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TESORO PETROLEUM CORPORATION
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SEC 1913 (02-02)
BRUCE A. SMITH
Chairman, President
and Chief Executive Officer
[TESORO LOGO]
Tesoro Petroleum Corporation
300 Concord Plaza Drive
San Antonio, Texas 78216-6999
210 828 8484
March 24, 2003
Dear Fellow Shareholder:
My letter last year stated that the challenge of the September terrorist attack
and a weak economy overshadowed the positives of the year, including our
acquisitions in North Dakota and Utah. In 2002, these two events more
profoundly affected our industry, creating one of the most difficult years in
recent history for the refining and marketing industry.
After September 11th, the demand for jet fuel declined, and immediately
thereafter, we had a 100-year record warm winter in the Northeast. U.S.
refineries had minimal scheduled or unscheduled maintenance, which pushed
production and product inventories higher, and margins to the low end of the
five-year range (1998 - 2002). In fact, in three of the twelve months last
year, we experienced the lowest margins in the past five years. In the most
meaningful measure of success, 2002 was very poor as we recorded four
consecutive quarterly losses.
We believe the outlook for the current year is much better, given the
following:
o The Northeast U.S. experienced a cold winter, which increased demand and
margins for distillates.
o Changing gasoline specifications, which are impacting industry supply
capabilities, are creating challenges around product blending and
logistical infrastructures.
o Continuing growth in gasoline and distillate demand, and softness in
demand for jet fuel.
Since January, margins have improved even though the price of crude oil
approached historical highs due to concern about potential supply shortages
caused by the strike in Venezuela and the conflict with Iraq. In 2002 finished
product prices did not rise with crude oil prices due to excess product
inventory levels; however, finished product prices have more closely followed
the price of crude in 2003.
Although supply/demand fundamentals support our view of better margins,
uncertainty and various other factors could create another difficult year.
Since global economic and industry conditions are beyond our control, I want to
focus on factors that we believe will positively impact our financial
performance in any margin environment:
1. In the past 18 months, we added important strategic components to our
asset base as we continued to build a geographically-focused refining and
marketing system and nearly doubled our refining capacity with the
purchase of refineries in North Dakota, Utah, and California. Today, we
have a more diversified system that makes Tesoro the second largest
refiner in our core market. We believe this system will have advantages
and synergies that will improve our financial performance. Relative to
other independent refiners, we will not spend significant capital to
comply with the new low sulfur fuel regulations that will be effective in
2004 and 2006. Many people believe these regulations will cause additional
U.S. refinery closures and restrict imports of high sulfur products. The
combined stringent fuel standards and the lack of infrastructure that
connects the West to other U.S. markets, positions Tesoro as a major
long-term competitor.
2. In 2002, there were several factors that limited Golden Eagle's
profitability that we do not expect to be repeated in 2003. First, we only
owned the refinery for about seven months. Second, the larger of the
refinery's two crude units immediately went through a 30-day turnaround
after our acquisition, and third, the integration into Tesoro was not
completed until August. Another benefit in 2003 will be the start-up of
Golden Eagle's CARB III project that can upgrade about 20,000 barrels per
day of conventional gasoline into CARB gasoline, which is the only
gasoline that can be sold in California. Conventional gasoline must be
transported to other states, resulting in a lower netback value to the
company. This project will be operational for the last nine months of
2003.
The purchase of three refineries increased our debt to a very high level.
Accordingly, the reduction of debt has become our single most important
financial objective, and after acquiring Golden Eagle, we announced a goal to
reduce debt by $500 million by the end of 2003.
The foundation of the debt reduction plan was to sell $200 million in assets.
At year-end 2002, we announced that we had surpassed that goal by selling
assets that raised a total of $207 million. The asset sales included the
Northern Great Plains Product Pipeline ($100 million), Northern California
retail sites ($66 million), and the sale and lease-back of 30 retail outlets
located in Hawaii, Alaska, Utah, and Idaho (approximately $40 million).
To help repay debt, we reduced and deferred our anticipated 2002 capital and
turnaround expenditures by about $70 million. Capital and turnaround spending
for the year totaled $244 million. This included about $24 million for the
heavy oil project at our Anacortes, Washington refinery, $60 million for the
CARB III project at Golden Eagle and $40 million for refinery turnarounds.
Our new information system gives us the ability to realize greater operational
efficiencies, and our debt reduction initiatives focus on extracting these
benefits. Subsequent to the California acquisition, we optimized our inventory
to reduce excess inventory, and we improved the sales invoicing process to
accelerate our cash collection. Both of these were made possible by the
investment we made in our information system. We set a financial goal to reduce
working capital by $50 million, a goal that we exceeded in the third quarter.
Another optimization goal was to generate $10 million of inter-refinery
synergies, a goal that we exceeded by year-end. Finally, we met a goal to
reduce operating costs by $10 million. In total, we repaid $140 million of term
debt since the Golden Eagle acquisition in May 2002, which was a notable
accomplishment considering the abysmal margin environment.
I mentioned that in 2003, we expect Golden Eagle to make a more meaningful
contribution, but we also have other plans to improve our performance in 2003.
In this dynamic and competitive industry, controlling costs is a primary goal
for the management team as we seek to consistently produce higher earnings. The
control of costs is therefore both our greatest challenge and opportunity. Over
the past two years, Tesoro has grown rapidly as we capitalized on the
opportunity to acquire quality assets and create a well-balanced system.
However, with rapid growth came some inefficiency and higher costs. With this
in mind, we set a goal to reduce operating expenses in 2003 by at least $65
million. Higher energy and other costs, such as insurance, salaries and
benefits, will make this a challenging goal. But, we believe the reduction is
achievable.
We continue to evaluate costs and are committed to permanently reduce costs in
future years.
Another initiative is to control invested capital. We have dramatically reduced
our planned capital expenditures and turnaround spending for 2003 to around
$164 million. The impact of the decision to eliminate capital, in order to
maximize debt reduction, will affect our retail investments. The strategy for
our retail operations has been to build a network of profitable retail outlets
that complement and support our refinery operations. We will continue to engage
in retail operations in a measured and strategic way; however, the poor
performance in the retail sector coupled with our capital expenditure reduction
efforts will limit the growth of our retail operations, including Mirastar. We
will continue to operate retail sites that are located in highly populated
areas in close proximity to our refineries and, where practical, utilize our
branded jobber network to more effectively market fuels in other areas.
Finally in 2003, we are targeting an additional $20 million in asset sales and
expect to realize an additional $25 million in system synergies. These plans
will improve cash flow to repay debt, which will reduce another major cost -
interest expense.
In future years, we believe we will be able to increase Tesoro's shareholder
value by focusing on:
(1) value drivers and the integration of those drivers into highly
effective supply, marketing and information systems;
(2) our management team and improvements in processes that enhance
decision-making;
(3) meeting the needs of our customers; and
(4) good corporate governance.
Earlier, I told you that we are beginning to realize the benefits of more
detailed financial information and operating data, which permits us to better
analyze and forecast our business. This is a result of both the investment we
made in our information systems and our search for best practices. Our recent
acquisitions have enabled us to accelerate this effort, and we expect continual
improvement.
Our acquisitions have also added depth and experience to our senior management
team. With our increased size, we have also been able to recruit talented
industry executives. We have changed our organizational structure to better
utilize skills, to align accountability with decision-making and improve our
responsiveness to a rapidly changing environment. To capitalize on our new
strengths, we have invested time and money to improve our processes.
To address a lack of investor confidence in publicly listed companies, the NYSE
proposed rules and the SEC has implemented the Sarbanes-Oxley legislation.
Before these rules were promulgated, we had governance guidelines for our
directors to assure their independence, a board that has been elected annually,
a lead director, and age limits for our directors. In that regard, last year
two directors could not be nominated for reelection. We support the governance
changes, but realize there will be added costs to comply with all the new
regulations.
In summary, while 2002 was a financial disappointment, there were significant
accomplishments that positioned us for better financial performance in future
years. I would like to acknowledge the outstanding performance of our employees
who made many personal sacrifices to address the challenges of 2002 in a
professional and committed way. We are pleased with the progress we have made
and thank you for your continued support.
Sincerely,
/s/ BRUCE A. SMITH
Bruce A. Smith