 2015 and December 31, 2014, respectively, which excludes TLLP total debt, net of unamortized issuance costs and TLLP capital leases of $2.6 billion and $2.5 billion at September 30, 2015 and December 31, 2014, respectively and excludes noncontrolling interest of $2.5 billion at both September 30, 2015 and December 31, 2014. TLLP’s debt is non-recourse to Tesoro, except for TLGP.

The Tesoro Corporation revolving credit facility (the “Revolving Credit Facility”) and senior notes each limit our ability, under certain circumstances, to make certain restricted payments (as defined in our debt agreements), which include dividends, purchases of our stock or voluntary prepayments of subordinate debt. The aggregate amount of restricted payments cannot exceed an amount defined in each of the debt agreements. The indentures for our senior notes also limit certain of our subsidiaries’ ability to make certain payments and distributions. We do not believe that these limitations will restrict our ability to pay dividends or buy back stock under our current programs.


46




Credit Facilities Overview

Our primary sources of liquidity are cash flows from operations with additional sources available under borrowing capacity from our revolving lines of credit. We ended the third quarter of 2015 with $959 million of cash and cash equivalents and $280 million of borrowings under the TLLP senior secured revolving credit agreement (the “TLLP Revolving Credit Facility”). We believe available capital resources will be adequate to meet our capital expenditure, working capital and debt service requirements. We had available capacity under our credit facilities as follows at September 30, 2015 (in millions):
 
Total
Capacity
 
Amount Borrowed as of September 30, 2015
 
Outstanding
Letters of Credit
 
Available Capacity
 
Expiration
Tesoro Corporation Revolving
Credit Facility (a)
$
3,000

 
$
—

 
$
76

 
$
2,924

 
November 18, 2019
TLLP Revolving Credit Facility
900

 
280

 
—

 
620

 
December 2, 2019
Letter of Credit Facilities
1,895

 
—

 
189

 
1,706

 
 
Total Credit Facilities
$
5,795

 
$
280

 
$
265

 
$
5,250

 
 
________________
(a)
Borrowing base is the lesser of the amount of the periodically adjusted borrowing base or the agreement’s total capacity of $3.0 billion.

As of September 30, 2015, our credit facilities were subject to the following expenses and fees:
Credit Facility
 
30 day Eurodollar (LIBOR) Rate
 
Eurodollar Margin
 
Base Rate
 
Base Rate Margin
 
Commitment Fee
(unused portion)
Tesoro Corporation Revolving Credit Facility
   ($3.0 billion) (b)
 
0.19%
 
1.50%
 
3.25%
 
0.50%
 
0.375%
TLLP Revolving Credit Facility ($900 million) (c)
 
0.19%
 
2.50%
 
3.25%
 
1.50%
 
0.50%
________________
(b)
We can elect the interest rate to apply to the facility between a base rate plus the base rate margin, or a Eurodollar rate, for the applicable term, plus the Eurodollar margin at the time of the borrowing. The applicable margin on the Revolving Credit Facility varies primarily based upon our senior secured credit ratings. Letters of credit outstanding under the Revolving Credit Facility incur fees at the Eurodollar margin rate.
(c)
TLLP has the option to elect if the borrowings will bear interest at either, a base rate plus the base rate margin or a Eurodollar rate, for the applicable period, plus the Eurodollar margin at the time of the borrowing. The applicable margin varies based upon a certain leverage ratio, as defined by the TLLP Revolving Credit Facility. TLLP incurs commitment fees for the unused portion of the TLLP Revolving Credit Facility. Letters of credit outstanding under the TLLP Revolving Credit Facility incur fees at the Eurodollar margin rate.

Tesoro Corporation Revolving Credit Facility

Overview. Our Revolving Credit Facility provides for borrowings (including letters of credit) up to the lesser of the amount of a periodically adjusted borrowing base, which consists of Tesoro’s eligible cash and cash equivalents, receivables and petroleum inventories, net of the standard reserve as defined, or the Revolving Credit Facility’s total capacity of $3.0 billion. We had unused credit availability of approximately 97% of the eligible borrowing base at September 30, 2015. Our Revolving Credit Facility is guaranteed by substantially all of Tesoro’s active domestic subsidiaries, excluding TLGP, TLLP and its subsidiaries, and certain foreign subsidiaries, and is secured by substantially all of Tesoro’s active domestic subsidiaries’ crude oil and refined product inventories, cash and receivables.


47




Covenants. Our Revolving Credit Facility, as amended and senior notes each limit our ability, under certain circumstances, to make certain restricted payments (as defined in our debt agreements), which include dividends, purchases of our stock or voluntary prepayments of subordinate debt. The aggregate amount of restricted payments cannot exceed an amount defined in each of the debt agreements. The indentures for our senior notes also limit certain of our subsidiaries ability to make certain payments and distributions. These existing covenants and restrictions may limit, among other things, our ability to:

•
pay dividends and make other distributions with respect to our capital stock and purchase, redeem or retire our capital stock;
•
incur additional indebtedness and issue preferred stock;
•
make voluntary prepayments of subordinate debt;
•
sell assets unless the proceeds from those sales are used to repay debt or are reinvested in our business;
•
incur liens on assets to secure certain debt;
•
engage in certain business activities;
•
make certain payments and distributions from our subsidiaries;
•
engage in certain mergers or consolidations and transfers of assets; and
•
enter into certain transactions with affiliates.

We do not believe that the limitations will restrict our ability to pay dividends or repurchase stock under our current programs. We have a default covenant that requires us to maintain specified levels of tangible net worth. There were no changes to the Revolving Credit Facility covenants during the nine months ended September 30, 2015. We were in compliance with our debt covenants as of and for the nine months ended September 30, 2015.

The Revolving Credit Facility allows us to obtain letters of credit under separate letter of credit agreements for foreign crude oil purchases. Our uncommitted letter of credit agreements had $189 million outstanding as of September 30, 2015. Letters of credit outstanding under these agreements incur fees ranging from 0.40% to 1.00% and are secured by the crude oil inventories for which they are issued. Capacity under these letter of credit agreements is available on an uncommitted basis and can be terminated by either party at any time.

TLLP Revolving Credit Facility

Overview. The TLLP Revolving Credit Facility provided for total loan availability of $900 million as of September 30, 2015, and TLLP may request that the loan availability be increased up to an aggregate of $1.5 billion, subject to receiving increased commitments from the lenders. The TLLP Revolving Credit Facility is non-recourse to Tesoro, except for TLGP, and is guaranteed by all of TLLP’s subsidiaries, with the exception of Rendezvous Gas Services L.L.C., and secured by substantially all of TLLP’s assets. Borrowings are available under the TLLP Revolving Credit Facility up to the total loan availability of the facility.

Covenants. The TLLP Revolving Credit Facility and TLLP senior notes contain certain covenants that may, among other things, limit or restrict TLLP’s ability (as well as those of TLLP’s subsidiaries) to:

•
incur additional indebtedness and incur liens on assets to secure certain debt;
•
pay and make certain restricted payments;
•
make distributions from its subsidiaries;
•
dispose of assets in excess of an annual threshold amount;
•
in the case of the TLLP Revolving Credit Facility, make certain amendments, modifications or supplements to organization documents and material contracts;
•
in the case of the TLLP Revolving Credit Facility, engage in certain business activities;
•
engage in certain mergers or consolidations and transfers of assets; and
•
enter into non-arm’s-length transactions with affiliates.

We do not believe that the limitations imposed by the TLLP Revolving Credit Facility will restrict TLLP’s ability to pay distributions. Additionally, the TLLP Revolving Credit Facility contains covenants that require TLLP to maintain certain interest coverage and leverage ratios. TLLP was in compliance with all TLLP Revolving Credit Facility and TLLP senior notes covenants as of and for the nine months ended September 30, 2015.


48




Tesoro Debt Repayments

During August 2015, we voluntarily repaid our obligation of $398 million under the Term Loan Facility in its entirety with available cash on hand. The Term Loan Facility originally funded a portion of the acquisition of BP’s integrated Southern California refining, marketing and logistics business (“The Los Angeles Acquisition”) and was scheduled to mature on May 30, 2016. Amounts paid on the Term Loan Facility cannot be re-borrowed.

Share Repurchases

We are authorized by our Board of Directors (the “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. We purchased approximately 5.5 million shares and 6.2 million shares of our common stock for approximately $494 million and $350 million during the nine months ended September 30, 2015 and 2014, respectively. We have $506 million remaining under our authorized programs. On October 28, 2015, our Board authorized a new $1.0 billion share repurchase program to become effective upon the full completion of our current $1.0 billion share repurchase authorization.

Cash Dividends

We paid cash dividends totaling $62 million and $169 million for the three and nine months ended September 30, 2015, respectively, based on a $0.50 per share and $0.425 per share quarterly cash dividend on common stock in the third and first two quarters, respectively. We paid cash dividends totaling $39 million and $104 million for the three and nine months ended September 30, 2014, respectively, based on a $0.30 per share and $0.25 per share quarterly cash dividend on common stock in the third and first two quarters, respectively. On October 27, 2015, our Board declared a cash dividend of $0.50 per share, payable on December 15, 2015 to shareholders of record on November 30, 2015.

Cash Flow Summary

Working capital (excluding cash) increased $239 million in the 2015 Period primarily related to the timing of our payments for crude oil and refined product purchases, which was offset by timing of receivables.

Components of our cash flows are set forth below (in millions):
 
Nine Months Ended
September 30,
 
2015
 
2014
Cash Flows From (Used in):
 
 
 
Operating activities
$
1,847

 
$
1,047

Investing activities
(783
)
 
(483
)
Financing activities
(1,105
)
 
(272
)
Increase (Decrease) in Cash and Cash Equivalents
$
(41
)
 
$
292


Net cash from operating activities during the 2015 Period totaled $1.8 billion as compared to $1.0 billion in the 2014 Period. The increase in net earnings of $851 million and impact of non-cash items were partially offset by the change in working capital during the 2015 Period compared to the 2014 Period. Net cash used in investing activities increased $300 million to $783 million in the 2015 Period as compared to $483 million in the 2014 Period, primarily due to the increase in capital expenditures to $773 million. Net cash used in financing activities during the 2015 Period totaled $1.1 billion as compared to $272 million in the 2014 Period. The change of $833 million is primarily attributable to an increase in the stock price per share of the repurchases of our common stock as well as increased dividend payments and distributions to noncontrolling interests during the 2015 Period compared to the 2014 Period, the impact of proceeds from debt offerings during the 2014 Period that did not occur in the 2015 Period and less net proceeds from issuance of TLLP common units partially offset by a decrease in net borrowings on revolving credit facilities.


49




Capital Expenditures

The cost estimates for capital expenditures, including environmental projects, described below are subject to further review and analysis and permitting requirements. Our capital spending plans include the following major projects (in millions):
Major Projects
 
Total Project Expected
Capital Expenditures (a)
 
Actual 2015
Capital Expenditures (b)
 
Expected
Capital Expenditures for Remainder of 2015 (a)
 
Expected
In-service Date
Completed:
 
 
 
 
 
 
 
 
Salt Lake City Refinery Expansion (c)
 
$
380

 
$
84

 
$
—

 
In-Service
 
 
 
 
 
 
 
 
 
In Process:
 
 
 
 
 
 
 
 
TLLP’s Connolly Gathering System (d)
 
$
150

 
$
93

 
$
22

 
2014-2015
Clean Product Upgrade Project (e)
 
300

 
19

 
6

 
2017
Avon Wharf Project (f)
 
168

 
67

 
16

 
2017
 
 
 
 
 
 
 
 
 
Under Development:
 
 
 
 
 
 
 
 
Los Angeles Refinery Integration (g)
 
$
460

 
$
29

 
$
14

 
2017
____________________
(a)
The cost estimates for capital expenditures exclude estimates for capitalized interest and labor costs.
(b)
2015 actual capital expenditure disclosures include capitalized interest and labor costs associated with the project.
(c)
The expansion project at the Salt Lake City refinery improved yields of gasoline and diesel, improved the flexibility of processing crude feedstocks and increased throughput capacity by 4 Mbpd. The expansion project increases potential Waxy Crude oil processing capabilities up to 26 Mbpd. We completed the work in the second quarter of 2015.
(d)
TLLP is building and funding the construction of a pipeline gathering system (the “Connolly Gathering System”) to gather crude oil from various points in Dunn County, North Dakota for delivery at its existing Connolly Station with an expected capacity of approximately 60 Mbpd. The first barrels were delivered into the main line at the end of 2014 and the project is expected to be completed in November 2015.
(e)
The Clean Product Upgrade Project at our Anacortes, Washington refinery allows compliance with Tier 3 gasoline sulfur reduction; reduction of gasoline production costs; extraction of existing mixed xylene from gasoline and logistics capability for its export to manufacturers of polyester fibers and films used in clothing, food packaging and beverage containers. The project was approved by our Board in February 2015 with approximately $25 million approved for the first phase of the project. The project remains subject to regulatory approval, which we expect to finalize in 2016.
(f)
The regulatory and compliance project for the Avon Wharf in Martinez, California is required under the California building code for Marine Oil Terminal Engineering and Maintenance Standards (“MOTEMS”). The project will replace the existing berth with a MOTEMS compliant structure that will improve clean product movements and has received all regulatory approval and permits.
(g)
The integration project at the Los Angeles refinery is designed to improve the flexibility of gasoline and diesel yields and reduce carbon dioxide emissions. The proposed project, subject to final Board approval, project scoping, engineering and regulatory approval, includes decommissioning the fluid catalytic cracking unit at our Wilmington refinery.

Capital expenditures during the 2015 Quarter and Period were $259 million and $756 million, respectively, including $92 million and $235 million of TLLP capital spending for the 2015 Quarter and Period, respectively. Our capital spending is expected to be $745 million for 2015, reflecting the Company’s emphasis on long-term strategic priorities including continued focus on safety and reliability and greater focus on value-driven growth. The 2015 capital budget excludes TLLP expected capital spending of $345 million, which is primarily financed by TLLP. Our 2015 Quarter, Period and full-year capital expenditure amounts, excluding TLLP capital spending, are comprised of the following project categories at September 30, 2015:
Project Category
 
Percent of 2015 Quarter Capital Expenditures
 
Percent of 2015 Period Capital Expenditures
 
Percent of 2015 Expected Capital Expenditures
Regulatory
 
40%
 
33%
 
25%
Sustaining
 
19%
 
20%
 
20%
Income Improvement
 
41%
 
47%
 
55%


50




Turnarounds and Branding Charges

We spent $82 million and $252 million during the 2015 Quarter and 2015 Period, respectively, for turnarounds, catalysts and branding charges, including $66 million and $220 million for turnarounds primarily at our Anacortes, Los Angeles and Martinez refineries during the 2015 Quarter and 2015 Period, respectively. Total expected spending for 2015 on turnarounds and catalysts is approximately $280 million primarily spent at our Los Angeles, Anacortes and Martinez refineries. Additionally, total expected spend on branding charges in our marketing segment is approximately $50 million for 2015.

Off-Balance Sheet Arrangements

We have not entered into any transactions, agreements or other contractual arrangements that would result in off-balance sheet liabilities.

Environmental and Other Matters

We are a party to various litigation and contingent loss situations, including environmental and income tax matters, arising in the ordinary course of business. Although we cannot predict the ultimate outcomes of these matters with certainty, we have accrued for the estimated liabilities when appropriate. We believe that the outcome of these matters will not have a material impact on our liquidity or financial position, although the resolution of certain of these matters could have a material impact on our interim or annual results of operations. Additionally, if applicable, we accrue receivables for probable third-party recoveries.

Environmental Laws and Regulations. We are subject to extensive federal, state and local environmental laws and regulations. These laws, which change frequently, regulate the discharge of materials into the environment and may require us to remove or mitigate the environmental effects of the disposal or release of petroleum or chemical substances at various sites, install additional controls or make other modifications to certain emission sources, equipment or facilities.

Future expenditures may be required to comply with the Clean Air Act and other federal, state and local requirements for our various sites, including our refineries, tank farms, pipelines and currently and previously owned or operated terminal and retail station properties. The impact of these legislative and regulatory requirements, including any greenhouse gas cap-and-trade program or low carbon fuel standards, could result in increased compliance costs, additional operating restrictions on our business and an increase in the cost of the products we manufacture, which could have a material adverse impact on our liquidity, consolidated financial position, or results of operations.

The U.S. Environmental Protection Agency (“EPA”) proposed regulating greenhouse gas (“GHG”) emissions under the Clean Air Act in 2009. The first of these regulations, finalized in April 2010, set standards for the control of GHG emissions from light trucks and cars, which could reduce the demand for our manufactured transportation fuels. In addition, the EPA has also finalized regulations to establish permitting requirements for stationary sources that emit GHG above a certain threshold. On June 23, 2014, the U.S. Supreme Court narrowed the EPA’s regulatory authority but upheld portions of the EPA’s rulemaking that would regulate GHG emissions from permitted stationary sources. The stationary source permitting requirements could impose emission controls that increase required capital expenditures at our refineries. We cannot currently predict the impact of these or other regulations on our liquidity, financial position, or results of operations.

The Energy Independence and Security Act was enacted into federal law in December 2007 creating a second Renewable Fuels Standard (“RFS2”) requiring the total volume of renewable transportation fuels (including ethanol and advanced biofuels) sold or introduced in the U.S. to reach 20.5 billion gallons in 2015 and to increase to 36.0 billion gallons by 2022. These requirements could reduce future demand growth for petroleum products that we manufacture. In the near term, the RFS2 presents ethanol production and logistics challenges for the ethanol, alternative fuel and refining and marketing industries. The EPA has proposed, but has yet to finalize, reduced total renewable fuel requirements of 15.9 billion gallons for 2014, 16.3 billion gallons for 2015 and 17.4 billion gallons for 2016. The final requirements are expected in November 2015. In the absence of binding renewable fuel requirements for 2014 and 2015, we believe that we are currently meeting our renewable fuel obligations pursuant to the RFS2, through a combination of Renewable Identification Numbers (“RINs”) that were carried over from prior periods, blending renewable fuels obtained from third parties and purchases of RINs in the open market. The spending related to the purchases of RINs for 2015 is not expected to be material based on our operations and the current regulatory environment. Actual costs related to RINs may differ due to changes in the market price of RINs and the ultimate destinations of our products. Additional expenditures could be required to logistically accommodate the increased use of renewable transportation fuels. While we cannot currently estimate the ultimate impact of this statute and implementing its regulations for future blending mandates, and currently believe that the outcome will not have a material impact on our liquidity or financial position, the ultimate outcome could have a material impact on our results of operations.


51




In California, Assembly Bill 32 (“AB 32”) created a statewide cap on greenhouse gas emissions by requiring that the state return to 1990 emission levels by 2020. AB 32 focuses on using market mechanisms, such as a cap-and-trade program and a low carbon fuel standard (“LCFS”), to achieve emissions reduction targets. The LCFS became effective in January 2010 and requires a 10% reduction in the carbon intensity of gasoline and diesel fuel by 2020. In 2011, the California Air Resources Board (“CARB”) approved cap-and-trade requirements that became effective in January 2013, and all of AB 32 related regulations are to be fully implemented by 2020. In December 2011, a U.S. District Court ruled that the LCFS violates the U.S. Constitution. CARB appealed the decision and, on September 18, 2013, the U.S. Ninth Circuit Court of Appeals reversed the lower court’s decision and remanded the case to the lower court to rule on whether the ethanol provisions of the LCFS are unconstitutional. We cannot predict the ultimate outcome of the lower court’s ruling on the LCFS, and the implementation and implications of AB 32 will take many years to realize. On January 1, 2015, transportation fuels were brought into the California cap-and-trade program, making fuel suppliers responsible for carbon emission from their products. The cost for carbon emissions is being passed through to customers. We cannot currently predict the long-term impact of the LCFS, cap and trade requirements, and other AB 32 related regulations on our liquidity, financial position, or results of operations.

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 a $2.4 million fine, which we appealed. L&I reassumed jurisdiction of the citation and affirmed the allegations in December 2010. We disagree with L&I’s characterizations of operations at our Washington refinery and believe, based on available evidence and scientific reviews, that many of the agency’s conclusions are mistaken. We filed an appeal of the citation in January 2011. In separate September 2013, November 2013 and February 2015 orders, the Board of Industrial Insurance Appeals (“BIIA”) Judge granted partial summary judgment in our favor rejecting 33 of the original 44 allegations in the citation as lacking legal or evidentiary support. A hearing on the remaining 11 allegations started on July 21, 2015, and we expect the Judge to issue a recommended decision for the BIIA’s review in 2016. 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 this time.

On November 20, 2013, we received a notice of violation (“NOV”) from the EPA alleging 46 violations of the Clean Air Act Risk Management Plan requirements at our Washington refinery. The EPA conducted an investigation of the refinery in 2011, following the April 2010 fire in the naphtha hydrotreater unit. We have provided a response to the NOV and additional information to the EPA. While we 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.

In January 2015, we received notice and demand for indemnity from the previous owner of our Washington refinery for the damages they incurred in the civil litigation involving us and the previous owner brought by the families of those fatally wounded in the April 2010 refinery fire. We settled our involvement in the civil litigation in 2012. Arbitration proceedings concerning the demand for indemnity were initiated in March 2015 after an unsuccessful mediation and we intend to vigorously defend ourselves against this claim.

Environmental Liabilities. We are incurring and expect to continue to incur expenses for environmental remediation liabilities at a number of currently and previously owned or operated refining, pipeline, terminal and retail station properties. We have accrued liabilities for these expenses and believe these accruals are adequate based on current information and projections that can be reasonably estimated. Additionally, we have recognized environmental remediation liabilities assumed in past acquisitions from the prior owners that include amounts estimated for site cleanup and monitoring activities arising from operations at refineries, certain terminals and pipelines, and retail stations prior to the dates of our acquisitions. Our environmental accruals are based on estimates including engineering assessments, and it is possible that our projections will change and that additional costs will be recorded as more information becomes available.

Our accruals for environmental expenditures totaled $229 million and $274 million at September 30, 2015 and December 31, 2014, respectively, including $15 million and $32 million for TLLP, respectively. These accruals include $196 million and $216 million at September 30, 2015 and December 31, 2014, respectively, related to amounts estimated for site cleanup activities arising from operations at our Martinez refinery and operations of assets acquired in the Los Angeles Acquisition prior to their respective acquisition dates. We cannot reasonably determine the full extent of remedial activities that may be required at the Martinez refinery and for assets acquired in the Los Angeles Acquisition, and it is possible that we will identify additional investigation and remediation costs for site cleanup activities as more information becomes available. The environmental remediation liabilities assumed in the Los Angeles Acquisition include amounts estimated for site cleanup activities and monitoring activities arising from operations at the Carson refinery, certain terminals and pipelines, and retail stations prior to our acquisition on June 1, 2013. These estimates for environmental liabilities are based on third-party assessments and available information. Our estimates for site cleanup activities reflect amounts for which we are responsible under applicable cost-sharing arrangements.


52




On July 10, 2015, a federal court issued an order denying coverage pursuant to insurance policies for environmental remediation liabilities at our Martinez refinery and those liabilities are included in our accruals above. The insurer had filed a declaratory relief action challenging coverage of the primary policy assigned to us when we acquired the refinery. The policies provide for coverage up to $190 million for expenditures in excess of $50 million in self-insurance. We have not recognized possible insurance recoveries under the policies and have appealed the order.

Other Matters

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. We have not established accruals for these matters unless a loss is probable, and the amount of loss is currently estimable.

Environmental. The EPA has alleged that we have violated certain Clean Air Act regulations at our Alaska, Washington, Martinez, North Dakota and Utah refineries. We also retained the responsibility for resolving similar allegations relating to our former Hawaii refinery, which we sold in September 2013. We previously received a NOV in March 2011 from the EPA alleging violations of Title V of the Clean Air Act at our Alaska refinery, which arose from a 2007 state of Alaska inspection and inspections by the EPA in 2008 and 2010. We also previously received NOVs in 2005 and 2008 alleging violations of the Clean Air Act at our Washington refinery. We are continuing discussions of all of these claims with the EPA and the U.S. Department of Justice. We have established an accrual for this matter although we cannot currently estimate the final amount or timing of its resolution. The ultimate resolution of these matters could have a material impact on us, as we may be required to incur material capital expenditures at our operating refineries. However, we do not believe that the final outcome of this matter will have a material impact on our liquidity, results of operations or financial position.

We have investigated conditions at certain active wastewater treatment units at our Martinez refinery pursuant to an order received in 2004 from the San Francisco Bay Regional Water Quality Control Board that named us as well as two previous owners of the Martinez refinery. We cannot currently estimate the amount of the ultimate resolution of the order, but we believe it will not have a material adverse impact on our liquidity, financial position, or results of operations.

Certain non-governmental organizations filed a Request for Agency Action (the “Request”) with the Utah Department of Environmental Quality (“UDEQ”) concerning our Utah refinery in October 2012. The Request challenges the UDEQ’s permitting of our refinery conversion project alleging that the permits do not conform to the requirements of the Clean Air Act. As the permittee, we are the real party in interest and are defending the permits with UDEQ. In orders issued on July 10 and September 9, 2014, the UDEQ Administrative Law Judge (“ALJ”) recommended the Executive Director of UDEQ deny Petitioners’ request for a stay of the project and dismiss their challenge to the permit. The Executive Director’s final decision approving the ALJ’s recommended order is currently under appeal. While we cannot estimate the timing or estimated amount, if any, associated with the outcome of this matter, we do not believe it will have a material adverse impact on our liquidity, financial position, or results of operations.

In response to incidents in February and March 2014 at our Martinez refinery involving sulfuric acid exposure at the Alkylation Unit the EPA is conducting an investigation to evaluate the Martinez refinery’s compliance with certain federal environmental acts and the Risk Management Plan requirements under the Clean Air Act. While we cannot currently predict the timing and the resolution of this investigation, we believe the outcome will not have a material impact on our liquidity, financial position, or results of operations.

In April 2015, we finalized settlement of citations from the California Department of Industrial Relations alleging violations of the California Labor Code associated with two incidents at our Martinez refinery in February and March 2014. The final resolution of this matter did not have a material impact on our liquidity, financial position, or results of operations.

Tax. We are subject to extensive federal, state and foreign tax laws and regulations. Newly enacted tax laws and regulations, and changes in existing tax laws and regulations, could result in increased expenditures in the future. We are also subject to audits by federal, state and foreign taxing authorities in the normal course of business. It is possible that tax audits could result in claims against us in excess of recorded liabilities. However, we believe that resolution of any such claim(s) would not have a material impact on our liquidity, financial position, or results of operations.


53




Unrecognized tax benefits increased by approximately $150 million in the second quarter of 2015 for tax positions taken on amended returns filed for 2006-2010. The positions taken exclude certain tax credits, for blending biofuels into refined products, from taxable income. These tax credits were received from the federal government during the years being amended. However, due to the complex and uncertain nature of the issue, we are unable to conclude that it is more likely than not that we will sustain the claims. Therefore, we have neither recognized a tax benefit, nor recorded a receivable for this item.

It is reasonably possible that unrecognized tax benefits may decrease by as much as $8 million in the next twelve months, related primarily to state apportionment matters. However, since the tax was fully paid in prior years, the unrecognized tax benefit would be eliminated without impacting expense.

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

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

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

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

•
the constantly changing margin between the price we pay for crude oil and other refinery feedstocks as well as RINs and carbon credits, and the prices at which we are able to sell refined products;
•
the timing and extent of changes in commodity prices and underlying demand for our refined products, natural gas and NGLs;
•
changes in the expected value of and benefits derived from acquisitions, including TLLP’s Rockies Natural Gas Business acquisition;
•
changes in global economic conditions and the effects of the global economic downturn on our business, especially in California, and the business of our suppliers, customers, business partners and credit lenders;
•
the availability and costs of crude oil, other refinery feedstocks and refined products;
•
changes in fuel and utility costs for our facilities;
•
changes in the cost or availability of third-party vessels, pipelines and other means of transporting crude oil feedstocks and refined products;
•
actions of customers and competitors;
•
state and federal environmental, economic, health and safety, energy and other policies and regulations, including those related to climate change and any changes therein, and any legal or regulatory investigations, delays or other factors beyond our control;
•
regulatory and other requirements concerning the transportation of crude oil, particularly from the Bakken area;
•
changes in the carrying costs of our inventory;
•
adverse rulings, judgments, or settlements in litigation or other legal or tax matters, including unexpected environmental remediation costs in excess of any reserves;
•
operational hazards inherent in refining operations and in transporting and storing crude oil and refined products;
•
earthquakes or other natural disasters affecting operations;
•
changes in our cash flow from operations;
•
changes in capital requirements or in execution of planned capital projects;
•
disruptions due to equipment interruption or failure at our facilities or third-party facilities;
•
direct or indirect effects on our business resulting from actual or threatened terrorist incidents or acts of war;
•
weather conditions affecting our operations or the areas in which our refined products are marketed;

54




•
seasonal variations in demand for refined products;
•
risks related to labor relations and workplace safety; and
•
political developments.

Many of these factors, as well as other factors, are described in our filings with the Securities and Exchange Commission. All future written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the previous statements. The forward-looking statements in this Quarterly Report on Form 10-Q speak only as of the date of this Quarterly Report on Form 10-Q. We undertake no obligation to update any information contained herein or to publicly release the results of any revisions to any forward-looking statements that may be made to reflect events or circumstances that occur, or that we become aware of, after the date of this Quarterly Report on Form 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Risk Management

We have established a risk committee comprised of senior level leadership from our financial, strategic, governance, administrative and operational functions. The risk committee’s responsibilities include the performance of an annual review to assess and prioritize the Company’s risks in coordination with our subject matter experts, assessment of the status and effectiveness of risk prevention and mitigation activities, identify emerging risks and facilitating management’s development of risk assessment and management practices. The risk committee is also responsible to assess and advise management on the Company’s system of controls to ensure policies and procedures are properly followed and appropriate accountability is present. The Company’s controls are designed to:

•
create and maintain a comprehensive risk management policy;
•
provide for authorization by the appropriate levels of management;
•
provide for segregation of duties;
•
maintain an appropriate level of knowledge regarding the execution of and the accounting for derivative instruments; and
•
implement key indicators to measure the performance of its hedging activities.

The risk committee meets at least monthly to review priority and emerging risks and risk prevention and mitigation activities. In addition, our risk committee chairman presents a quarterly risk update to executive management and an annual update to our Board concerning the status and effectiveness of our risk prevention and mitigation activities, emerging risks and risk assessment and management practices.

Commodity Price Risks

Our primary source of market risk is the difference between the sale prices for our refined products and the purchase prices for crude oil and other feedstocks. Refined product prices are directly influenced by the price of crude oil. Our earnings and cash flows from operations depend on the margin, relative to fixed and variable expenses (including the costs of crude oil and other feedstocks), at which we are able to sell our refined products. The prices of crude oil and refined products fluctuate substantially and depend on many factors including the global supply and demand for crude oil and refined products. This demand is impacted by changes in the global economy, the level of foreign and domestic production of crude oil and refined products, geo-political conditions, the availability of imports of crude oil and refined products, the relative strength of the U.S. dollar, the marketing of alternative and competing fuels and the impact of government regulations. Our refined product sale prices are also affected by local factors such as local market conditions and the level of operations of other suppliers in our markets.

In most cases, an increase or decrease in the price of crude oil results in a corresponding increase or decrease in the price of gasoline and other refined products. The timing, direction and the overall change in refined product prices versus crude oil prices could have a significant impact on our profit margins, earnings and cash flows. Assuming all other factors remained constant, a $1 per barrel change in average gross refining margins, based on our quarter-to-date average throughput of 861 thousand barrels per day, would change annualized pre-tax operating income by approximately $310 million. This analysis may differ from actual results.


55




We maintain inventories of crude oil, intermediate products and refined products, the values of which are subject to fluctuations in market prices. Our inventories of refinery feedstocks and refined products totaled 44 million barrels and 42 million barrels at September 30, 2015 and December 31, 2014, respectively. Since the replacement cost of our inventories declined to a level below our average cost, we recorded a lower of cost or market adjustment of $83 million and $42 million as of September 30, 2015 and December 31, 2014, respectively.

We use non-trading derivative instruments to manage exposure to commodity price risks associated with the purchase or sale of crude oil and finished products and inventories above or below our target levels. We also use these instruments to manage the impact of market volatility and arbitrage opportunities for crude oil where the price of crude oil is higher in the future than the current spot price. For the purchase or sale of crude oil and finished products to be used in our normal operations, we may enter into physical commodity forward purchase and sale contracts (“Forward Contracts”), which are not typically classified and reported as derivatives for accounting purposes. The gains or losses associated with these Forward Contracts are recognized as incurred in our financial statements separate from the gains or losses associated with other derivative instruments reported below and in Note 6 to our financial statements in Part 1 Item 1.

Also, we may enter into derivative contracts such as exchange-traded futures, over-the-counter swaps, options and over-the-counter options, most of which had remaining durations of less than one year as of September 30, 2015, to economically hedge price risk associated with our physical commodity Forward Contracts or to take advantage of other market opportunities. We mark-to-market these derivative instruments each period during the contract term, which can create timing differences for gain or loss recognition in our financial statements. The derivative gains or losses presented below do not reflect the realized losses or gains, respectively, from the settlement of our physical commodity transactions. Both the derivative and the physical commodity Forward Contracts’ gains and losses are reflected in our gross refining margin in the refining segment. We evaluate our performance based on all contract types available to manage our risk, which includes contracts that may or may not be classified and reported as derivatives for accounting purposes.

We believe the governance structure that we have in place is adequate given the size and sophistication of our commodity optimization, inventory management and trading activities. Our governance over commodity activities includes regular monitoring of the performance of our risk management strategies and limits over dollar and volume based transactional authority, commodity position, aggregate spread, stop-loss and value-at-risk. Performance against our strategies and authorized limits is monitored daily via position reports and profit and loss analysis and is reviewed on a regular basis, at least monthly, by our risk committee.

Net earnings during the third quarters of 2015 and 2014 included a net gain of $154 million and $166 million, respectively, on our commodity derivative positions comprised of the following (in millions):
 
Net Gain
 
Three Months Ended
September 30,
 
2015
 
2014
Unrealized gain carried on open derivative positions from prior period
$
13

 
$
14

Realized gain on settled derivative positions
105

 
103

Unrealized gain on open net derivative positions
36

 
49

Net Gain
$
154

 
$
166


Our open derivative positions at September 30, 2015 will expire at various times through 2017. We prepared a sensitivity analysis to estimate our exposure to market risk associated with our derivative instruments. This analysis may differ from actual results. Based on our open net positions at September 30, 2015, a 1% change in quoted market prices of our derivative instruments, assuming all other factors remain constant, could change the fair value of our derivative instruments and pre-tax operating income by approximately $4 million.


56




Counterparty Credit Risk

We have exposure to concentrations of credit risk related to the ability of our counterparties to meet their contractual payment obligations, and the potential non-performance of counterparties to deliver contracted commodities or services at the contracted price. Customer concentrations within the refining industry may affect our overall exposure to counterparty risk because these customers may be similarly impacted by changes in economic or other conditions. In addition, financial services companies are the counterparties in certain of our price risk management activities, and such financial services companies could be adversely impacted by periods of uncertainty and illiquidity in the credit or capital markets. We have credit management processes in place, by which we closely monitor the status of our counterparties by performing ongoing credit evaluations of their financial condition. In certain circumstances, we require prepayments, letters of credit or other credit enhancement.

Interest Rate Risk

Our use of fixed or variable-rate debt directly exposes us to interest rate risk. Fixed rate debt, such as our senior notes, exposes us to changes in the fair value of our debt due to changes in market interest rates. Fixed rate debt also exposes us to the risk that we may need to refinance maturing debt with new debt at higher rates, or that we may be obligated to pay rates higher than the current market. Variable-rate debt, such as borrowings under our Revolving Credit Facility, exposes us to short-term changes in market rates that impact our interest expense. The carrying values of our debt were approximately $3.9 billion and $4.3 billion at September 30, 2015 and December 31, 2014, respectively, and the fair values of our debt were approximately $3.8 billion and $4.3 billion at September 30, 2015 and December 31, 2014, respectively. These carrying and fair values of our debt do not consider the unamortized issuance costs, which are netted against our total debt.

We currently do not use interest rate swaps to manage our exposure to interest rate risk; however, we continue to monitor the market and our exposure, and in the future, we may enter into these transactions to mitigate risk. We believe in the short-term we have acceptable interest rate risk and continue to monitor the risk on our long-term obligations. There were no borrowings outstanding under the Revolving Credit Facility and $280 million borrowings outstanding under the TLLP Revolving Credit Facility as of September 30, 2015.

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

Our disclosure controls and procedures are designed to provide reasonable assurance that the information that we are required to disclose in reports we file under the Securities Exchange Act of 1934, as amended (“the Exchange Act”), is accumulated and appropriately communicated to management. There have been no significant changes in our internal controls over financial reporting (as defined by applicable Securities and Exchange Commission rules) during the quarter ended September 30, 2015 that have materially affected or are reasonably likely to materially affect these controls.

We carried out an evaluation required by Rule 13a-15(b) of the Exchange Act, under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures at the end of the reporting period. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.


57




PART II — OTHER INFORMATION

ITEM 1. 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, except as may be specifically disclosed, will not have a material adverse impact on our liquidity, financial position, or results of operations.

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 a $2.4 million fine, which we appealed. L&I reassumed jurisdiction of the citation and affirmed the allegations in December 2010. We disagree with L&I’s characterizations of operations at our Washington refinery and believe, based on available evidence and scientific reviews, that many of the agency’s conclusions are mistaken. We filed an appeal of the citation in January 2011. In separate September 2013, November 2013 and February 2015 orders, the Board of Industrial Insurance Appeals (“BIIA”) Judge granted partial summary judgment in our favor rejecting 33 of the original 44 allegations in the citation as lacking legal or evidentiary support. A hearing on the remaining 11 allegations started on July 21, 2015, and we expect the Judge to issue a recommended decision for the BIIA’s review in early 2016. 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 this time.

In January 2015, we received notice and demand for indemnity from the previous owner of our Washington refinery for the damages they incurred in the civil litigation involving us and the previous owner brought by the families of those fatally wounded in the April 2010 refinery fire. We settled our involvement in the civil litigation in 2012. Arbitration proceedings concerning the demand for indemnity were initiated in March 2015 after an unsuccessful mediation and we intend to vigorously defend ourselves against this claim.

In July 2015, we agreed to settle four notices of violations (“NOV”) we received from the Bay Area Air Quality Management District (the “BAAQMD”) in May through September 2013. The allegations concern hydrocarbon emissions from a process water drain system at our Martinez refinery. The final resolution of this matter did not have a material impact on our liquidity, financial position or results of operations.

On October 30, 2014, we received an offer to settle 36 NOVs received from the BAAQMD. The NOVs were issued from March 2012 to October 2013 and allege violations of air quality regulations at our Martinez refinery. While we actively discussing a settlement of the allegations with BAAQMD, we cannot currently estimate the amount or timing of the resolution of this matter.

On June 10, 2015, we agreed to settle a NOV previously received in January 2014 from the Alaska Department of Environmental Conservation (“ADEC”). ADEC alleged that we violated emission limits in 7 process heaters at our Kenai refinery. The resolution of this matter did not have a material impact on our liquidity, financial position or results of operations.

On October 7, 2015, Tesoro Logistics LP (“TLLP”) received an offer to settle a NOV received from the North Dakota Department of Health. The NOV was issued on March 21, 2015 and alleges violations of water pollution regulations as a result of a release of crude oil that occurred near Tioga, North Dakota on the Tesoro High Plains Pipeline system in September 2013. TLLP cannot currently estimate the timing of the resolution of this matter while it evaluates a settlement offer. The ultimate resolution of this matter will not have a material impact on TLLP’s liquidity, financial position, or results of operations.

In October 2015, we finalized settlement of twelve NOVs we received from the South Coast Air Quality Management District in January 2013 through March 2015. The allegations concern violations of air quality regulations at our Los Angeles refinery. The final resolution of this matter will not have a material impact on our liquidity, financial position or results of operations.

ITEM 1A. RISK FACTORS

There have been no significant changes from the risk factors previously disclosed in Item 1A of our 2014 Annual Report on Form 10-K.


58




ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

The table below provides a summary of all purchases by Tesoro Corporation of its common stock during the three-month period ended September 30, 2015.
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 (b)
 
Approximate Dollar
Value of Shares that May
Yet Be Purchased Remaining at Period End Under the Plans or Programs (In Millions) (b)
July 2015
1,888

 
$
97.12

 
—

 
$
731

August 2015
561,721

 
$
95.41

 
559,369

 
$
678

September 2015
1,796,337

 
$
95.64

 
1,795,200

 
$
506

Total
2,359,946

 
 
 
2,354,569

 
 
________________
(a)
Includes 5,377 shares acquired from employees during the third quarter of 2015 to satisfy tax withholding obligations in connection with the vesting of performance share awards, market stock units and restricted stock issued to them.
(b)
Our Board of Directors authorized a $1.0 billion share repurchase program in July 2014. Under the program, management is permitted to purchase Tesoro common stock at its discretion in the open market. On October 28, 2015, our Board authorized a new $1.0 billion share repurchase program to become effective upon the full completion of our current $1.0 billion share repurchase authorization. The authorization has no time limit and may be suspended or discontinued at any time.

ITEM 5. OTHER INFORMATION

Amended and Restated Executive Deferred Compensation Plan

On October 27, 2015, the Compensation Committee approved amendments to the Executive Deferred Compensation Plan. Among other things, these changes clarify the types of elections that may be made by participants regarding the timing and form of distributions from the Plan, clarify the types of compensation that may be eligible for deferral under the Plan, and provide for an automatic acceleration of distributions to participants (absent an affirmative participant election to the contrary) upon the occurrence of certain corporate change in control events. These amendments and modifications are not expected to increase the cost to participants. The amendments will become effective for deferrals made after January 1, 2016.

Code of Business Conduct and Ethics for Senior Financial Executives

On October 27, 2015, the Company adopted an amended Code of Business Conduct and Ethics for Senior Financial Executives (the “Code”). The amendment to the Code added discussion under the Enforcement section stating that the Company may recoup incentive payments previously made to a Senior Financial Executive if the executive is found to be in violation of the Code.

The foregoing description of the amendment to the Code is qualified in its entirety by reference to the full text of the Code, which is attached hereto as Exhibit 14.1 and is posted on the Company’s website at www.tsocorp.com under the heading “Investors” and subheading “Corporate Governance.”


59




ITEM 6. EXHIBITS

(a)
Exhibits
Exhibit Number
 
Description of Exhibit
 
 
 
4.1
 
Second Supplemental Indenture, dated as of May 21, 2015, among TLLP Merger Sub LLC, Tesoro Logistics LP, Tesoro Logistics Finance Corp., the guarantors named therein and U.S. Bank National Association, as trustee, relating to the 5.50% Senior Notes due 2019 and the 6.25% Senior Notes due 2022 (incorporated by reference herein to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, File No. 1-3473)
 
 
 
4.2
 
Fourth Supplemental Indenture, dated as of May 21, 2015, among TLLP Merger Sub LLC, Tesoro Logistics LP, Tesoro Logistics Finance Corp., the guarantors named therein and U.S. Bank National Association, as trustee, relating to the 6.125% Senior Notes due 2021 (incorporated by reference herein to Exhibit 4.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, File No. 1-3473)
 
 
 
4.3
 
Sixth Supplemental Indenture, dated as of May 21, 2015, among TLLP Merger Sub LLC, Tesoro Logistics LP, Tesoro Logistics Finance Corp., the guarantors named therein and U.S. Bank National Association, as trustee, relating to the 5.875% Senior Notes due 2020 (incorporated by reference herein to Exhibit 4.3 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, File No. 1-3473)
 
 
 
#10.1
 
Tesoro Corporation Non-Employee Director Compensation Program (incorporated by reference herein to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015, File No. 1-3473).
 
 
 
10.2
 
Amendment No. 2 to the Third Amended and Restated Omnibus Agreement, dated as of August 3, 2015, among Tesoro Corporation, Tesoro Refining & Marketing Company LLC, Tesoro Companies, Inc., Tesoro Alaska Company LLC, Tesoro Logistics LP and Tesoro Logistics GP, LLC (incorporated by reference herein to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2015, File No. 1-3473)
 
 
 
*10.3
 
Omnibus Amendment No. 2 and Consent to Sixth Amended and Restated Credit Agreement and Amendment No. 3 to the Amended and Restated Security Agreement, dated as of August 21, 2015, among Tesoro Corporation and Subsidiaries of the Borrower.
 
 
 
*10.4
 
Amended and Restated Executive Deferred Compensation Plan, effective as of January 1, 2016.
 
 
 
*14.1
 
Code of Business Conduct and Ethics for Senior Financial Executives, amended as of October 27, 2015.
 
 
 
*31.1
 
Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
*31.2
 
Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
*32.1
 
Certification by Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
*32.2
 
Certification by Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
**101.INS
 
XBRL Instance Document
 
 
 
**101.SCH
 
XBRL Taxonomy Extension Schema Document
 
 
 
**101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
 
 
 
**101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
 
 
 
**101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document
 
 
 
**101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
________________
*
Filed herewith.
**
Submitted electronically herewith.
#
Compensatory plan or arrangement.


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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
TESORO CORPORATION
 
 
 
Date:
October 29, 2015
/s/ GREGORY J. GOFF
 
 
Gregory J. Goff
 
 
President and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
Date:
October 29, 2015
/s/ STEVEN M. STERIN
 
 
Steven M. Sterin
 
 
Executive Vice President and Chief Financial Officer
 
 
(Principal Financial Officer)


61





Exhibit 10.3

EXECUTION COPY



OMNIBUS AMENDMENT NO. 2 AND CONSENT
TO
SIXTH AMENDED AND RESTATED CREDIT AGREEMENT
AND
AMENDMENT NO. 3 TO AMENDED AND RESTATED SECURITYAGREEMENT


This OMNIBUS AMENDMENT NO. 2 AND CONSENT to SIXTH AMENDED AND RESTATED CREDIT AGREEMENT and AMENDMENT NO. 3 TO AMENDED AND RESTATED SECURITY AGREEMENT (the “Amendment”), dated as of August 21, 2015, is entered into by and among Tesoro Corporation (the “Borrower”), the Subsidiaries of the Borrower party hereto (the “Subsidiary Grantors” and, together with the Borrower, the “Grantors”), the financial institutions listed on the signature pages hereof (the “Lenders”), and JPMorgan Chase Bank, National Association, as Administrative Agent (the “Agent”), under the below-defined Credit Agreement. Each capitalized term used herein and not otherwise defined herein shall have the meaning given to it in the below-defined Credit Agreement.

WITNESSETH

WHEREAS, the Borrower, the Lenders, and the Agent are parties to a Sixth Amended and Restated Credit Agreement dated as of January 4, 2013 (as the same may be amended, restated, supplemented or otherwise modified from time to time, the “Credit Agreement”);

WHEREAS, the Borrower wishes to amend the Credit Agreement in certain respects and the Lenders party hereto and the Agent are willing to amend the Credit Agreement on the terms and conditions set forth herein;

WHEREAS, the Borrower has informed the Agent that, notwithstanding the terms of Section 6.25 of the Credit Agreement as in effect prior to this Amendment, the Borrower has caused funds on deposit in the Collection Accounts to be released to Borrower operating accounts maintained at Lenders other than JPMorgan (collectively, the “Collection Account Transfers”);

WHEREAS, the Borrower has requested that the Lenders party hereto and the Agent consent to the Collection Account Transfers;

WHEREAS, subject to the terms and conditions of this Amendment, the Lenders party hereto and the Agent are willing to consent to the Collection Account Transfers;

WHEREAS, the Grantors and the Agent are parties to an Amended and Restated Security Agreement, dated as of March 16, 2011 (as the same may be amended, restated, supplemented or otherwise modified from time to time, the “Security Agreement”); and

WHEREAS, the Grantors wish to amend the Security Agreement in certain respects and the Lenders party hereto and the Agent are willing to amend the Security Agreement on the terms and conditions set forth herein.


ACTIVE 209499242v.12



NOW, THEREFORE, in consideration of the premises set forth above, the terms and conditions contained herein, and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, the Subsidiary Grantors, the Agent and the Lenders party hereto hereby agree as follows:

1.    Amendments to Credit Agreement.    Effective as of the date of satisfaction of the conditions precedent set forth in Section 4 below, the Credit Agreement is hereby amended as follows:

(a) Section 1.1 of the Credit Agreement is hereby amended to add the following definitions in their appropriate alphabetical order therein:

“ “JPMorgan Money Market Mutual Fund Interests” means shares in certain money market mutual funds advised by J.P. Morgan Investment Management Inc., an affiliate of JPMorgan, each as reflected on such fund’s shareholder records maintained by Boston Financial Data Services, Inc., as transfer agent on behalf of each such fund.”

“ “Second Amendment Effective Date” means August 21, 2015.”

(b) The definition of “Perfected Cash Interests” contained in Section 1.1 of the Credit
Agreement is hereby amended to amend and restate such definition in its entirety as follows:

““Perfected Cash Interests” means Dollars or Cash Equivalent Investments on deposit in collection accounts, other accounts or otherwise (including the JPMorgan Money Market Mutual Fund Interests), in each case subject to control agreements in form and substance acceptable to the Agent that grant the Agent first priority perfected security interests in such accounts or investments and the Dollars and Cash Equivalent Investments (including proceeds thereof) on deposit or otherwise maintained or reflected therein or other similar arrangements whereby the bank, financial institution or other agent holding or reflecting such deposits or investments (or the issuer of such investments, as applicable to establish control) have acknowledged the Lien created thereon and the Agent holds a first priority perfected security interest therein.”

(c) Section 6.25 of the Credit Agreement is hereby amended and restated in its entirety as follows:

“6.25 Collection Account. The Borrower and its Subsidiaries shall cause all collections of Receivables constituting Collateral and all proceeds of Collateral to be directly deposited into collection accounts (such accounts, “Collection Accounts”) maintained with JPMorgan or an Affiliate thereof or other financial institutions. Collection Accounts shall, upon the request of the Agent, be subject to account control agreements, in form and substance acceptable to the Agent, which grant the Agent control over and a first-priority perfected security interest in such Collection Accounts, including, without limitation, amounts and other items on deposit therein. If any collections referred to in the first sentence of this Section 6.25 are received by the Borrower, a Subsidiary, or any other Person, such collections shall be deemed to have been received by the Borrower, such Subsidiary or such other Person in trust for the Agent, and, upon the Borrower’s, such Subsidiary’s, or such other Person’s receipt thereof, the Borrower shall (or shall cause such Subsidiary or other Person to) promptly remit all of such collections, in their original form, for deposit into a Collection Account. Following the occurrence and during the continuance of a Default, all amounts received by the Agent, all amounts on deposit in the Collection Accounts, and all amounts constituting collections required to be deposited into Collection Accounts shall be the sole property of the Agent for the benefit of the Holders of Secured Obligations and shall be deemed received by the Agent for application to the Secured Obligations pursuant to the terms of this Agreement. With respect to any Collection Account described in this Section 6.25 not already

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subject to a control agreement on the Second Amendment Effective Date, the Borrower and its Subsidiaries shall have ninety (90) days from the date of the Agent’s request therefor to cause such account to become subject to one of the aforementioned account control agreements. For the avoidance of doubt, amounts on deposit in any Collection Account and other Cash Equivalent Investments not subject to an account control agreement shall not constitute Perfected Cash Interests and therefore shall not be included in the Borrowing Base. Notwithstanding the foregoing, or anything to the contrary in Section 2.11.1, (a) the Borrower and its Subsidiaries shall be permitted to transfer amounts on deposit in any Collection Account to any other account or investment constituting a Cash Equivalent Investment (including the JPMorgan Money Market Mutual Fund Interests) so long as after giving effect to such transfer such amounts constitute Perfected Cash Interests and (b) at all times that (i) no Default exists and (ii) Excess Availability equals or exceeds $300,000,000, amounts which are on deposit in Collection Accounts or other accounts or investments referenced in the preceding clause (a) may be released, in a manner mutually satisfactory to the Borrower and the Agent, on a daily basis to the Borrower’s operating accounts maintained with JPMorgan or with any other Lender or otherwise at the direction of the Borrower (and such released amounts shall be automatically released from the Lien created by the Security Agreement and cease to be Collateral without delivery of any instrument or performance of any act by any party, and all rights to such released amounts shall revert to the Borrower or applicable Subsidiary). In connection with any release described in clause (b) of the immediately preceding sentence, the Agent, at the request and sole expense of the Borrower, shall execute and deliver to the Borrower all releases or other documents reasonably necessary or desirable for the release of the Lien on such released amounts.”

2.    Amendments to Security Agreement and Reaffirmation of Security Interest.

(a)    Effective as of the date of satisfaction of the conditions precedent set forth in
Section 4 below, the Security Agreement is hereby amended as follows:

(i) The definition of “Cash Equivalents” contained in Section 1.3 of the Security Agreement is hereby amended by (i) deleting the word “and” at the end of clause (4), (ii) replacing the period at the end of clause (5) with “; and” and (iii) adding new clause (6) as follows:

“(6)    Cash Equivalent Investments.”

(ii) The following new definition of “Cash Equivalent Investments” is hereby added to Section 1.3 of the Security Agreement in its appropriate alphabetical order therein:

“Cash Equivalent Investments” shall have the meaning set forth in the Credit
Agreement.”

(iii) Section 4.6 of the Security Agreement is hereby amended and restated in its entirety as follows:

“4.6. Deposit Accounts and Cash Equivalent Investments. Each Grantor will, within ninety (90) days of the Agent’s request (and as required pursuant to Section 6.25 of the Credit Agreement), cause each bank or other financial institution in which it maintains (a) a Deposit Account (other than a Deposit Account maintained for collections from retail sales) to enter into a control agreement with the Agent, in form and substance satisfactory to the Agent in order to give the Agent Control of the Deposit Account, (b) other Cash Equivalent Investments to enter into control agreements in form and substance acceptable to the Agent that grant the Agent Control over such investments, or (c) other deposits (general or special, time or demand, provisional or final) to be notified of the security interest granted to the Agent hereunder and cause each such

3


bank or other financial institution to acknowledge such notification in writing. In the case of deposits maintained with Lenders, the terms of such letter shall be subject to the provisions of the Credit Agreement regarding setoffs.”

(b) For the avoidance of doubt, each Grantor hereby reaffirms the security interest granted under the terms and conditions of the Security Agreement and agrees that such security interest remains in full force and effect and is hereby ratified, reaffirmed and confirmed, and each Grantor hereby pledges, assigns and grants to the Agent, on behalf of and for the ratable benefit of the Holders of Secured Obligations and (to the extent specifically provided for in the Security Agreement) their Affiliates, a security interest in all of such Grantor’s right, title and interest, whether now owned or hereafter acquired, in and to the Collateral (as defined in the Security Agreement as amended hereby and including Cash Equivalent Investments) to secure the prompt and complete payment and performance of (i) the Secured Obligations in the case of the Borrower and (ii) the “Guaranteed Obligations” (as defined in the Guaranty) in the case of each other Grantor.

3. Consent. Subject to the satisfaction of the conditions precedent set forth in Section 4 below, and notwithstanding the terms of Section 6.25 of the Credit Agreement as in effect prior to the effectiveness of this Amendment, the Lenders party hereto and the Agent hereby consent to the Collection Account Transfers and agree that the Collection Account Transfers are deemed to have been, and any subsequent actions taken with respect to amounts on deposit in Collection Accounts shall hereafter be, subject to Section 6.25 of the Credit Agreement as amended pursuant to this Amendment.

4. Conditions of Effectiveness. This Amendment shall become effective and be deemed effective as of the date hereof, if, and only if:

(a) the Agent shall have received executed copies of this Amendment from the Borrower, the Subsidiary Grantors and all of the Lenders required to execute and deliver this Amendment pursuant to the terms of the Credit Agreement;

(b) the Agent shall have received those agreements, documents, instruments and other deliverables appearing in Annex A hereto; and

(c) the Borrower shall have paid all fees and expenses of the Agent (including, to the extent invoiced, attorneys’ fees and expenses) in connection with this Amendment.

5. Representations and Warranties of the Borrower and Subsidiary Grantors. The Borrower and each Subsidiary Grantor hereby represents and warrants as follows:

(a) The Credit Agreement and Security Agreement, each as previously executed and amended and as amended hereby constitutes the legal, valid and binding obligation of the Borrower and each Subsidiary Grantor party thereto, and is enforceable against the Borrower and each Subsidiary Grantor party thereto in accordance with its terms, except as enforceability may be limited by (i) bankruptcy, insolvency, fraudulent conveyances, reorganization or similar laws relating to or affecting the enforcement of creditors’ rights generally; (ii) general equitable principles (whether considered in a proceeding in equity or at law); and (iii) requirements of reasonableness, good faith and fair dealing.

(b) (i) The representations and warranties contained in Article V of the Credit Agreement and Article 3 of the Security Agreement are true and correct as of the date hereof, after giving effect to this Amendment, except (x) with respect to Sections 5.5 and 5.7 of the Credit Agreement, the representations and warranties set forth in such Sections shall have been true and correct on and as of the date of the most recent Form 10-K or Form 10-Q filing, as applicable, made by the Borrower with the

4


U.S. Securities and Exchange Commission, and (y) with respect to any other representation and warranty set forth in Article V of the Credit Agreement and Article 3 of the Security Agreement, to the extent such representation or warranty is stated to relate solely to an earlier date, such representation or warranty shall have been true and correct on and as of such earlier date and (ii) after giving effect to this Amendment, no event shall have occurred and then be continuing which constitutes a Default or an Unmatured Default.

(c) The modifications contemplated by this Amendment are permitted under the terms of indentures and other agreements referenced in Section 9.17 of the Credit Agreement that remain in effect as of the date hereof.

(d) The Borrower and each Subsidiary Grantor has the power and authority and legal right to execute and deliver this Amendment and to perform its obligations hereunder. The execution and delivery by the Borrower and each Subsidiary Grantor of this Amendment and the performance of its obligations hereunder have been duly authorized by proper proceedings and the Amendment has been duly executed and delivered by the Borrower and each Subsidiary Grantor. No order, consent, adjudication, approval, license, authorization, or validation of, or exemption by, any governmental or public body or authority, or any subdivision thereof, which has not been obtained by the Borrower or any Subsidiary Grantor, is required to be obtained by the Borrower or any Subsidiary Grantor in connection with the execution and delivery of the Amendment except where failure to obtain the same would not reasonably be expected to have a Material Adverse Effect.

6.    Effect on the Credit Agreement and Security Agreement.

(a) Upon the effectiveness of this Amendment, on and after the date hereof, each reference in the Credit Agreement or the Security Agreement to “this Agreement,” “hereunder,” “hereof,” “herein” or words of like import shall mean and be a reference to the Credit Agreement or Security Agreement, as applicable, as amended and modified hereby.

(b) Except as specifically amended and modified above, the Credit Agreement, the Security Agreement and all other documents, instruments and agreements executed and/or delivered in connection therewith shall remain in full force and effect, and are hereby ratified and confirmed.

(c) The execution, delivery and effectiveness of this Amendment shall neither, except as expressly provided herein, operate as a waiver of any right, power or remedy of the Lenders or the Agent, nor constitute a waiver of any provision of the Credit Agreement, the Security Agreement or any other documents, instruments and agreements executed and/or delivered in connection therewith.

(d)    For the avoidance of doubt, the parties hereto acknowledge and agree that this
Amendment constitutes a Loan Document as defined under the Credit Agreement.

7. Costs and Expenses. The Borrower agrees to pay all reasonable costs, fees and out-of-pocket expenses (including attorneys’ fees and expenses charged to the Agent) incurred by the Agent and the Lenders in connection with the preparation, arrangement, execution and enforcement of this Amendment.

8. Governing Law. THIS AMENDMENT SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK.

9. Headings. Section headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purpose.

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10. Counterparts. This Amendment may be executed by one or more of the parties to the Amendment on any number of separate counterparts and all of said counterparts taken together shall be deemed to constitute one and the same instrument. Delivery of an executed counterpart of a signature page of this Amendment by facsimile shall be effective as delivery of a manually executed counterpart of this Amendment.

11. No Strict Construction. The parties hereto have participated jointly in the negotiation and drafting of this Amendment. In the event an ambiguity or question of intent or interpretation arises, this Amendment shall be construed as if drafted jointly by the parties hereto and no presumption or burden of proof shall arise favoring or disfavoring any party by virtue of the authorship of any provisions of this Amendment.

12. Reaffirmation. Each of the undersigned Subsidiary Grantors and each other Subsidiary Guarantor signatory hereto hereby acknowledges receipt of a copy of this Amendment, and the Borrower and each Subsidiary Grantor and Subsidiary Guarantor affirms the terms and conditions of each Loan Document executed by it, including, without limitation, the Security Agreement and each Guaranty to which it is a party, and acknowledges and agrees that each such Loan Document executed by it in connection with the Credit Agreement remains in full force and effect and is hereby reaffirmed, ratified and confirmed.




The remainder of this page is intentionally blank.



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IN WITNESS WHEREOF, this Amendment has been duly executed as of the day and year first above written.


TESORO CORPORATION,
as the Borrower


By: s Brad S. Lakhia            
Name: Brad S. Lakhia
Title: Vice President and Treasurer


SUBSIDIARY GRANTORS:

TESORO WASATCH, LLC
TESORO COMPANIES, INC.
TESORO ALASKA COMPANY LLC (formerly known as
Tesoro Alaska Company)
TESORO REFINING & MARKETING COMPANY LLC
(formerly known as Tesoro Refining and Marketing Company)
TESORO WEST COAST COMPANY, LLC
TESORO SIERRA PROPERTIES, LLC
TESORO NORTHSTORE COMPANY
TESORO SOUTH COAST COMPANY, LLC
TESORO TRADING COMPANY
TESORO ENVIRONMENTAL RESOURCES COMPANY
TESORO AVIATION COMPANY
TESORO MARITIME COMPANY
TESORO FAR EAST MARITIME COMPANY
GOLD STAR MARITIME COMPANY
CARSON COGENERATION COMPANY
TESORO INSURANCE HOLDING COMPANY
TRANS-FORELAND PIPELINE COMPANY LLC
TESORO RENEWABLES COMPANY LLC
UINTA EXPRESS PIPELINE COMPANY LLC
TESORO SOCAL COGEN COMPANY LLC


By: s Brad S. Lakhia        
Name: Brad S. Lakhia
Title: Vice President and Treasurer



SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT



SUBSIDIARY GRANTORS:

TREASURE FRANCHISE COMPANY LLC

By: s ROBERT R. MOTLEY        
Name: Robert R.Motley
Title: President and Manager


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




Solely with respect to Section 12 hereof:

TESORO CANADA SUPPLY & DISTRIBUTION LTD.
TESORO PANAMA COMPANY, S.A.

By: s BRAD S. LAKHIA        
Name: Brad S. Lakhia
Title: Vice President and Treasurer



SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




JPMORGAN CHASE BANK, NATIONAL ASSOCIATION,
individually, as the Non-Ratable Lender and as Administrative
Agent

By: s J. DEVIN MOCK        
Name: J. Devin Mock
Title: Authorized Officer



SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




THE ROYAL BANK OF SCOTLAND PLC,
as a Lender


By: s SIMON MOCKFORD        
Name: Simon Mockford
Title: Managing Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




WELLS FARGO BANK, N.A.,
as a Lender


By: s MATT HARBOUR        
Name: Matt Harbour
Title: Duly Authorized Signer


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




BANK OF AMERICA, N.A.,
as a Lender


By: s BRANDON WATKINS        
Name: Brandon Watkins
Title: Senior Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT



BARCLAYS BANK PLC,
as a Lender


By: s LUKE SYME            
Name: Luke Syme
Title: Assistant Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




THE BANK OF TOKYO MITSUIBISHI UFJ, LTD.,
as a Lender


By: s TODD VAUBEL        
Name: Todd Vaubel
Title: Vice President






SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT





CITIBANK, N.A.,
as a Lender


By: s BRENDAN MACKAY        
Name: Brendan Mackay
Title: Vice President and Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




CREDIT AGRICOLE CORPORATE & INVESTMENT BANK,
as a Lender


By: s DARRELL STANLEY        
Name: Darrell Stanley
Title: Managing Director


By: s MICHAEL WILLIS        
Name: Michael Willis
Title: Managing Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




MIZUHO BANK, LTD.,
as a Lender


By: s DONNA DEMAGISTRIS        
Name: Donna DeMagistris
Title: Authorized Signatory


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




NATIXIS, NEW YORK BRANCH
as a Lender


By: s JARRETT PRICE        
Name: Jarrett Price
Title: Director


By: s CARLOS QUINTEROS    
Name: Carlos Quinteros
Title: Managing Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT





BANCO BILBAO VIZCAYA ARGENTARIA S.A.,
NEW YORK BRANCH, as a Lender


By: s NURYS MALEKI        
Name: Nurys Maleki
Title: Global Trade Finance


By: s LUCA SACCHI        
Name: Luca Sacchi
Title: Managing Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




BNP PARIBAS,
as a Lender


By: s NICOLAS ANBERREE        
Name: Nicolas Anberree
Title: Vice President


By: s CLAUDIA ZARATE            
Name: Claudia Zarate
Title: Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




DEUTSCHE BANK AG NEW YORK BRANCH,
as a Lender


By: s PETER CUCCHIARA        
Name: Peter Cucchiara
Title: Vice President


By: s MICHAEL SHANNON            
Name: Michael Shannon
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




REGIONS BANK,
as a Lender


By: s GREGORY GARBUZ        
Name: Gregory Garbuz
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




SUNTRUST BANK,
as a Lender


By: s DAN CLUBB        
Name: Dan Clubb
Title: Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




UBS AG, STAMFORD BRANCH,
as a Lender


By: s DARLENE ARIAS        
Name: Darlene Arias
Title: Director


By: s CRAIG PEARSON        
Name: Craig Pearson
Title: Associate Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




THE BANK OF NOVA SCOTIA,
as a Lender


By: s JOHN FRAZELL    
Name: John Frazell
Title: Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




ROYAL BANK OF CANADA,
as a Lender


By: s JASON YORK        
Name: Jason York
Title: Authorized Signatory


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




CIBC INC.,
as a Lender


By: s RICHARD ANTL        
Name: Richard Antl
Title: Authorized Signatory


By: s TRUDY NELSON        
Name: Trudy Nelson
Title: Authorized Signatory


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




FIFTH THIRD BANK,
as a Lender


By: s LARRY HAYES        
Name: Larry Hayes
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




SUMITOMO MITSUI BANKING CORPORATION,
as a Lender


By: s JAMES D. WEINSTEIN        
Name: James D. Weinstein
Title: Managing Director


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




RB INTERNATIONAL FINANCE (USA), LLC,
as a Lender


By: s JOHN A. VALISKA            
Name: John A. Valiska
Title: First Vice President


By: s STEVEN VANSTEENBERGEN    
Name: Steven VanSteenbergen
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




PNC BANK, NATIONAL ASSOCIATION,
as a Lender


By: s ART BOYLE            
Name: Art Boyle
Title: Officer


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




CAPITAL ONE, NATIONAL ASSOCIATION,
as a Lender


By: s NANCY MAK        
Name: Nancy Mak
Title: Senior Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




HSBC BANK USA, NATIONAL ASSOCIATION,
as a Lender


By: s WADIE C. HABIBY        
Name: Wadie C. Habiby
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




U.S. BANK NATIONAL ASSOCIATION,
as a Lender


By: s ROD SWENSON        
Name: Rod Swenson
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




AMEGY BANK NATIONAL ASSOCIATION,
as a Lender


By: s MARK A. SERICE        
Name: Mark A. Serice
Title: Senior Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




CITY NATIONAL BANK, a national banking association,
as a Lender


By: s MIA BOLIN            
Name: Mia Bolin
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




FROST BANK,
as a Lender


By: s SARAH CERNOSEK        
Name: Sarah Cernosek
Title: Senior Vice President



SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




COMERICA BANK,
as a Lender


By: s L. J. PERENYL        
Name: L. J. Perenyl
Title: Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




CREDIT SUISSE AG, CAYMAN ISLANDS BRANCH,
as a Lender


By: s MIKHAIL FAYBUSOVICH        
Name: Mikhail Faybusovich
Title: Authorized Signatory


By: s GREGORY FANTERI        
Name: Gregory Fanteri
Title: Authorized Signatory


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




AMALGAMATED BANK,
as a Lender


By: s MICHAEL L. LAMANES        
Name: Michael L. LaManes
Title: First Vice President


SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT




SIEMENS FINANCIAL SERVICES, INC.,
as a Lender


By: s JEFFREY B. IERVESE        
Name: Jeffrey B. Iervese
Title: Vice President


By: s JOHN FINORE        
Name: John Finore
Title: Vice President




SIGNATURE PAGE TO AMENDMENT NO.2 AND CONSENT
TO SIXTH AMENDED AND RESTATED CREDIT AGREEMENT AND
AMENDMENT NO. 3 TO
AMENDED AND RESTATED SECURITY AGREEMENT



ANNEX A
TO
OMNIBUS AMENDMENT


List of Closing Deliverables1 

1.
Omnibus Amendment No. 2 to Sixth Amended and Restated Credit Agreement and Amendment No. 3 to Amended and Restated Security Agreement (the “Amendment”) by and among the Borrower, the Subsidiary Grantors, the Lenders signatory thereto and the Agent.

2.
Evidence that the credit facility evidenced by that certain Term Loan Credit Agreement, dated as of January 28, 2013, among the Borrower, JPMorgan Chase Bank, National Association, as administrative agent and collateral agent, and the lenders party thereto, has been terminated and cancelled, and that all indebtedness thereunder shall have been fully repaid and any and all liens thereunder shall have been terminated.

3.
UCC-1 Financing Statements naming each Credit Party as debtor and the Agent as secured party filed in the appropriate offices in the jurisdictions as described on Schedule I hereto.

4.
Control Agreement with respect to the JPMorgan Money Market Mutual Fund Interests.

5.
Opinion of Simpson Thacher & Bartlett LLP, special outside counsel to the Borrower and theSubsidiary Grantors addressed to the Agent and the Lenders.

6.
Certificate of the Secretary or an Assistant Secretary of each Grantor certifying (i) that there have been no changes in the Articles or Certificate of Incorporation, Certificate of Formation or other analogous charter document of such Credit Party, either as attached thereto and as certified as of a recent date by the Secretary of State (or the equivalent thereof) of its jurisdiction of organization since the date of the certification thereof by such Secretary of State (or equivalent thereof) or as previously certified to the Agent as of a prior date pursuant to documentation delivered in connection with the closing of the Credit Agreement, (ii) that there has been no change to the By-Laws, Limited Liability Company Agreement, Partnership Agreement or other analogous organizational document of such Grantor as previously certified to the Agent as of a prior date pursuant to documentation delivered in connection with the closing of the Credit Agreement, (iii) resolutions of the Board of Directors, Board of Managers or other analogous governing body of such Grantor authorizing the execution, delivery and performance of the Amendment and the Credit Agreement and Security Agreement as amended thereby, and (iv) the names and true signatures of the incumbent officers of such Grantor authorized to sign the Amendment and, in the case of the Borrower, authorized to request a Borrowing and the issuance, amendment, renewal or extension of a Letter of Credit under the Credit Agreement.












___________________________
1 Items appearing in bold and italics shall be prepared and/or provided by the Borrower and/or Borrower’s counsel.




Schedule I

UCC-1 Financing Statements

Debtor
Secured Party
Filing Jurisdiction
Tesoro
Corporation
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Carson
Cogeneration
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Gold Star
Maritime
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Alaska
Company LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Aviation
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro
Companies, Inc.
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro
Environmental Resources Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Far East
Maritime
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Insurance
Holding Company
JPMorgan Chase
Bank, National
Association, as
Secretary of State of
Delaware





 
Agent
 
Tesoro Maritime
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Northstore
Company
JPMorgan Chase
Bank, National Association, as Agent
Department of
Natural Resources of
Alaska
Tesoro Refining & Marketing
Company LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro
Renewables
Company LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Sierra
Properties, LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro SoCal
Cogen Company
LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro South
Coast Company, LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Trading
Company
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro Wasatch,
LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Tesoro West Coast
Company, LLC
JPMorgan Chase
Bank, National
Association, as
Secretary of State of
Delaware










 
Agent
 
Trans-Foreland
Pipeline Company
LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Treasure Franchise
Company LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware
Uinta Express
Pipeline Company
LLC
JPMorgan Chase
Bank, National Association, as Agent
Secretary of State of
Delaware




Exhibit 10.4


TESORO CORPORATION

EXECUTIVE DEFERRED COMPENSATION PLAN

ARTICLE I
GENERAL PROVISIONS

1.1     Establishment and Purpose.

WHEREAS, Tesoro Corporation (the "Company") previously established the Tesoro Corporation Executive Deferred Compensation Plan (the "Plan"), as amended, primarily for the purpose of providing benefits for a select group of management and highly compensated employees of the Company and its Subsidiaries so as to provide benefits comparable to those not provided under the Tesoro Corporation Thrift Plan due to salary and deferral limitations imposed under the Code;

WHEREAS, the Plan is intended to qualify as a "top hat" plan under Sections 201(2), 301(a)(3) and 401(a)(l) of ERISA; and

WHEREAS, the Company previously amended and restated the Plan, effective January 1, 2009, to comply with Regulations under Section 409A of the Code and to clarify certain provisions of the Plan relating to Supplemental Discretionary Awards;

WHEREAS, the Company desires to amend and restate the Plan to incorporate Amendments No.1-4 and to effectuate certain design changes, effective for contributions made to the Plan on account of a Participant’s service on or after January 1, 2016;

WHEREAS, all contributions made to the Plan on account of a Participant’s service prior to January 1, 2016 shall remain subject to the Plan terms prior to this amended and restated Plan;

NOW, THEREFORE, the Company adopts this amended and restated Tesoro Corporation Executive Deferred Compensation Plan, effective January 1, 2016, as follows:

1.2     Definitions.

"Affiliate" means each entity that would be considered a single employer with the Company under Section 414(b) or Section 414(c) of the Code, except that the phrase "at least 50%" shall be substituted for the phrase "at least 80%" as used therein.

"Aggregated Plan" means all agreements, methods, programs and other arrangements that are aggregated with this Plan under Section 1.409A-1(c) of the Regulations.

"Beneficiary" means the person or persons designated by a Participant as his beneficiary hereunder in accordance with the provisions of Article V.

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"Board" means the Board of Directors of the Company.

"Bonus Compensation" means, as determined in the sole discretion of the Committee, such annual bonus or other bonus paid to a Participant including, but not limited to, executive bonus and long-term incentive bonus, but excluding special compensation, bonuses paid because of service overseas, expense allowances, all other extraordinary compensation, and, except as permitted with the prior written consent of the Committee, excluding Sign-On Bonus and Retention Bonus. For the avoidance of doubt, the Committee shall have the sole discretion to determine at any time which types of Bonus Compensation are deferrable under the Plan.

"Chief Executive Officer" means the Chief Executive Officer of the Company.

"Code" means the Internal Revenue Code of 1986, as amended from time to time.

"Committee" means the Employee Benefits Committee appointed by the Compensation Committee of the Board, or such other committee designated by the Compensation Committee of the Board to discharge the duties of the Committee hereunder.

"Company" means Tesoro Corporation, a Delaware corporation, or any successor thereto.

"Company Matching Contribution" means the employer matching contributions allocated to the Participant's account under the Thrift Plan for the Plan Year.

"Compensation" shall, unless otherwise determined by the Committee, for purposes of Sections 2.1 and 2.2 of the Plan, have the meaning assigned thereto in the Thrift Plan (determined without regard to any limits imposed on Compensation by the Code, but including amounts voluntarily deferred under the terms of this Plan and any 401(k) deferrals under the Thrift Plan) and shall, as applicable, include Bonus Compensation.

"Corporate Change in Control" means (i) there shall be consummated (A) any consolidation or merger of Company in which Company is not the continuing or surviving corporation or pursuant to which shares of Company's Common Stock would be converted into cash, securities or other property, other than a merger of Company where a majority of the board of directors of the surviving corporation are, and for a one-year period after the merger continue to be, persons who were directors of Company immediately prior to the merger or were elected as directors, or nominated for election as director, by a vote of at least two-thirds of the directors then still in office who were directors of Company immediately prior to the merger, or (B) any sale, lease, exchange or transfer (in one transaction or a series of related transactions) of all or substantially all of the assets of Company, or (ii) the shareholders of Company shall approve any plan or proposal for the liquidation or dissolution of Company, or (iii) (A) any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934), other than Company or a Subsidiary or any employee benefit plan sponsored by Company or a Subsidiary, shall become the beneficial owner (within the meaning of Rule 13d-3 under the Securities Exchange Act of 1934) of securities of Company representing 35 percent or more of the combined voting power of Company's then outstanding securities ordinarily (and apart from rights accruing in special

2

circumstances) having the right to vote in the election of directors, as a result of a tender or exchange offer, open market purchases, privately negotiated purchases or otherwise, and (B) at any time during a period of one-year thereafter, individuals who immediately prior to the beginning of such period constituted the Board shall cease for any reason to constitute at least a majority thereof, unless election or the nomination by the Board for election by Company's shareholders of each new director during such period was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period.

"Deferral Account" means the bookkeeping account(s) established on behalf of a Participant to track the Participant's supplemental benefits as described in Article II hereof. A Deferral Account can refer to either a Termination Account or Specified Date Account as defined herein.

"Deferral Election" means an election by a Participant to defer Compensation in accordance with the provisions of Section 2.1 of the Plan, including an election as to the Distribution Date and Distribution Option.

"Deferrals" shall have the meaning ascribed thereto in Section 2.1(b) hereof.
    
"Disability" means disability as determined under the Retirement Plan.
    
"Disability Date" means the date on which a Participant's Separation from Service due to Disability occurs.
    
"Distribution Date" means the date on which distribution of the applicable portion of a Participant's Deferral Account (other than the portion, if any, of such Deferral Account that is attributable to Supplemental Discretionary Awards) is to commence. Distribution Dates are determined according to each Participant's Deferral Elections for each Deferral Account or as otherwise provided under the terms of the Plan.
    
"Distribution Option" means the form in which distribution of the applicable portion of a Participant's Deferral Account (other than the portion, if any, of such Participant's Deferral Account that is attributable to Supplemental Discretionary Awards) is to be made. Distribution Options are determined according to each Participant's Deferral Elections for each Plan Year or as otherwise provided under the terms of the Plan.

"Earnings" shall have the meaning ascribed thereto in Section 2.4(b) of the Plan.

"ERISA" means the Employee Retirement Income Security Act of 1974, as amended
from time to time.

“409A Change in Control” means any of the following events: (i) a change in the ownership of the Company, (ii) a change in the effective control of the Company, or (iii) a change in the ownership of a substantial portion of the assets of the Company.


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For purposes of this definition, a change in the ownership of the Company occurs on the date on which any one person, or more than one person acting as a group, acquires ownership of stock of the Company that, together with stock held by such person or group constitutes more than 50% of the total fair market value or total voting power of the stock of the Company. A change in the effective control of the Company occurs on the date on which either: (i) a person, or more than one person acting as a group, acquires ownership of stock of the Company possessing 30% or more of the total voting power of the stock of the Company, taking into account all such stock acquired during the 12-month period ending on the date of the most recent acquisition, or (ii) a majority of the members of the Board is replaced during any 12-month period by directors whose appointment or election is not endorsed by a majority of the members of the Board prior to the date of the appointment or election, but only if no other corporation is a majority shareholder of the Company. A change in the ownership of a substantial portion of assets occurs on the date on which any one person, or more than one person acting as a group, other than a person or group of persons that is related to the Company, acquires assets from the Company that have a total gross fair market value equal to or more than 40% of the total gross fair market value of all of the assets of the Company immediately prior to such acquisition or acquisitions, taking into account all such assets acquired during the 12-month period ending on the date of the most recent acquisition.

An event constitutes a 409A Change in Control with respect to a Participant only if the Participant performs services for the Company that has experienced the 409A Change in Control, or the Participant’s relationship to the affected Company otherwise satisfies the requirements of Treasury Regulation Section 1.409A-3(i)(5)(ii). The determination as to the occurrence of a 409A Change in Control shall be based on objective facts and in accordance with the requirements of Section 409A of the Code.

"Insolvency" means, with respect to the Company: (1) an adjudication of bankruptcy; (2) an assignment for the benefit of creditors of or by the Company; (3) a material part or all of the property of the Company becomes subject to the control and direction of a receiver, which receivership is not dismissed within sixty (60) days of such receiver's appointment; or (4) the filing by the Company of a petition for relief under any federal or other bankruptcy or other insolvency law or for an arrangement with creditors.

"Participant" means any employee who has satisfied the eligibility requirements set forth in Section 1.4 of the Plan and has a credit to a Deferral Account or has completed a Deferral Election.

"Performance-Based Compensation" means the total amounts payable to a Participant as remuneration based upon the Participant's performance of services for the Company over a period of not less than twelve (12) months, the payment of which or the amount of which is contingent on the satisfaction of established organizational or individual performance criteria, and that otherwise meets the definition of "performance-based compensation", as that term is defined in Section 1.409A-2(a)(7) of the Regulations. For these purposes, Performance-Based Compensation shall be based upon criteria established no later than 90 days following commencement of the applicable performance period.


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"Person" means any individual, corporation, joint venture, association, joint stock company, trust, unincorporated organization or government or any agency or political subdivision thereof.

"Plan Year" means the twelve-month period beginning each January 1.

"Regulations" means the Treasury Regulations promulgated under the Code.

“Retention Bonus” means a cash-based award outside of an employee's regular compensation that is offered as an incentive to keep such employee on the job during a particularly important business cycle (such as a merger or acquisition).

"Retirement Plan" means the Tesoro Corporation Retirement Plan, as amended.

"Separation from Service" means a reasonably anticipated permanent reduction in the level of bona fide services performed by the Participant for the Company and its Affiliates to 20% or less of the average level of bona fide services performed by the Participant for the Company and its Affiliates (whether as an employee or an independent contractor) in the immediately preceding thirty-six (36) months (or the full period of service to the Company and its Affiliates if the Participant has been providing services to the Company and its Affiliates for fewer than thirty-six (36) months). The determination of whether a Separation from Service has occurred shall be made by the Committee in accordance with the provisions of Section 409A of the Code and the Regulations promulgated thereunder.

“Sign-On Bonus” means a cash-based award that is payable to an eligible individual pursuant to the terms and conditions of such individual’s offer of employment to induce him or her to become an employee of the Company, or any similar item of compensation.

“Specified Date Account” means a Deferral Account established by the Committee to record the amounts payable to a Participant at a future date as specified in such Participant’s Deferral Election or, as applicable, pursuant to a Supplemental Discretionary Award. Unless otherwise permitted by the Committee, a Participant may maintain no more than five Specified Date Accounts. A Specified Date Account may be identified herein and in enrollment materials as an “In-Service Account”, “Fixed Date Account” or such other name as established by the Committee without affecting the meaning thereof.

"Subsidiary" means any entity in which the Company owns or otherwise controls, directly or indirectly, stock or other ownership interests having the voting power to elect a majority of the board of directors, or other governing group having functions similar to a board of directors, as determined by the Committee.

"Supplemental Discretionary Award" means a discretionary amount, if any, credited to a Participant's Deferral Account pursuant to Section 2.2(b).


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“Supplemental Discretionary Profit Sharing Award” means a discretionary amount, if any, credited to a Participant’s Deferral Account pursuant to Section 2.2(c).

"Supplemental Match" means an amount credited to the Participant's Deferral Account pursuant to Section 2.2(a).

“Termination Account” means a Deferral Account established by the Committee to record the amounts payable to a Participant upon Separation from Service. Unless a Specified Date Account has been established by or on behalf of a Participant, all Deferrals and Company contributions shall be allocated to a Termination Account on behalf of the Participant.

"Thrift Plan" means the Tesoro Corporation Thrift Plan, as amended.

"Unforeseeable Emergency" means a severe financial hardship to the Participant resulting from an illness or accident of the Participant, the Participant's spouse, or a dependent (as determined under Section 152 of the Code, but without regard to subsections (b)(1), (b)(2) and (d)(1)(B) of Section 152) of the Participant, loss of the Participant's property due to casualty (including the need to rebuild a home following damage to a home not otherwise covered by insurance), or other similar extraordinary and unforeseeable circumstances arising as a result of events beyond the control of the Participant.

1.3     Administration.

(a) The Committee shall administer the Plan and have sole and absolute authority and discretion to decide all matters relating to the administration of the Plan, including, without limitation, determining the rights and status of Participants or their Beneficiaries under the Plan. The Committee is authorized to interpret the Plan, to adopt administrative rules, regulations, and guidelines for the Plan, and may correct any defect, supply any omission or reconcile any inconsistency or conflict in the Plan. The Committee's determinations under the Plan need not be uniform among all Participants, or classes or categories of Participants, and may be applied to such Participants, or classes or categories of Participants, as the Committee, in its sole and absolute discretion, considers necessary, appropriate or desirable. All determinations by the Committee shall be final, conclusive and binding on the Company, the Participant and any and all interested parties.

(b) The Committee may delegate such of its powers and authority under the Plan to the Company's officers or such other person(s) as it deems necessary or appropriate. In the event of such delegation, all references to the Committee in this Plan shall be deemed references to such officers or such other person(s) as it relates to those aspects of the Plan that have been delegated.

(c) Any action taken by the Committee with respect to the rights or benefits under the Plan of any Participant shall be subject to correction by the Committee as to payments not yet made to such person, and acceptance of any deferred compensation benefits under the Plan constitutes acceptance of and agreement to the Committee's or the Company's

6

making any appropriate adjustments in future payments to such person (or to recover from such person) any excess payment or underpayment previously made to him.

(d) Notwithstanding any provision of the Plan to the contrary, if any benefit provided under this Plan is subject to the provisions of Section 409A of the Code and the Regulations issued thereunder, the provisions of the Plan shall be administered, interpreted and construed in a manner necessary to comply with Section 409A and the Regulations issued thereunder (or disregarded to the extent such provision cannot be so administered, interpreted or construed).

1.4     Eligibility and Participation.

(a) Participation in the Plan is limited to those individuals who are eligible to participate in the Thrift Plan and are within the category of a select group of management and highly compensated employees as referred to in Sections 201(2), 301(a)(3) and 401(a)(l) of ERISA, and who are within those classifications of officers and key management employees of the Company and its Subsidiaries as determined in the sole discretion of the Compensation Committee of the Board for each Plan Year. Plan eligibility for new participants shall commence as of the first day of the Plan Year or the first day of the 7th month of the Plan Year (each, a "semi-annual entry date") as determined by the Compensation Committee of the Board. Employees hired, promoted or reclassified to a category of officer and key management employees of the Company and/or its Subsidiaries eligible for participation shall become eligible as of the semiannual entry date determined by the Compensation Committee of the Board. A newly eligible Participant shall make his or her Deferral Elections within the designated time periods as set forth in Section 2.1 hereof.

(b) A Participant shall cease to be a Participant upon receiving payment for the full amount of benefits to which the Participant is entitled under the Plan. A Participant who becomes ineligible to participate based on eligibility status as determined pursuant to Section 1.4(a) of this Plan shall become an ineligible Participant at the time determined by the Committee. Once a Participant is no longer eligible to actively participate in the Plan, he shall not be entitled to defer Compensation pursuant to Section 2.1 or receive a Supplemental Match, Supplemental Discretionary Profit Sharing Award or Supplemental Discretionary Award (except to the extent otherwise provided in an Award Agreement) under Section 2.2.

ARTICLE II
SUPPLEMENTAL BENEFITS

2.1     Supplemental Deferral Elections.

(a) Each Participant shall be eligible to elect to defer Compensation under the Plan with respect to a Plan Year in accordance with the terms of the Plan and the rules and procedures established by the Committee. Deferral Elections under the Plan are entirely voluntary and, with respect to the Plan Year to which they relate, following the end of the

7

election period established under Section 2.1(b), are irrevocable, except as provided in Sections 2.1(e) and 3.5 hereof.

(b) A Participant may make a Deferral Election by filing a written or electronic election with the Committee or its designee directing the Company to reduce the Participant's Compensation, including as applicable, Bonus Compensation and to credit the amount of any such reduction (the "Deferrals") to the Deferral Account established and maintained for such Participant pursuant to Section 2.4 of the Plan. Each Deferral Election shall specify whether to allocate Deferrals to a Termination Account or one or more Specified Date Accounts (and if no such designation is made, Deferrals shall automatically be allocated to the Termination Account). Each Deferral Election shall be partitioned for each available deferral source (e.g. salary and each type of bonus). The Committee may, in its sole discretion, establish a minimum deferral period for the establishment of a Specified Date Account (e.g. the third Plan Year following the year that the Deferral is allocated to such account). Deferral Elections hereunder shall be made in accordance with the terms of the Plan and the rules established by the Committee and, except as provided below, must be filed not later than December 31 of the calendar year preceding the Plan Year to which the election relates (or at such earlier times as may be established by the Committee) (such period established by the Committee on an annual basis shall be the “Annual Enrollment Period”). With regard to Performance- Based Compensation, such Deferral Elections shall initially be permitted to be made in the Annual Enrollment Period preceding the Plan Year(s) to which such election relates and subsequently may be changed, elected or withdrawn on or before June 30 of the calendar year that coincides with the applicable performance period in accordance with Section 409A of the Code and the Regulations. A Participant may revoke or modify such election up until the end of the election period established by the Committee under this Section 2.1(b). Notwithstanding the preceding, for the first Plan Year in which a Participant is eligible to participate in the Plan, a Participant's initial Deferral Election may be made within thirty (30) days after the date the Participant becomes eligible to participate in the Plan and shall apply only to Compensation and Bonus Compensation paid for services to be performed after the election for such Plan Year in accordance with Section 409A of the Code. Unless otherwise determined by the Committee, a Deferral Election must be filed each Plan Year, and will not carry over from Plan Year to Plan Year.

(c) Deferrals shall be credited to each Participant's Deferral Account at such time or times as determined by the Committee; provided, however, that Deferrals shall be credited to each Participant's Deferral Account not later than thirty (30) days after the date on which such Compensation would have otherwise been paid, without regard to whether or not the Participant has reached the limit on 401(k) deferrals under the Thrift Plan. Deferrals shall be deemed to be invested in accordance with a Participant's investment designations as permitted under Section 2.4(b).

(d) Unless otherwise determined by the Committee, a Participant may elect to defer up to 50% of Compensation (exclusive of Bonus Compensation) and up to 100% of Bonus Compensation payable to the Participant. Notwithstanding the foregoing, the Committee may implement additional conditions with respect to a Participant’s Deferral Election,

8

including but not limited to applying deferral percentages only to amounts in excess of certain thresholds.

(e) Notwithstanding the foregoing and unless otherwise determined by the Committee, a Deferral Election shall automatically terminate on the earliest to occur of: (1) the end of the Plan Year to which the Deferral Election applies; (2) the termination of a Participant's employment for any reason; (3) the Committee's determination that the Participant is no longer eligible to participate in the Plan; or (4) the termination or discontinuance of the Plan.

(f) Each Participant shall at all times be vested in the portion of his Deferral Account attributable to Deferrals, including Earnings thereon.

2.2
Supplemental Match, Discretionary Profit Sharing Awards and Discretionary Awards.

(a) With respect to each Plan Year and to the extent provided under this Section 2.2, the Company shall credit a supplemental matching award ("Supplemental Match") to each eligible Participant's Deferral Account. The Supplemental Match shall be in such percentage of the Participants’ Compensation (excluding Bonus Compensation) deferred under this Plan as shall be determined by the Compensation Committee of the Board in its sole discretion from year to year. The Supplemental Match shall apply to each Participant as of the first payroll period during the Plan Year in which such Participant’s Compensation (including Bonus Compensation) exceeds the limitations imposed under Section 401(a)(17) of the Code and shall be credited to the Participant’s Deferral Account for such payroll period and each subsequent payroll period during the Plan Year in which the Participant is eligible for the Supplemental Match. The Supplemental Match shall be credited to such Participant’s Termination Account or, as applicable, Specified Date Account (determined by the Deferral Election of such Participant for the Deferral to which such Supplemental Match relates) within thirty (30) days of such Deferral (recognizing that the Supplemental Match relates only to Deferrals of Compensation exceeding the statutory limit set forth above. Those Participants eligible to participate in the Company's Executive Security Plan, or who, through the terms of an individual employment agreement have an entitlement to supplemental retirement benefits, shall not be eligible to participate in the Supplemental Match. In the event a Participant subsequently loses eligibility to participate in the Executive Security Plan or his employment agreement is amended to eliminate supplemental retirement benefits, such Participant shall regain eligibility to share in the Supplemental Match for that portion of the Plan Year following such Participant's loss of eligibility to participate in the Executive Security Plan or elimination of supplemental retirement benefits as set forth herein. Participants who become eligible for participation in the Executive Security Plan, or who are granted supplemental retirement benefits through an individual employment agreement will be allowed to retain the Supplemental Match contributed up to such eligibility, subject to the normal vesting provisions in Section 2.2(e).


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(b) With respect to any Plan Year and to the extent provided under this Section 2.2, the Company may credit a Supplemental Discretionary Award (the "Supplemental Discretionary Award") to any eligible Participant's Deferral Account. The determination of a Participant to whom such Supplemental Discretionary Award applies, as well as the amount of such award, if any, shall be in the sole discretion of the Chief Executive Officer, pursuant to an agreement between the Company and such Participant (the "Award Agreement"), provided, however, that deferrals of Supplemental Discretionary Awards may be negotiated with a Participant prior to the date the Participant has a legally binding right to such award. A Supplemental Discretionary Award shall be credited to a Participant’s Termination Account or, as applicable, Specified Date Account in accordance with the provisions of the applicable Award Agreement.

(c) With respect to any Plan Year for which the Company makes a profit sharing contribution to the Thrift Plan and for which a Participant has Compensation (including Bonus Compensation) that exceeds the limitations imposed under Section 401(a)(17) of the Code, to the extent provided under this Section 2.2, the Company may credit to such Participant’s Deferral Account a discretionary profit sharing award. Such award, if any, shall be a percentage of such excess compensation that may or may not be equal to the percentage of compensation contributed for such Plan Year as a profit sharing contribution on behalf of participants in the Thrift Plan. Further, for any Plan Year in which a Participant is not able to receive the entire allocation to which such Participant would otherwise be entitled under the terms of the Thrift Plan due solely to the limitations of Section 415 of the Code, the Company may credit to such Participant’s Deferral Account the amount by which such Participant’s allocation to the Thrift Plan would otherwise exceed the limits of Section 415 for such Plan Year. Amounts, if any, credited under this section 2.2(c) shall be “Supplemental Discretionary Profit Sharing Awards”. Supplemental Discretionary Profit Sharing Awards, if any, will be credited to the Participant's Termination Account or, as applicable, Specified Date Account in accordance with the Deferral Election of such Participant for the Plan Year to which such Supplemental Discretionary Profit Sharing Award relates.

(d) Supplemental Match, Supplemental Discretionary Awards, and Supplemental Discretionary Profit Sharing Awards shall be credited to a Participant’s Termination Account or, as applicable, Specified Date Account as provided above and shall be deemed invested in the same manner in which the remainder of such account is deemed to be invested under Section 2.4(b).

(e) Subject to Section 2.3 and Exhibit 1 hereof, each Participant shall vest in the portion of his Deferral Account attributable to a Supplemental Match upon the completion of three (3) years of service and to that portion of his Deferral Account attributable to a Supplemental Discretionary Profit Sharing Award upon the completion of one (1) year of service. Years of service shall be determined in accordance with the methodology set forth in the Thrift Plan for determining years of service for vesting purposes thereunder. Each Participant shall vest in that portion of his Deferral Account attributable to a Supplemental Discretionary Award in accordance with the provisions of the Award Agreement pursuant to which such Supplemental Discretionary Award is credited.

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2.3     Change in Control.

In the event of a Corporate Change in Control, the portion of a Participant's Deferral Account attributable to any Supplemental Match, Supplemental Discretionary Profit Sharing Award, and any Supplemental Discretionary Award shall become fully vested. A Corporate Change in Control is not an event which triggers an automatic distribution of benefits.

2.4     Deferral Accounts/Earnings.

(a) Unless otherwise determined by the Committee, the Company shall maintain on behalf of each Participant separate Deferral Account(s), which shall consist of a Termination Account and, as applicable, Specified Date Accounts up to the maximum permitted under this Plan.

(b) The Participant's Termination Account and, as applicable, Specified Date Accounts shall be adjusted by an amount equal to the amount that would have been earned (or lost) if the Deferrals of such Participant and Company contributions credited on behalf of such Participant under this Plan had been invested in hypothetical investments designated by the Participant from time to time, based on a list of hypothetical investments provided by the Committee from time to time (such hypothetical earnings or losses shall be referred to as "Earnings"); provided, however, in no event shall the common stock of the Company or any Subsidiary ever constitute a hypothetical investment maintained under the Plan. The Participant shall designate the investments used to measure Earnings from the list of authorized investments provided by the Committee by completing the appropriate form (or electronically via the website made available for such purpose) or in such other manner as the Committee may designate from time to time. The Participant may change such designations at such times as are permitted by the Committee, provided that the Participant shall be entitled to change such designations at least quarterly. Earnings shall be credited to the Participant's Deferral Account at least annually (or more frequently at the discretion of the Committee). Earnings shall be credited to a Deferral Account until all payments with respect to such account have been made under this Plan. Neither the Company nor the Committee shall act as a guarantor, or be liable or otherwise responsible for the investment performance of the designated investments (including any losses sustained by a Participant) with respect to a Participant's Deferral Account.

(c) Each Participant shall be vested in his Deferral Account balances in accordance with the vesting designated in Sections 2.1(f), 2.2(e) and 2.3 hereof, or, as applicable, pursuant to Exhibit 1.

ARTICLE III
DISTRIBUTIONS

3.1     Termination Account Distribution Dates.


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Except in the event of death or a Separation from Service due to Disability, distributions of a Participant’s Termination Account upon such Participant’s Separation from Service shall be made or, as applicable, commence on (i) the first business day of the January immediately following such Separation from Service or (ii) if later, the first business day of the seventh month following the month in which such Separation from Service occurs. Notwithstanding the foregoing, distribution of that portion of a Participant's Termination Account that is attributable to Supplemental Discretionary Awards shall be made at such time as may be designated and set forth in the Award Agreement pursuant to which such Supplemental Discretionary Award is credited. Each distribution shall be valued as of the last business day of the month immediately
preceding the month in which such distribution occurs.

3.2     Termination Account Distribution Option/Manner of Payment.

The Distribution Option for a Participant’s Termination Account shall be determined in accordance with such election procedures as are established by the Committee and distributions shall, in accordance with such Participant’s Deferral Election, be paid in the form of a lump sum or in installments over a period of 2-to-15 years; provided, however, that the Distribution Option must be established at the time of such Participant's Deferral Election, in accordance with the requirements of Section 2.1 hereof, and must be in a form acceptable to the Committee as determined from time to time. Notwithstanding the preceding provisions of this Section 3.2, if a Participant fails to designate a form of distribution, or if the balance in the Participant's Deferral Account(s) in the aggregate is less than $100,000 at such Participant’s Separation from Service, the distribution will be paid in the form of a lump sum regardless of the Participant's Deferral Election. Notwithstanding the foregoing, distribution of that portion of a Participant's Termination Account that is attributable to Supplemental Discretionary Awards shall be made in such manner as may be designated and set forth in the Award Agreement pursuant to which such Supplemental Discretionary Award is credited. All payments under the Plan shall be made in cash.

3.3     Specified Date Account Distribution Dates.

Distribution Dates for a Participant's Specified Date Account(s) shall be established and determined in accordance with the Participant's Deferral Elections. A Participant must choose a designated Distribution Date for each Specified Date Account among the following: (i) benefits to be paid or, as applicable, commence on the designated Distribution Date regardless of whether such Participant’s employment status with the Company or any Affiliate (a “Future Date Account”) or (ii) benefits to be paid or, as applicable, commence at the earlier of the designated Distribution Date or such Participant’s Separation from Service (an “In-Service Account”). Notwithstanding the foregoing, distribution of that portion of a Participant's Specified Date Account that is attributable to Supplemental Discretionary Awards shall be made at such time as may be designated and set forth in the Award Agreement pursuant to which such Supplemental Discretionary Award is credited. Payment of each Specified Date Account will be made or, as applicable, commence on the first business day of the month immediately following the month in which the Distribution Date or, as applicable, the date set forth in the Award Agreement occurs and shall be valued as of the last business day of the month immediately preceding the month in which such distribution occurs.

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With respect to a Future Date Account, the vested portion of such account will be paid only in accordance with the Distribution Date elected by the Participant or, as applicable, the date set forth in the Award Agreement, notwithstanding any intervening Separation from Service of such Participant prior to such Distribution Date.

With respect to an In-Service Account, the vested portion of such account will be paid or, as applicable, commence in accordance with the Distribution Date elected by the Participant or, as applicable, the date set forth in the Award Agreement, unless there is an intervening Separation from Service of such Participant prior to the commencement of the distribution of such In-Service Account, in which case, such In-Service Account shall be paid at the same time as such Participant’s Termination Account.

Any Specified Date Account of a Participant for which distribution has commenced prior to such Participant’s Separation from Service shall continue distributions in the manner originally elected by the Participant for such account, or, as applicable, set forth in such Participant’s Award Agreement, notwithstanding any subsequent Separation from Service of such Participant.

3.4     Specified Date Account Distribution Option/Manner of Payment.

Subject to Section 3.3, a Participant’s Distribution Option for a Specified Date Account shall be determined in accordance with such election procedures as are established by the Committee and distributions shall, in accordance with such Participant’s Deferral Election, be paid in the form of a lump sum or in installments over a period of 2-to-5 years; provided, however, that the Distribution Option must be established at the time of the Participant's Deferral Election, in accordance with the requirements of Section 2.1 hereof, and must be in a form acceptable to the Committee as determined from time to time. Notwithstanding the preceding provisions of this Section 3.4, if a Participant fails to designate a form of distribution, or if the balance in the Participant's Deferral Account(s) in the aggregate is less than $100,000 at such Participant’s Separation from Service, the distribution will be paid in the form of a lump sum regardless of the Participant's Deferral Election. Notwithstanding the foregoing, distribution of that portion of a Participant's Specified Date Account that is attributable to Supplemental Discretionary Awards shall be made in such manner as may be designated and set forth in the Award Agreement pursuant to which such Supplemental Discretionary Award is credited. All payments under the Plan shall be made in cash.

3.5     Modification of Distribution Elections.

A Participant has the right to change any Distribution Date or Distribution Option associated with the Deferral Account previously designated by the Participant in one or more Deferral Elections pursuant to this Article III; provided, however, that: (1) the Participant must file an election designating the new Distribution Date and Distribution Option at least one year prior to the Distribution Date previously designated; (2) the new Distribution Option may extend, but not accelerate, payments; and (3) the new election must also provide that the new Distribution Date be a minimum of five years later than the existing Distribution Date. Any such election shall be made

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in accordance with such rules and procedures as are established by the Committee and shall not take effect for at least twelve (12) months after the date on which such election is made.

3.6     Separation from Service.

Notwithstanding the foregoing provisions, in the event of a Participant's Separation from Service for any reason other than death or Disability, the Participant will receive a payment of all vested amounts credited to the Participant's Deferral Accounts (other than Future Date Accounts and In-Service Accounts that have commenced distribution) as elected by the Participant pursuant to Section 3.2, subject to any modifications elected by the Participant pursuant to Section 3.5, or as otherwise provided in Section 3.2 hereof. Any portion of a Participant's Deferral Account attributable to a Supplemental Match, Supplemental Discretionary Profit Sharing Award, or a Supplemental Discretionary Award that is not vested on the date of such Participant's Separation from Service shall be forfeited by the Participant should he or she fail to satisfy the vesting conditions of Sections 2.1(f), 2.2(e) or 2.3. Such forfeited amount shall revert to the Company and shall remain a general corporate asset to be used for any purpose determined by the Company.

3.7     Death.

Notwithstanding the foregoing provisions, the Beneficiary or Beneficiaries of a Participant shall be entitled to receive the entire amount credited to such Participant's Deferral Accounts (including all Specified Date Accounts) at the time of such Participant's death, valued as of the last business day of the month in which such Participant’s death occurred. Any unvested amounts remaining in such Participant's Deferral Accounts shall immediately become fully vested upon the Participant's death. The value of the Participant's Deferral Accounts will be paid to the Participant's Beneficiary, including the Participant's estate if designated as the Beneficiary, in a lump sum within ninety (90) days following the Participant's death. The Participant shall designate his Beneficiary in accordance with the provisions of Article V hereof.

3.8     Disability.

Notwithstanding the foregoing provisions, in the event of Disability, a Participant shall continue to accrue vesting service until fully vested in his Deferral Accounts or, if earlier, until his Disability Date. The Participant will receive a payment of all vested amounts credited to such Participant's Deferral Accounts (including all Specified Date Accounts) as of his Disability Date, in the manner provided in his Deferral Election (or, as applicable Award Agreement) or, if earlier, on his Distribution Date. Any portion of a Participant's Deferral Account attributable to a Supplemental Match, Supplemental Discretionary Profit Sharing Award, or a Supplemental Discretionary Award that is not vested on such Participant's Disability Date shall be forfeited by the Participant should he or she fail to satisfy the vesting conditions of Sections 2.1(f), 2.2(e) or 2.3. Such forfeited amount shall revert to the Company and shall remain a general corporate asset to be used for any purpose determined by the Company.

3.9     Unforeseeable Emergency.


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The Committee may, upon request of a Participant, cause to be paid to such Participant an amount equal to all or any part of the amounts credited to such Participant's Deferral Account if the Committee determines, in its absolute discretion based on such reasonable evidence that it shall require, that such a payment or payments is necessary for the purpose of alleviating the consequences of an Unforeseeable Emergency occurring with respect to the Participant. The amounts distributed with respect to an Unforeseeable Emergency may not exceed the amount necessary to satisfy the emergency plus amounts necessary to pay taxes on the distribution, after taking into account the extent to which the hardship is or may be relieved through reimbursement or compensation by insurance or otherwise or by liquidation of the Participant's assets (to the extent liquidation would not itself cause severe financial hardship). The amount of emergency payment shall be subtracted first from the vested portion of such Participant’s Termination Account until depleted and then from the vested portion of such Participant’s Specified Date Accounts, beginning with the Specified Date Account with the latest payment commencement date. Any such distribution upon an Unforeseeable Emergency shall result in a termination of Deferrals that would otherwise be credited on behalf of such Participant for the Plan Year in which the distribution on account of an Unforeseeable Emergency occurs, together with any Supplemental Match associated with such Deferrals.

3.10     Change in Time of Payments.

Notwithstanding any provision of this Article III to the contrary, the benefits payable hereunder may, to the extent expressly provided in this Section 3.10, be paid prior to or later than the date on which they would otherwise be paid to the Participant.

(a) Distribution in the Event of Income Inclusion Under Code Section 409A. If any portion of a Participant's Deferral Accounts is required to be included in income by the Participant prior to receipt due to a failure of this Plan or any Aggregated Plan to comply with the requirements of Code Section 409A and the Regulations, the Committee may determine that such Participant shall receive a distribution from the Plan in an amount equal to the lesser of: (i) the portion of his or her Deferral Account required to be included in income as a result of the failure of the Plan or any Aggregated Plan to comply with the requirements of Code Section 409A and the Regulations, or (ii) the balance of the Participant's Deferral Account.

(b) Distribution Necessary to Satisfy Applicable Tax Withholding. If the Company is required to withhold amounts to pay the Participant’s portion of the Federal Insurance Contributions Act (FICA) tax imposed under Code Sections 3101, 3121(a) or 3121(v)(2) with respect to amounts that are or will be paid to the Participant under the Plan before they otherwise would be paid, the Committee may determine that such Participant shall receive a distribution from the Plan in an amount equal to the lesser of: (i) the amount in the Participant's Deferral Accounts or (ii) the aggregate of the FICA taxes imposed and the income tax withholding related to such amount.

(c) Delay for Payments in Violation of Federal Securities Laws or Other Applicable Law. In the event the Company reasonably anticipates that the payment of benefits as specified hereunder would violate Federal securities laws or other applicable law, the

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Committee may delay the payment under this Article III until the earliest date at which the Company reasonably anticipates that the making of such payment would not cause such violation.

(d) Delay for Insolvency or Compelling Business Reasons. In the event the Company determines that the making of any payment of benefits on the date specified hereunder would jeopardize the ability of the Company to continue as a going concern, the Committee may delay the payment of benefits under this Article III until the first calendar year in which the Company notifies the Committee that the payment of benefits would not have such effect.

(e) Administrative Delay in Payment. The payment of benefits hereunder shall begin at the date specified in accordance with the provisions of the foregoing paragraphs of this Article III; provided that, in the case of administrative necessity, the payment of such benefits may be delayed up to the later of the last day of the calendar year in which payment would otherwise be made or the 15th day of the third calendar month following the date on which payment would otherwise be made. Further, if, as a result of events beyond the control of the Participant (or following the Participant's death, the Participant's Beneficiary), it is not administratively practicable for the Committee to calculate the amount of benefits due to Participant as of the date on which payment would otherwise be made, the payment may be delayed until the first calendar year in which calculation of the amount is administratively practicable.

(f) No Participant Election. Notwithstanding the foregoing provisions, if the period during which payment of benefits hereunder will be made occurs, or will occur, in two calendar years, the Participant shall not be permitted to elect the calendar year in which the payment shall be made.

3.11     409A Change in Control.

If a 409A Change in Control occurs before all Deferral Account(s) have been fully distributed, the remaining balance of all such Deferral Account(s) (including all Specified Date Accounts) shall be distributed in the form of a single lump sum payable at the end of the fifteenth (15th) month following the month in which such 409A Change in Control is effective, unless a Participant makes a timely election during the first three (3) months following the 409A Change in Control, in compliance with Section 3.5, to delay commencement of benefits from such Participant’s Deferral Account(s) by a minimum of five (5) years and to receive the benefits in the form of a lump sum, in which case distribution shall be made in accordance with such Participant’s modified election.

ARTICLE IV
FUNDING

4.1     Unsecured Obligation of Company.


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(a) Any benefit payable pursuant to this Plan shall be paid from the general assets of the Company. Nothing contained in this Plan and no action taken pursuant to the provisions of this Plan shall create a trust of any kind or a fiduciary relationship between any Participant (or any other interested person) and the Company or the Committee, or require the Company to maintain or set aside any specific funds for the purpose of paying any benefit hereunder. To the extent that a Participant or any other person acquires a right to receive payments from the Company under this Plan, such right shall be no greater than the right of any unsecured general creditor of the Company.

(b) If the Company maintains a separate fund or makes specific investments, including the purchase of insurance on the life of the a Participant, to assure its ability to pay any benefits due under this Plan, neither the Participant nor the Participant's Beneficiary shall have any legal or equitable ownership interest in, or lien on, such fund, policy, investment or any other asset of the Company. The Company, in its sole discretion, may determine the exact nature and method of informal funding (if any) of the obligations under this Plan. If the Company elects to maintain a separate fund or makes specific investments to fund its obligations under this Plan, the Company reserves the right, in its sole discretion, to terminate such method of funding at any time, in whole or in part. In addition, the Company may, in its sole and absolute discretion, set aside or earmark funds in an amount, determined by the Committee, equal to the total amounts necessary to provide benefits under the Plan. The Committee may, at its discretion direct the Company to establish one or more grantor trusts to provide for the ultimate payment of the Company's obligations under this Plan, but the trust instrument for any such trust must specifically provide that its assets are subject to the claims of the Company's creditors. Such grantor trust may require that the Company fully fund said trust with respect to benefits accrued through the date of a Corporate Change in Control following such a Corporate Change in Control.

4.2     Cooperation of Participant.

If the Company, in its sole discretion, elects to invest in a life insurance, disability or
annuity policy on the life of a Participant to assist with the informal funding of its obligations
under this Plan, the Participant shall assist the Company, from time to time, promptly upon the
request of the Company, in obtaining such insurance policy by supplying any information
necessary to obtain such policy as well as submitting to any physical examinations required
therefore. The Company shall be responsible for the payment of all premiums with respect to
any whole life, variable, or universal life insurance policy purchased in connection with this Plan
unless otherwise expressly agreed.

ARTICLE V
BENEFICIARIES

5.1     Beneficiary Designations.

A designation of a Beneficiary hereunder may be made only by an instrument (in form acceptable to the Committee) signed by the Participant and filed with the Committee prior to the

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Participant's death. In the absence of such a designation and at any other time when there is no existing Beneficiary designated hereunder, the unpaid value of the Participant's Deferral Accounts to which the Participant was entitled at his death shall be distributed to the Participant's estate. A Beneficiary who dies or which ceases to exist shall not be entitled to any part of any payment thereafter to be made to the Participant's Beneficiary unless the Participant's designation specifically provides to the contrary. If two or more persons designated as a Participant's Beneficiary are in existence with respect to a single deferred compensation benefit, the amount of any payment to the Beneficiary under this Plan shall be divided equally among such persons, unless the Participant's designation specifically provides to the contrary.

5.2     Change in Beneficiary.

A Participant may, at any time and from time to time, change a Beneficiary designation hereunder without the consent of any existing Beneficiary or any other person. Any change in Beneficiary shall be made only by an instrument (in form acceptable to the Committee) signed by the Participant, and any change shall be effective only if received by the Committee prior to the death of the Participant.

ARTICLE VI
CLAIMS PROCEDURES

6.1     Claims for Benefits.

The Committee shall determine the rights of any Participant to any deferred compensation benefits hereunder. Any Participant who believes that he has not received the deferred compensation benefits to which he is entitled under the Plan may file a claim in writing with the Committee. The Committee shall, no later than 90 days after the receipt of a claim (plus an additional period of 90 days if required for processing, provided that notice of the extension of time is given to the claimant with the first 90-day period), either allow or deny the claim in writing.

A denial of a claim by the Committee, wholly or partially, shall be written in a manner intended to be understood by the claimant and shall include:
(a) the specific reasons for the denial;
(b) specific reference to pertinent Plan provisions on which the denial is based;
(c) a description of any additional material or information necessary for the claimant to perfect the claim and an explanation of why such material or information is necessary; and
(d) an explanation of the claim review procedure and the time limits applicable to such procedures, including a statement of the claimant's right to bring a civil action under Section 502(a) of ERISA.

6.2     Appeal Provisions.

A claimant whose claim is denied (or his duly authorized representative) may within 60 days after receipt of denial of a claim file with the Committee a written request for a review of

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such claim. If the claimant does not file a request for review of his claim within such 60-day period, the claimant shall be deemed to have acquiesced in the original decision of the Committee on his claim, the decision shall become final and the claimant will not be entitled to bring a civil action under Section 502(a) of ERISA. If such an appeal is so filed within such 60- day period the Company (or its delegate) shall conduct a full and fair review of such claim. During such review, the claimant (or the claimant's authorized representative) shall be given the opportunity to review all documents that are pertinent to his claim and to submit issues and comments in writing.

The Company shall mail or deliver to the claimant a written decision on the matter based on the facts and the pertinent provisions of the Plan within 60 days after the receipt of the request for review (unless special circumstances require an extension of up to 60 additional days, in which case written notice of such extension shall be given to the claimant prior to the commencement of such extension). Such decision shall be written in a manner intended to be understood by the claimant, shall state the specific reasons for the decision and the specific Plan provisions on which the decision was based and shall, to the extent permitted by law, be final and binding on all interested persons.

ARTICLE VII
MISCELLANEOUS

7.1     Withholding.

The Company shall be required to withhold from any distribution payable under the Plan an amount sufficient to satisfy all federal, state and local tax withholding requirements.

7.2     No Guarantee of Employment.

Nothing in this Plan shall be construed as guaranteeing future employment to any Participant. Without limiting the generality of the preceding sentence, except as otherwise set forth in a written agreement, a Participant continues to be an employee of the Company solely at the will of the Company subject to discharge at any time, with or without cause. The benefits provided for herein for a Participant shall not be deemed to modify, affect or limit any salary or salary increases, bonuses, profit sharing or any other type of compensation of a Participant in any manner whatsoever. Nothing contained in this Plan shall affect the right of a Participant to participate in or be covered by or under any qualified or nonqualified pension, profit sharing, group, bonus or other supplemental compensation, retirement or fringe benefit Plan constituting any part of the Company's compensation structure whether now or hereinafter existing.

7.3     Payment to Guardian.

If a benefit payable hereunder is payable to a minor, to a person declared incompetent or to a person incapable of handling the disposition of his property, the Committee may direct payment of such benefit to the guardian, legal representative or person having the care and custody of such minor, incompetent or person. The Committee may require such proof of incompetency, minority, incapacity or guardianship, as it may deem appropriate prior to distribution of the benefit. Such distribution shall completely discharge the Company from all liability with respect to such benefit.

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7.4     Assignment.

No right or interest under this Plan of any Participant or Beneficiary shall be assignable or transferable in any manner or be subject to alienation, anticipation, sale, pledge, encumbrance or other legal process or in any manner be liable for or subject to the debts or liabilities of the Participant or Beneficiary.

7.5     Severability.

If any provision of this Plan or the application thereof to any circumstance(s) or person(s) is held to be invalid by a court of competent jurisdiction, the remainder of the Plan and the application of such provision to other circumstances or persons shall not be affected thereby.

7.6     Amendment and Termination.

The Company may at any time (without the consent of any Participant) modify, amend or terminate any or all of the provisions of this Plan; provided, however, that no modification, amendment or termination of this Plan shall adversely affect the rights of a Participant under the Plan without the consent of such Participant. Notwithstanding the foregoing or any provision of the Plan to the contrary, the Company may at any time (without the consent of any Participant) modify, amend or terminate any or all of the provisions of this Plan to the extent necessary to conform the provisions of the Plan with Section 409A of the Code regardless of whether such modification, amendment or termination of this Plan shall adversely affect the rights of a Participant under the Plan. Any amendment or termination of the Plan shall be at the direction of the Compensation Committee of the Board. Notwithstanding the foregoing, the Plan shall automatically terminate, without further action of the Company, upon Insolvency of the Company.

7.7     Effect of Termination.

If the Plan is terminated, all deferrals shall thereupon cease, but Earnings shall continue to be credited to the Deferral Accounts in accordance with Section 2.4 hereof. Notwithstanding the foregoing, to the extent provided by the Company in accordance with Section 7.6, the Plan may be liquidated following a termination under any of the following circumstances:

(a) the termination and liquidation of the Plan within twelve (12) months of a complete dissolution of the Company taxed under Section 331 of the Code or with the approval of a bankruptcy court pursuant to 11 U.S.C. § 503(b)(1)(A); provided that the amounts deferred under this Plan are included in the Participants' gross incomes in the latest of the following years (or, if earlier, the taxable year in which the amount is actually or constructively received): (i) the calendar year in which the Plan is terminated; (ii) the first calendar year in which the amount is no longer subject to a substantial risk of forfeiture; or (iii) the first calendar year in which the payment is administratively practicable.


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(b) the termination and liquidation of the Plan pursuant to irrevocable action taken by the Company within the thirty (30) days preceding or the twelve (12) months following a 409A Change of Control; provided that all Aggregated Plans are terminated and liquidated with respect to each Participant that experienced such change of control, so that under the terms of the termination and liquidation, all such Participants are required to receive all amounts of deferred compensation under this Plan and any other Aggregated Plans within twelve (12) months of the date the Company irrevocably takes all necessary action to terminate and liquidate this Plan and such other Aggregated Plans;

(c) the termination and liquidation of the Plan, provided that: (i) the termination and liquidation does not occur proximate to a downturn in the Company's financial health; (2) the Company terminates and liquidates all Aggregated Plans; (3) no payments in liquidation of this Plan are made within twelve (12) months of the date the Company irrevocably takes all necessary action to terminate and liquidate this Plan, other than payments that would be payable under the terms of this Plan if the action to terminate and liquidate this Plan had not occurred; (4) all payments are made within twenty four (24) months of the date on which the Company irrevocably takes all action necessary to terminate and liquidate this Plan; and (5) the Company does not adopt a new Aggregated Plan at any time within three (3) years following the date on which the Company irrevocably takes all action necessary to terminate and liquidate the Plan.

7.8     Exculpation and Indemnification.

The Company shall indemnify and hold harmless the members of the Committee from and against any and all liabilities, costs and expenses incurred by such persons as a result of any act, or omission to act, in connection with the performance of such person's duties, responsibilities and obligations under the Plan, other than such liabilities, costs and expenses as may result from the gross negligence, willful misconduct, and/or criminal acts of such persons.

7.9     Confidentiality.

In further consideration of the benefits available to each Participant under this Plan, each Participant shall agree that, except as such may be disclosed in financial statements and tax returns, or in connection with estate planning, all terms and provisions of this Plan, and any agreement between the Company and the Participant entered into pursuant this Plan, are and shall forever remain confidential until the death of Participant; and the Participant shall not reveal the terms and conditions contained in this Plan or any such agreement at any time to any person or entity, other than his respective financial and professional advisors unless required to do so by a court of competent jurisdiction or as otherwise may be required by law.

7.10     Gender and Number.

For purposes of interpreting the provisions of this Plan, the masculine gender shall be deemed to include the feminine, the feminine gender shall be deemed to include the masculine, and the singular shall include the plural unless otherwise clearly required by the context.

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7.11     Governing Law.

Except as otherwise preempted by the laws of the United States, this Plan shall be governed by and construed in accordance with the laws of the State of Texas, without giving effect to its conflict of law provisions.

7.12     Effective Date.

Executed this _______ day of _________________, 2015, to be effective January 1, 2016.


TESORO CORPORATION


By:
Name:
Title:

                





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TESORO CORPORATION

EXECUTIVE DEFERRED COMPENSATION PLAN

Exhibit 1

Notwithstanding any provision of the Plan to the contrary, each Participant who was
employed by Tesoro Hawaii, LLC as of September 25, 2013, the date of the sale by the
Company of all of its interest in Tesoro Hawaii, LLC, shall be immediately 100% vested in his
Deferral Account as of such date.



4815-1583-0558v.8 47436-12
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Exhibit 14.1


Code of Business Conduct and Ethics for Senior Financial
Executives (Overview)

General Policy

It is the policy of Tesoro Corporation and its subsidiaries (the “Company”) to conduct its business in accordance with the highest standards of honesty and integrity, the provisions of this Code of Business Conduct and Ethics for Senior Financial Executives (the “Code”), the Company’s Code of Business Conduct; other Company policies and all applicable laws and regulations of the United States, and the states, counties, cities and other jurisdictions in which the Company operates.

The specific policy and application of the Company’s commitment to assuring ethical and lawful conduct for all employees, officers, directors and independent agents acting on behalf of the Company (“associates”) is contained in the Company’s Code of Business Conduct.

In addition to the requirements and expectations contained in the Company’s Code of Business Conduct, the Company believes that senior financial executives shall abide by a further code of ethics to ensure that the Company maintains the highest integrity with respect to the preparation and reporting of financial information related to the Company. Accordingly, this Code shall apply to the following: Chief Executive Officer; Chief Financial Officer; head of Finance; Controller; and persons performing similar functions (the “Senior Financial Executives”).

All illegal and/or unethical acts are prohibited under this Code.


Commitment and Focus

The Company is committed to complying with all standards of ethical and lawful conduct. This commitment goes beyond compliance. We believe that ethical and lawful conduct is the foundation for our success. Integrity in everything we do is a requirement in all business operations. It is the foundation for mutually beneficial relationships with our customers, suppliers, and communities in which we live and work. All Associates have assigned responsibilities in the operation of our business. Yet, there is another that we all share - responsibility of acting with integrity in all business practices and relationships. This unanimity of purpose allows us to move quickly in exploring new ground; to act boldly in the face of competition; and to take risks whenever they are
justified.

This Code is intended as a codification of standards that are reasonably designed to deter wrongdoing and to promote and reinforce the following:

•Honest and ethical conduct, including ethical handling of actual or apparent conflicts of interest between personal and professional relationships.
•Full, fair, accurate, timely and understandable disclosure in reports and documents that the Company files with or submits to regulatory authorities or releases to the public.
•Compliance with applicable governmental laws, rules and regulations.
•The prompt reporting to an appropriate person or persons identified in this Code of violations of the Code.

Tesoro Corporation Amended Date: October 27, 2015


•Accountability for adherence to this Code.


Disclosure Controls

Each Senior Financial Executive shall endeavor, through actions which include, without limitation, the establishment, maintenance and periodic evaluation of appropriate disclosure controls and procedures and internal controls, to ensure that, with respect to each quarterly or annual report required by law to be filed by the Company (each a “Report”):


•The Report does not contain any untrue statements of material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading.
•The financial statements, and other financial information contained in each Report fairly present in all material respects the financial condition and results of operations of the Company as of, and for, the periods presented in the Report.
•The Report discloses financial information relating to the Company in a full, fair, accurate, timely and understandable manner.

Each Senior Financial Executive shall endeavor to design disclosure controls and procedures and internal controls to ensure that material information relating to the Company and its consolidated subsidiaries is made known to such Senior Financial Executives by others within the Company.


Accuracy and Completeness

Senior Financial Executives, as the primary executives responsible for the complete and accurate financial reporting of the Company, to the best of their ability, shall not permit the reporting of any financial information of the Company which they believe is false or misleading in any material respect.

Should any Senior Financial Executive have reason to believe that the Company has reported or may be intending to report any false or misleading financial information, he/she shall promptly advise the Chief Executive Officer of the Company. If having done so, such Senior Financial Executive believes that appropriate action will not be taken to prevent such reporting, then the Senior Financial Executive shall report the matter to the Chairman of the Audit Committee of the Tesoro Corporation Board of Directors (the “Board”).


Prior Employment

Each Senior Financial Executive shall fully disclose to the Chairman of the Audit Committee of the Board any prior employment of such executive with any accounting firm which the Company has engaged or proposes to engage, to perform auditing services.


Tesoro Corporation Amended Date: October 27, 2015


Such Senior Financial Executive shall also fully disclose the scope of any work performed for the Company while employed by such accounting firm, and the time period during which such work was performed.


Questionable Transactions

No Senior Financial Executive, shall, directly or indirectly, through any business entity in which he/she or any of such executive’s family members have an interest or otherwise, engage in any transaction with the Company which is required to be reported in, or requires the exercise of any judgment as to whether it is required to be reported in, the financial records or statements of the Company.

The following are exceptions:

•Regular compensation, including bonuses, and employee benefits received in such executive’s capacity as an executive and employee of the Company.
•Transactions in goods and services routinely engaged in by the Company with its unaffiliated clients or customers on terms, subject to customary employee discounts and benefits, generally offered to its unaffiliated clients and customers.
•Transactions with publicly held entities in which the executive has less than 1.0 percent equity interest and with respect to which transactions such executive has no decision-making role on behalf of such entity.
•Transactions fully disclosed to and approved in advance by the Audit Committee of the Board.


Prompt Disclosure

Each Senior Financial Executive shall promptly disclose to the Company’s independent auditors and to the Chairman of the Audit Committee of the Board his/her knowledge of the following:


•All significant deficiencies in the design or operation of the Company’s internal controls which could adversely affect the Company’s ability to record, process, summarize, and report financial data.
•Any material weakness in the Company’s internal controls.
•Any fraud, whether or not material, that involves the Company’s management or other employees who have a significant role in the Company’s internal controls.
The Senior Financial Executives shall ensure that each Report fully, accurately and timely discloses whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls in connection with such Report, including any corrective actions with regard to significant deficiencies and material weakness.

Each Senior Financial Executive shall promptly report to the Chairman of the Audit Committee of the Board any violations of this Code.


Reporting Violations

In the event any Senior Financial Executive shall believe that the Company has engaged or is about to engage in any activity which violates any foreign, federal, state, or local law, rule or

Tesoro Corporation Amended Date: October 27, 2015


regulations, such Senior Financial Executive shall promptly advise the Chief Executive Officer, the Chief Financial Officer, or the General Counsel (Compliance
Officer) in person or by telephone, letter, or electronic mail as follows:


•By Letter:
Tesoro Corporation
19100 Ridgewood Parkway
San Antonio, Texas 78259


•By Telephone:
o Direct Telephone 210-626-6000
o Toll Free Telephone 866-876-2455
o Toll Free Hotline 877-782-3763

If this is uncomfortable or inappropriate, or if having done so, such Senior Financial Executive believes that appropriate action will not be taken to address the violation or potential violation, then such Senior Financial Executive shall report the matter to the Chairman of the Audit Committee of the Board.

The Company will not permit retaliation of any kind by or on behalf of the Company, as a result of a good faith report of an actual or suspected violation of this Code or any standard of ethical and lawful conduct by a Senior Financial Executive. Retaliation is itself a violation of this Code. Any such retaliation shall be reported using the reporting procedures outlined above.


Enforcement

If a Senior Financial Executive is found to be in violation of this Code, the Company shall take appropriate action up to and including recoupment of incentive payments previously made to the Senior Financial Executive pursuant to the Company’s Policy on Recoupment of Incentive Payments for Material Financial Restatement (commonly referred to as the “clawback” policy), discharge and, if warranted, legal proceedings.

To the extent possible, investigations of allegations of violations of this Code will be maintained in confidence. The Company will inform only those individuals who have a need to know of the report in order to conduct a full and fair investigation of the allegations that have been made.

The Compliance Officer may assist in the investigation and resolution of such alleged violation of this Code.


Amendment, Modification, Waiver and Intent

This Code may be amended, modified or waived by the Board of Directors and waivers may also be granted by the Governance Committee of the Board subject to the disclosure and other provisions of the Securities Exchange Act of 1934, and the rules thereunder and the applicable rules of the New York Stock Exchange.


Tesoro Corporation Amended Date: October 27, 2015


This Code is intended as a directive for the efficient and professional performance of all Senior Financial Executives. Nothing herein contained shall be construed to be a contract between Tesoro Corporation and the Senior Financial Executives. Additionally, this Code is not to be construed as containing binding terms and conditions of employment. This employment relationship with the Company is “at will” and the Company retains the absolute right to terminate any Senior Financial Executive, at any time, with or without cause.

The Company shall immediately disclose, by means of the filing of a Current Report on
Form 8-K or by such other means as the Securities and Exchange Commission may
require, any amendments to or any waiver of this Code.


Tesoro Corporation Amended Date: October 27, 2015





Exhibit 31.1

CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002

I, Gregory J. Goff, certify that:

1.
I have reviewed this quarterly report on Form 10-Q of Tesoro Corporation;

2.
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for the periods presented in this quarterly report;

4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

(d)
Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:
October 29, 2015
/s/ GREGORY J. GOFF
 
 
Gregory J. Goff
 
 
Chief Executive Officer







Exhibit 31.2

CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002

I, Steven M. Sterin, certify that:

1.
I have reviewed this quarterly report on Form 10-Q of Tesoro Corporation;

2.
Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.
Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for the periods presented in this quarterly report;

4.
The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15(d)-15(f)) for the registrant and have:

(a)
Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)
Designed such internal control over financial reporting, or caused such internal controls over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c)
Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

(d)
Disclosed in this quarterly report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5.
The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a)
All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b)
Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

Date:
October 29, 2015
/s/ STEVEN M. STERIN
 
 
Steven M. Sterin
 
 
Chief Financial Officer







Exhibit 32.1

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


In connection with the Quarterly Report of Tesoro Corporation (the “Company”) on Form 10-Q for the period ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Gregory J. Goff, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)
The Report fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and

(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ GREGORY J. GOFF
 
Gregory J. Goff
 
Chief Executive Officer
 
October 29, 2015
 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.







Exhibit 32.2

CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002


In connection with the Quarterly Report of Tesoro Corporation (the “Company”) on Form 10-Q for the period ended September 30, 2015 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steven M. Sterin, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

(1)
The Report fully complies with the requirements of section 13(a) or 15 (d) of the Securities Exchange Act of 1934; and

(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

/s/ STEVEN M. STERIN
 
Steven M. Sterin
 
Chief Financial Officer
 
October 29, 2015
 

A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request.



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