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, 2009

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                                          to                                           

Commission file number 1-13175

VALERO ENERGY CORPORATION

(Exact name of registrant as specified in its charter)

Delaware (State or other jurisdiction of incorporation or organization)		74-1828067 (I.R.S. Employer Identification No.)

One Valero Way
San Antonio, Texas
(Address of principal executive offices)
78249
(Zip Code)

(210) 345-2000
(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 o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files). Yes þ No o

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

Large accelerated filer þ		Accelerated filer o		Non-accelerated filer o		Smaller reporting company o

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

The number of shares of the registrant’s only class of common stock, $0.01 par value, outstanding as of October 30, 2009 was 564,349,512.

 

 

VALERO ENERGY CORPORATION AND SUBSIDIARIES

INDEX

		Page
PART I – FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2009 and December 31, 2008			3
Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2009 and 2008			4
Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008			5
Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2009 and 2008			6
Condensed Notes to Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			46
Item 3. Quantitative and Qualitative Disclosures About Market Risk			72
Item 4. Controls and Procedures			77
PART II – OTHER INFORMATION
Item 1. Legal Proceedings			78
Item 1A. Risk Factors			79
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			80
Item 6. Exhibits			81
SIGNATURE			82

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

VALERO ENERGY CORPORATION AND SUBSIDIARIES

		September 30,				December 31,
		2009				2008
		(Unaudited)
ASSETS
Current assets:
Cash and temporary cash investments		$	1,605			$	940
Restricted cash			144				131
Receivables, net			3,923				2,897
Inventories			4,576				4,637
Income taxes receivable			81				197
Deferred income taxes			150				98
Prepaid expenses and other			386				550
Total current assets			10,865				9,450
Property, plant and equipment, at cost			29,863				28,103
Accumulated depreciation			(5,632	)			(4,890	)
Property, plant and equipment, net			24,231				23,213
Intangible assets, net			229				224
Deferred charges and other assets, net			1,480				1,530
Total assets		$	36,805			$	34,417
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Current portion of debt and capital lease obligations		$	213			$	312
Accounts payable			5,756				4,446
Accrued expenses			633				374
Taxes other than income taxes			667				592
Income taxes payable			64				–
Deferred income taxes			424				485
Total current liabilities			7,757				6,209
Debt and capital lease obligations, less current portion			7,162				6,264
Deferred income taxes			3,872				4,163
Other long-term liabilities			2,124				2,161
Commitments and contingencies
Stockholders’ equity:
Common stock, $0.01 par value; 1,200,000,000 shares authorized; 673,501,593 and 627,501,593 shares issued			7				6
Additional paid-in capital			7,975				7,190
Treasury stock, at cost; 110,454,703 and 111,290,436 common shares			(6,830	)			(6,884	)
Retained earnings			14,670				15,484
Accumulated other comprehensive income (loss)			68				(176	)
Total stockholders’ equity			15,890				15,620
Total liabilities and stockholders’ equity		$	36,805			$	34,417

See Condensed Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION AND SUBSIDIARIES

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Operating revenues (1)		$	19,489			$	35,960			$	51,238			$	100,545
Costs and expenses:
Cost of sales			18,104				32,506				46,275				91,848
Operating expenses			923				1,136				2,778				3,383
Retail selling expenses			182				201				522				579
General and administrative expenses			167				169				435				421
Depreciation and amortization expense			389				370				1,156				1,106
Asset impairment loss			417				43				575				43
Gain on sale of Krotz Springs Refinery			–				(305	)			–				(305	)
Total costs and expenses			20,182				34,120				51,741				97,075
Operating income (loss)			(693	)			1,840				(503	)			3,470
Other income (expense), net			9				36				(16	)			71
Interest and debt expense:
Incurred			(149	)			(112	)			(386	)			(335	)
Capitalized			19				31				95				74
Income (loss) before income tax expense (benefit)			(814	)			1,795				(810	)			3,280
Income tax expense (benefit)			(185	)			643				(236	)			1,133
Net income (loss)		$	(629	)		$	1,152			$	(574	)		$	2,147
Earnings (loss) per common share		$	(1.12	)		$	2.20			$	(1.08	)		$	4.07
Weighted-average common shares outstanding (in millions)			561				522				534				526
Earnings (loss) per common share – assuming dilution		$	(1.12	)		$	2.18			$	(1.08	)		$	4.02
Weighted-average common shares outstanding – assuming dilution (in millions)			561				529				534				535
Dividends per common share		$	0.15			$	0.15			$	0.45			$	0.42
Supplemental information:
(1) Includes excise taxes on sales by our U.S. retail system		$	226			$	207			$	659			$	605

See Condensed Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION AND SUBSIDIARIES

		Nine Months Ended September 30,
		2009				2008
Cash flows from operating activities:
Net income (loss)		$	(574	)		$	2,147
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization expense			1,156				1,106
Asset impairment loss			575				43
Gain on sale of Krotz Springs Refinery			–				(305	)
Stock-based compensation expense			35				36
Deferred income tax expense (benefit)			(302	)			260
Changes in current assets and current liabilities			1,154				381
Changes in deferred charges and credits and other operating activities, net			(104	)			(148	)
Net cash provided by operating activities			1,940				3,520
Cash flows from investing activities:
Capital expenditures			(1,820	)			(1,894	)
Deferred turnaround and catalyst costs			(301	)			(279	)
Purchase of certain VeraSun Energy Corporation facilities			(556	)			–
Return of investment in Cameron Highway Oil Pipeline Company			18				11
Proceeds from the sale of Krotz Springs Refinery			–				463
Contingent payment in connection with acquisition			–				(25	)
Minor acquisitions			(29	)			(144	)
Other investing activities, net			5				16
Net cash used in investing activities			(2,683	)			(1,852	)
Cash flows from financing activities:
Proceeds from the sale of common stock, net of issuance costs			799				–
Non-bank debt:
Borrowings			998				–
Repayments			(209	)			(374	)
Bank credit agreements:
Borrowings			–				296
Repayments			–				(296	)
Accounts receivable sales program:
Proceeds from sale of receivables			500				–
Repayments			(500	)			–
Purchase of common stock for treasury			–				(774	)
Issuance of common stock in connection with employee benefit plans			7				14
Effect of tax deduction in excess of (less than) recognized stock-based compensation cost			(2	)			15
Common stock dividends			(239	)			(221	)
Debt issuance costs			(8	)			–
Other financing activities			(3	)			(2	)
Net cash provided by (used in) financing activities			1,343				(1,342	)
Effect of foreign exchange rate changes on cash			65				(23	)
Net increase in cash and temporary cash investments			665				303
Cash and temporary cash investments at beginning of period			940				2,464
Cash and temporary cash investments at end of period		$	1,605			$	2,767

See Condensed Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION AND SUBSIDIARIES

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Net income (loss)		$	(629	)		$	1,152			$	(574	)		$	2,147
Other comprehensive income (loss):
Foreign currency translation adjustment			214				(105	)			324				(167	)
Pension and other postretirement benefits net (gain) loss reclassified into income, net of income tax expense of $1, $-, $1, and $1			(1	)			–				(1	)			(1	)
Net gain (loss) on derivative instruments designated and qualifying as cash flow hedges:
Net gain (loss) arising during the period, net of income tax (expense) benefit of $(12), $(34), $(46), and $20			24				62				87				(38	)
Net (gain) loss reclassified into income, net of income tax expense (benefit) of $29, $(9), $89, and $(18)			(54	)			16				(166	)			33
Net gain (loss) on cash flow hedges			(30	)			78				(79	)			(5	)
Other comprehensive income (loss)			183				(27	)			244				(173	)
Comprehensive income (loss)		$	(446	)		$	1,125			$	(330	)		$	1,974

See Condensed Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION AND SUBSIDIARIES

1. BASIS OF PRESENTATION, PRINCIPLES OF CONSOLIDATION, AND SIGNIFICANT ACCOUNTING POLICIES

As used in this report, the terms “Valero,” “we,” “us,” or “our” may refer to Valero Energy Corporation, one or more of its consolidated subsidiaries, or all of them taken as a whole.

These unaudited consolidated financial statements include the accounts of Valero and subsidiaries in which Valero has a controlling interest. Intercompany balances and transactions have been eliminated in consolidation. Investments in significant non-controlled entities are accounted for using the equity method.

These unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the Securities Exchange Act of 1934. Accordingly, they do not include all of the information and notes required by GAAP for complete consolidated financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included. All such adjustments are of a normal recurring nature unless disclosed otherwise. Financial information for the three and nine months ended September 30, 2009 and 2008 included in these Condensed Notes to Consolidated Financial Statements is derived from our unaudited consolidated financial statements. Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009.

The consolidated balance sheet as of December 31, 2008 has been derived from the audited financial statements as of that date. For further information, refer to the consolidated financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2008.

See Note 3 for a discussion of the presentation in the statements of income of the results of operations of the Krotz Springs Refinery, which was sold effective July 1, 2008.

We have evaluated subsequent events that occurred after September 30, 2009 through the filing of this Form 10-Q on November 5, 2009. Any material subsequent events that occurred during this time have been properly recognized or disclosed in our financial statements.

Use of Estimates
The preparation of financial statements in conformity with GAAP requires our management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. On an ongoing basis, management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.

Reclassifications
Certain amounts previously reported in 2008 and 2009 have been reclassified to conform to the current 2009 presentation. The primary reclassification relates to the presentation of asset impairment losses (discussed in Note 4) on a separate line in the consolidated statements of income due to the materiality of the amount in the third quarter of 2009. For comparability with this presentation, asset impairment losses resulting from the cancellation of certain capital projects classified as “construction in progress” of

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

$158 million for the first six months of 2009 and $43 million for both the three months and nine months ended September 30, 2008 have been reclassified from operating expenses and reflected on a separate line. The asset impairment losses are also presented on a separate line in the consolidated statements of cash flows, which resulted in an adjustment to capital expenditures previously reported for the nine months ended September 30, 2008.

2. ACCOUNTING PRONOUNCEMENTS

Financial Accounting Standards Board (FASB) “Accounting Standards Codification™” (the Codification or ASC)
The Codification is the single source of authoritative GAAP recognized by the FASB, to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the Securities and Exchange Commission (SEC) under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification became effective for interim and annual periods ending after September 15, 2009 and superseded all previously existing non-SEC accounting and reporting standards. All other non-grandfathered non-SEC accounting literature not included in the Codification is nonauthoritative. Commencing with the quarter ended September 30, 2009, all of our references to GAAP now use the specific Codification Topic or Section rather than prior accounting and reporting standards. The Codification did not change existing GAAP and, therefore, did not affect our financial position or results of operations.

Fair Value Measurements and Disclosures
In February 2008, ASC Topic 820, “Fair Value Measurements and Disclosures,” was modified to delay the effective date for applying fair value measurement disclosures for nonfinancial assets and nonfinancial liabilities until fiscal years beginning after November 15, 2008. The implementation of this provision of Topic 820 for these assets and liabilities effective January 1, 2009 did not affect our financial position or results of operations but did result in additional disclosures, which are provided in Note 10.

In August 2009, the FASB modified Topic 820 to address the measurement of liabilities at fair value in circumstances in which a quoted price in an active market for the identical liability is not available. In such circumstances, a reporting entity is required to measure fair value using one or more of the following techniques: (i) a valuation technique that uses the quoted price of the identical liability when traded as an asset, or the quoted prices for similar liabilities or similar liabilities when traded as assets; or (ii) another valuation technique that is consistent with Topic 820. The FASB also clarified that when estimating the fair value of the liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. This modification also clarified that both a quoted price in an active market for the identical liability at the measurement date and the quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. This guidance is effective for the first reporting period (including interim periods) beginning after issuance, the adoption of which in the fourth quarter of 2009 is not expected to materially affect our financial position or results of operations.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Business Combinations
In December 2007, ASC Topic 805, “Business Combinations,” was issued to improve the financial reporting of business combinations and clarify the accounting for these transactions. This guidance in Topic 805 is to be applied prospectively to business combinations with acquisition dates on or after the beginning of an entity’s fiscal year that begins on or after December 15, 2008, with early adoption prohibited. In April 2009, Topic 805 was modified to address application issues raised related to (i) initial recognition and measurement, (ii) subsequent measurement and accounting, and (iii) disclosure of assets and liabilities arising from contingencies in a business combination. These provisions are to be applied to contingent assets or contingent liabilities acquired in business combinations for which the acquisition date is on or after the beginning of an entity’s fiscal year that begins on or after December 15, 2008.

Due to the adoption of the new business combination provisions of Topic 805 effective January 1, 2009, these provisions were applied to the acquisition of certain ethanol plants from VeraSun Energy Corporation (VeraSun, with the acquisition referred to as the VeraSun Acquisition) in the second quarter of 2009, which is discussed in Note 3.

Noncontrolling Interests in Consolidated Financial Statements
In December 2007, ASC Topic 810, “Consolidation,” was modified to provide guidance for the accounting and reporting of noncontrolling interests, changes in controlling interests, and the deconsolidation of subsidiaries. In addition, this modification provides that an entity shall disclose pro forma net income and pro forma earnings per share if an entity has one or more noncontrolling interests. The adoption of these provisions of Topic 810 effective January 1, 2009 has not affected our financial position or results of operations.

Derivatives and Hedging
In March 2008, ASC Topic 815, “Derivatives and Hedging,” was modified to establish disclosure requirements for derivative instruments and for hedging activities. The required disclosures include qualitative disclosures about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains and losses on derivative instruments, and disclosures about contingent features related to credit risk in derivative agreements. These disclosures are effective for fiscal years, and interim periods within those fiscal years, beginning on or after November 15, 2008. The adoption of these provisions of Topic 815 effective January 1, 2009 did not affect our financial position or results of operations but did result in additional disclosures, which are provided in Note 11.

Earnings Per Share
In June 2008, the FASB modified ASC Topic 260, “Earnings Per Share,” to address whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method described in Topic 260. These Codification amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2008; early adoption is not permitted. Shares of restricted stock granted under certain of our stock-based compensation plans represent participating securities covered by these provisions. The adoption of these provisions effective January 1, 2009 did not have any effect on the calculation of basic earnings per common share for the three and nine months ended September 30, 2009, but did reduce basic earnings per common share from the $2.21 and $4.08 amounts originally reported for the three and nine months ended September 30, 2008, respectively, to $2.20 and $4.07, respectively. The calculation is provided in Note 8.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Equity Method Investments
In November 2008, the FASB modified ASC Topic 323, “Investments—Equity Method and Joint Ventures,” to provide guidance regarding (i) initial measurement of an equity investment, (ii) recognition of an other-than-temporary impairment of an equity method investment, including any impairment charge taken by the investee, and (iii) accounting for a change in ownership level or degree of influence on an investee. These provisions are effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years. These provisions are to be applied prospectively to equity method investments acquired after the effective date, and earlier application is not permitted. Because we have not acquired any equity method investments during 2009, the adoption of these provisions effective January 1, 2009 has not affected our financial position or results of operations.

Compensation – Retirement Benefits
In December 2008, the FASB modified ASC Topic 715, “Compensation—Retirement Benefits,” to require enhanced disclosures regarding (i) investment policies and strategies, (ii) categories of plan assets, (iii) fair value measurements of plan assets, and (iv) significant concentrations of risk. These disclosures are effective for fiscal years ending after December 15, 2009, with earlier application permitted. Since only disclosures are affected by these requirements, the adoption of these provisions will not affect our financial position or results of operations.

Financial Instruments
In April 2009, the provisions of ASC Topic 825, “Financial Instruments,” were modified to require a publicly traded company to include disclosures about the fair value of its financial instruments for interim reporting periods as well as in annual financial statements. This provision is effective for interim reporting periods ending after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009 if an entity also elects to apply the early adoption provisions of certain other fair value modifications in Topic 820, “Fair Value Measurements and Disclosures,” and Topic 320, “Investments—Debt and Equity Securities.” We adopted all of these provisions in the first quarter of 2009, none of which has affected our financial position or results of operations. However, the adoption of the modified provisions of Topic 825 resulted in additional interim disclosures discussed below.

Our financial instruments include cash and temporary cash investments, restricted cash, receivables, payables, debt, capital lease obligations, commodity derivative contracts, and foreign currency derivative contracts. The estimated fair values of these financial instruments approximate their carrying amounts as reflected in the consolidated balance sheets, except for certain debt as discussed in Note 6. The fair values of our debt, commodity derivative contracts, and foreign currency derivative contracts were estimated primarily based on quoted market prices and inputs other than quoted prices that are observable for the asset or liability.

Subsequent Events
In May 2009, ASC Topic 855, “Subsequent Events,” was issued, which established general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, guidance was provided regarding (i) the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, (ii) the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and (iii) the disclosures that an entity should make about events or transactions that occur after the balance sheet date. The provisions of Topic 855 are to be applied

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

prospectively and are effective for interim or annual financial periods ending after June 15, 2009. The adoption of the provisions of Topic 855 in the second quarter of 2009 did not affect our financial position or results of operations but did result in additional disclosures, which are provided in Note 1.

FASB Statement No. 166
In June 2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial Assets – an amendment of FASB Statement No. 140.” According to ASC Topic 105, “Generally Accepted Accounting Principles,” Statement No. 166 shall continue to represent authoritative guidance until it is integrated into the Codification. Statement No. 166 amends and clarifies provisions related to the transfer of financial assets in order to address application and disclosure issues. In general, Statement No. 166 clarifies the requirements for derecognizing transferred financial assets, removes the concept of a qualifying special-purpose entity and related exceptions, and requires additional disclosures related to transfers of financial assets. Statement No. 166 is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2009, and earlier application is prohibited. The adoption of Statement No. 166 effective January 1, 2010 is not expected to materially affect our financial position or results of operations.

FASB Statement No. 167
In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46(R).” According to ASC Topic 105, Statement No. 167 shall continue to represent authoritative guidance until it is integrated into the Codification. Statement No. 167 amends provisions related to variable interest entities to include entities previously considered qualifying special-purpose entities, as the concept of these entities was eliminated by Statement No. 166. This statement also clarifies consolidation requirements and expands disclosure requirements related to variable interest entities. Statement No. 167 is effective for fiscal years, and interim periods within those fiscal years, beginning after November 15, 2009, and earlier application is prohibited. The adoption of Statement No. 167 effective January 1, 2010 is not expected to materially affect our financial position or results of operations.

3. ACQUISITION AND DISPOSITION

Acquisition of VeraSun
In the second quarter of 2009, we acquired seven ethanol plants and a site under development from VeraSun. Because VeraSun was subject to bankruptcy proceedings and different lenders were involved with various plants, three separate closings were required to consummate the acquisition of these ethanol plants. On April 1, 2009, we closed on the acquisition of ethanol plants located in Charles City, Fort Dodge, and Hartley, Iowa; Aurora, South Dakota; and Welcome, Minnesota, and a site under development located in Reynolds, Indiana for consideration of $350 million. Through subsequent closings on April 9, 2009 and May 8, 2009, we acquired VeraSun’s ethanol plant in Albert City, Iowa, for consideration of $72 million and VeraSun’s ethanol plant in Albion, Nebraska, for consideration of $55 million, respectively. In conjunction with the acquisition of the seven ethanol plants, we also paid $79 million primarily for inventory and certain other working capital. We have elected to use the LIFO method of accounting for the commodity inventories related to the acquired ethanol business. We incurred approximately $10 million of acquisition-related costs that were recognized in general and administrative expenses in the consolidated statement of income for the nine months ended September 30, 2009.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The acquired ethanol business involves the production and marketing of ethanol and its co-products, including distillers grains. The ethanol operations are reflected as a reportable segment in Note 12, the operations of which will complement our existing clean motor fuels business. The acquisition cost was funded with part of the proceeds from a $1 billion issuance of notes in March 2009, which is discussed in Note 6.

An independent appraisal of the assets acquired in the VeraSun Acquisition has been completed, and the assets acquired and the liabilities assumed have been recognized at their acquisition-date fair values as determined by the appraisal and other evaluations as follows (in millions):

Current assets, primarily inventory		$	77
Property, plant and equipment			491
Identifiable intangible assets			1
Current liabilities			(10	)
Other long-term liabilities			(3	)
Total consideration		$	556

Neither goodwill nor a gain from a bargain purchase was recognized in conjunction with the VeraSun Acquisition, and no significant contingent assets or liabilities were acquired or assumed in the acquisition.

The consolidated statements of income include the results of operations of the various ethanol plants commencing on their respective closing dates. As a result, pro forma information for the three months ended September 30, 2009 presented below represents actual results of operations. The operating revenues and net income associated with the acquired ethanol plants included in our consolidated statements of income for the three and nine months ended September 30, 2009, and the consolidated pro forma operating revenues, net income (loss), and earnings (loss) per common share – assuming dilution of the combined entity had the VeraSun Acquisition occurred on January 1, 2009 and 2008, are shown in the table below (in millions, except per share amounts). The pro forma information assumes that the purchase price was funded with proceeds from the issuance of $556 million of debt on January 1 of each respective year. The pro forma financial information is not necessarily indicative of the results of future operations.

		Three Months Ended								Nine Months Ended
		September 30,								September 30,
		2009				2008				2009				2008
Actual amounts from acquired business:
Operating revenues		$	410				N/A			$	673				N/A
Net income			29				N/A				42				N/A
Consolidated pro forma:
Operating revenues			19,489			$	36,429				51,461			$	101,756
Net income (loss)			(629	)			1,078				(581	)			2,082
Earnings (loss) per common share – assuming dilution			(1.12	)			2.04				(1.09	)			3.89

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Sale of Krotz Springs Refinery
Effective July 1, 2008, we sold our refinery in Krotz Springs, Louisiana to Alon Refining Krotz Springs, Inc. (Alon), a subsidiary of Alon USA Energy, Inc. The nature and significance of our post-closing participation in an offtake agreement with Alon represents a continuation of activities with the Krotz Springs Refinery for accounting purposes, and as such the results of operations related to the Krotz Springs Refinery have not been presented as discontinued operations in the consolidated statements of income for the three and nine months ended September 30, 2008. Under the offtake agreement, we agreed to (i) purchase all refined products from the Krotz Springs Refinery for three months after the effective date of the sale, (ii) purchase certain products for an additional one to five years after the expiration of the initial three-month period of the agreement, and (iii) provide certain refined products to Alon that are not produced at the Krotz Springs Refinery for an initial term of 15 months and thereafter until terminated by either party.

The sale resulted in a pre-tax gain of $305 million ($170 million after tax), which is presented in “gain on sale of Krotz Springs Refinery” in the consolidated statements of income for the three and nine months ended September 30, 2008. Cash proceeds, net of certain costs related to the sale, were $463 million, including approximately $135 million from the sale of working capital to Alon primarily related to the sale of inventory by our marketing and supply subsidiary.

In addition to the cash consideration received, we also received contingent consideration in the form of a three-year earn-out agreement based on certain product margins. This earn-out agreement qualified as a derivative contract and had a fair value of $171 million as of July 1, 2008. We hedged the risk of a decline in the referenced product margins by entering into certain commodity derivative contracts. On August 27, 2009, we settled the earn-out agreement with Alon for $35 million, of which $18 million was received on the settlement date and the remaining amount will be received in eight payments of $2.2 million each quarter beginning in the fourth quarter of 2009. In connection with the settlement of the earn-out agreement, we effectively closed our positions in the related commodity derivative contracts during the third quarter of 2009, as a result of which we locked in $175 million of cash proceeds on those contracts, approximately $80 million of which was received as of September 30, 2009 with the remaining proceeds to be received in varying monthly amounts through July 2011. As such, the total amount earned on the Alon earn-out agreement, including the related commodity derivative contracts, was $210 million.

Financial information as of July 1, 2008 related to the Krotz Springs Refinery assets and liabilities sold is summarized as follows (in millions):

Current assets (primarily inventory)		$	138
Property, plant and equipment, net			153
Goodwill			42
Deferred charges and other assets, net			4
Assets held for sale		$	337
Current liabilities		$	10
Liabilities related to assets held for sale		$	10

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

4. ASSET IMPAIRMENTS

Impairment of Long-Lived Assets
Long-lived assets are tested for recoverability whenever events or changes in circumstances indicate that the carrying amount of the long-lived assets may not be recoverable. A long-lived asset is not recoverable if its carrying amount exceeds the sum of the undiscounted cash flows expected to result from its use and eventual disposition. If a long-lived asset is not recoverable, an impairment loss is recognized in an amount by which its carrying amount exceeds its fair value.

In order to test long-lived assets for recoverability, management must make estimates of projected cash flows related to the asset being evaluated, which include, but are not limited to, assumptions about the use or disposition of the asset, its estimated remaining life, and future expenditures necessary to maintain its existing service potential. In order to determine fair value, management must make certain estimates and assumptions including, among other things, an assessment of market conditions, projected cash flows, investment rates, interest/equity rates, and growth rates, that could significantly impact the fair value of the asset being tested for impairment.

During the second half of 2008, there were severe disruptions in the capital and commodities markets that contributed to a significant decline in our common stock price, thus causing our market capitalization to decline to a level substantially below our net book value. Due to these adverse changes in market conditions during 2008, we evaluated our significant operating assets for potential impairment as of December 31, 2008, and we determined that the carrying amount of each of these assets was recoverable. The economic slowdown that began in 2008 continued throughout the first nine months of 2009, thereby impacting demand for refined products and putting significant pressure on refined product margins. Due to these economic conditions, in June 2009, we announced our plan to temporarily shut down the Aruba Refinery, which had a net book value of approximately $1.0 billion as of September 30, 2009, as narrow heavy sour crude oil differentials made the refinery uneconomical to operate. The Aruba Refinery was shut down in July 2009 and is expected to continue to be shut down until market conditions improve. We are continuing to evaluate potential alternatives for this refinery, which may include the sale of the refinery. In June 2009, the coker unit at the Corpus Christi East Refinery was also temporarily shut down and remains shut down. In September 2009, we announced the shutdown of our coker and gasification units at our Delaware City Refinery also due to economic reasons. The coker unit is expected to remain shut down until economics improve and the gasification unit has been permanently shut down. As a result of these factors, we readdressed the potential impairment of all of our facilities (excluding the Delaware City gasification unit) as of September 30, 2009 based on an assumption that we would operate these facilities in the future, incorporating updated 2009 price assumptions into our estimated cash flows. Based on this analysis, we determined that the carrying amount of each of our significant operating assets continued to be recoverable as of September 30, 2009. However, due to the permanent shutdown of the gasification unit at the Delaware City Refinery, we recorded a pre-tax loss of approximately $280 million related to the abandonment of that unit.

Capital Project Write-offs
Due to the impact of the continuing economic slowdown on refining industry fundamentals, we further evaluated the recoverability of all of our capital projects currently classified as “construction in progress” during the third quarter of 2009. This is a continuation of an ongoing process that had commenced during the second half of 2008. As a result of this assessment, certain additional capital projects were permanently cancelled, resulting in write-offs of $137 million of project costs for the three months ended

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 30, 2009 (of which approximately $60 million was for projects related to the gasification unit at our Delaware City Refinery). This amount, combined with capital projects written off earlier in 2009, has resulted in total write-offs of capital projects of $295 million for the nine months ended September 30, 2009. During the three months and nine months ended September 30, 2008, we wrote off $43 million of capital projects, the amount of which has been reclassified from operating expenses and presented separately for comparability with the 2009 presentation.

In addition to capital projects that have been written off, we have also suspended continued construction activity on various other projects. For example, our two hydrocracker projects on the Gulf Coast, one at the St. Charles Refinery and the other at the Port Arthur Refinery, have been temporarily suspended until market conditions and cash flows improve. As of September 30, 2009, approximately $1.0 billion of costs had been incurred on these two projects. In addition, various other projects with a total cost of approximately $600 million as of September 30, 2009 have also been temporarily suspended. These suspended projects are included in our strategic plan, and the costs incurred to date have not been written off. We believe that the overall market conditions and our cash flows will improve in the future such that the completion and recoverability of these temporarily suspended projects is probable.

Due to the effect of the current unfavorable economic conditions on the refining industry, and our expectations of a continuation of such conditions for the near term, we will continue to monitor both our operating assets and our capital projects for additional potential asset impairments until conditions improve. Changes in market conditions, as well as changes in assumptions used to test for recoverability and to determine fair value, could result in additional significant impairment charges in the future, thus affecting our earnings.

5. INVENTORIES

Inventories consisted of the following (in millions):

		September 30,				December 31,
		2009				2008
Refinery feedstocks		$	1,936			$	2,140
Refined products and blendstocks			2,240				2,224
Ethanol feedstocks and products			101				–
Convenience store merchandise			94				90
Materials and supplies			205				183
Inventories		$	4,576			$	4,637

As of September 30, 2009 and December 31, 2008, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by approximately $3.2 billion and $686 million, respectively.

6. DEBT

Non-Bank Debt
Under the indenture related to our $100 million of 6.75% senior notes with a maturity date of October 15, 2037, on July 31, 2009, we notified the holders of such notes of our obligation to purchase any of those notes for which a written notice of purchase (purchase notice) was received from the holders prior to

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

September 15, 2009. A purchase notice was received related to $76 million of the outstanding notes, which resulted in a charge of $6 million in the third quarter of 2009 to write off a pro rata portion of unamortized fair value adjustment. We redeemed the $76 million of notes at 100% of their principal amount plus accrued and unpaid interest to October 15, 2009, the date of the payment of the purchase price.

On April 1, 2009, we made scheduled debt repayments of $200 million related to our 3.5% notes and $9 million related to our 5.125% Series 1997D industrial revenue bonds.

In March 2009, we issued $750 million of 9.375% notes due March 15, 2019 and $250 million of 10.5% notes due March 15, 2039. Proceeds from the issuance of these notes totaled $998 million, before deducting underwriting discounts and other issuance costs of $8 million.

On February 1, 2008, we redeemed our 9.50% senior notes for $367 million, or 104.75% of stated value. These notes had a carrying amount of $381 million on the date of redemption, resulting in a gain of $14 million that was included in “other income (expense), net” in the consolidated statement of income. In addition, in March 2008, we made a scheduled debt repayment of $7 million related to certain of our other debt.

Bank Credit Facilities
In October 2009, Lehman Brothers Bank, FSB, one of the participating banks under our $2.5 billion revolving credit facility, failed to fund its loan commitment related to our borrowing under this facility discussed below. Lehman Brothers’ aggregate commitment under the revolving credit facility was $84 million. As a result, our borrowing capacity under that revolving credit facility has been reduced to $2.4 billion commencing in October 2009.

During the nine months ended September 30, 2009, we had no borrowings or repayments under our revolving bank credit facilities. As of September 30, 2009, we had no borrowings outstanding under our revolving bank credit facilities. In October 2009, we borrowed and subsequently repaid approximately $40 million under our U.S. committed revolving bank credit facility.

As of September 30, 2009, we had $76 million of letters of credit outstanding under our uncommitted short-term bank credit facilities and $113 million of letters of credit outstanding under our U.S. committed revolving credit facilities. Under our Canadian committed revolving credit facility, we had Cdn. $19 million of letters of credit outstanding as of September 30, 2009.

In June 2008, we entered into a one-year committed revolving letter of credit facility under which we could obtain letters of credit of up to $300 million to support certain of our crude oil purchases. In June 2009, we amended this agreement to extend the maturity date to June 2010. We are being charged letter of credit issuance fees in connection with the letter of credit facility.

During the nine months ended September 30, 2008, we borrowed and repaid $296 million under our U.S. committed revolving bank credit facility.

In July 2008, we entered into a one-year committed revolving letter of credit facility under which we could obtain letters of credit of up to $275 million. This credit facility expired in July 2009.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Accounts Receivable Sales Facility
We have an accounts receivable sales facility with a group of third-party entities and financial institutions to sell on a revolving basis up to $1 billion of eligible trade receivables. We amended our agreement in June 2009 to extend the maturity date to June 2010.

As of December 31, 2008, the amount of eligible receivables sold to the third-party entities and financial institutions was $100 million, which was repaid in February 2009. In March 2009, we sold $100 million of eligible receivables to the third-party entities and financial institutions. In April 2009, we sold an additional $400 million of eligible receivables under this program, which we repaid in June 2009. As of September 30, 2009, the amount of eligible receivables sold to the third-party entities and financial institutions was $100 million. Proceeds from the sale of receivables under this facility are reflected as debt in our consolidated balance sheets.

Other Disclosures
The estimated fair value of our debt, including current portion, was as follows (in millions):

		September 30,				December 31,
		2009				2008
Carrying amount		$	7,338			$	6,537
Fair value			8,335				6,462

7. STOCKHOLDERS’ EQUITY

Common Stock Offering
On June 3, 2009, we sold in a public offering 46 million shares of our common stock, which included 6 million shares related to an overallotment option exercised by the underwriters, at a price of $18.00 per share and received proceeds, net of underwriting discounts and commissions and other issuance costs, of $799 million.

Treasury Stock
No significant purchases of our common stock were made during the nine months ended September 30, 2009. During the nine months ended September 30, 2008, we purchased 14.6 million shares of our common stock at a cost of $774 million in connection with the administration of our employee benefit plans and common stock purchase programs authorized by our board of directors. During the nine months ended September 30, 2009 and 2008, we issued 0.9 million shares and 1.3 million shares, respectively, from treasury for our employee benefit plans.

Common Stock Dividends
On October 15, 2009, our board of directors declared a regular quarterly cash dividend of $0.15 per common share payable on December 9, 2009 to holders of record at the close of business on November 11, 2009.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

8. EARNINGS (LOSS) PER COMMON SHARE

Earnings (loss) per common share amounts were computed as follows (dollars and shares in millions, except per share amounts):

		Three Months Ended September 30,
		2009								2008
		Restricted				Common				Restricted				Common
		Stock				Stock				Stock				Stock
Earnings (loss) per common share:
Net income (loss)						$	(629	)						$	1,152
Less dividends paid:
Common stock							84								78
Nonvested restricted stock							–								–
Undistributed earnings (loss)						$	(713	)						$	1,074
Weighted-average common shares outstanding			2				561				1				522
Earnings (loss) per common share:
Distributed earnings		$	0.15			$	0.15			$	0.14			$	0.15
Undistributed earnings (loss)			–				(1.27	)			2.05				2.05
Total earnings (loss) per common share (1)		$	0.15			$	(1.12	)		$	2.19			$	2.20
Earnings (loss) per common share – assuming dilution:
Net income (loss)						$	(629	)						$	1,152
Weighted-average common shares outstanding							561								522
Common equivalent shares (2):
Stock options							–								6
Performance awards and other benefit plans							–								1
Weighted-average common shares outstanding – assuming dilution							561								529
Earnings (loss) per common share – assuming dilution						$	(1.12	)						$	2.18

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

		Nine Months Ended September 30,
		2009								2008
		Restricted				Common				Restricted				Common
		Stock				Stock				Stock				Stock
Earnings (loss) per common share:
Net income (loss)						$	(574	)						$	2,147
Less dividends paid:
Common stock							238								221
Nonvested restricted stock							1								–
Undistributed earnings (loss)						$	(813	)						$	1,926
Weighted-average common shares outstanding			2				534				1				526
Earnings (loss) per common share:
Distributed earnings		$	0.44			$	0.45			$	0.41			$	0.42
Undistributed earnings (loss)			–				(1.53	)			3.65				3.65
Total earnings (loss) per common share (1)		$	0.44			$	(1.08	)		$	4.06			$	4.07
Earnings (loss) per common share – assuming dilution:
Net income (loss)						$	(574	)						$	2,147
Weighted-average common shares outstanding							534								526
Common equivalent shares (2):
Stock options							–								8
Performance awards and other benefit plans							–								1
Weighted-average common shares outstanding – assuming dilution							534								535
Earnings (loss) per common share – assuming dilution						$	(1.08	)						$	4.02

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table reflects potentially dilutive securities that were excluded from the calculation of “earnings (loss) per common share – assuming dilution” as the effect of including such securities would have been antidilutive (in millions). As indicated above, common equivalent shares, which represent primarily stock options, were excluded as a result of the net losses reported for the three and nine months ended September 30, 2009. In addition, for all periods, certain stock option amounts presented below were excluded, representing outstanding stock options for which the exercise prices were greater than the average market price of the common shares during each respective reporting period.

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Common equivalent shares			4				–				4				–
Stock options			10				7				10				7

9. SUPPLEMENTAL CASH FLOW INFORMATION

In order to determine net cash provided by operating activities, net income (loss) is adjusted by, among other things, changes in current assets and current liabilities as follows (in millions):

		Nine Months Ended September 30,
		2009				2008
Decrease (increase) in current assets:
Restricted cash		$	(13	)		$	(90	)
Receivables, net			(966	)			1,120
Inventories			198				(842	)
Income taxes receivable			137				–
Prepaid expenses and other			119				(6	)
Increase (decrease) in current liabilities:
Accounts payable			1,466				476
Accrued expenses			94				32
Taxes other than income taxes			54				(77	)
Income taxes payable			65				(232	)
Changes in current assets and current liabilities		$	1,154			$	381

The above changes in current assets and current liabilities differ from changes between amounts reflected in the applicable consolidated balance sheets for the respective periods for the following reasons:

•

the amounts shown above exclude changes in cash and temporary cash investments, deferred income taxes, and current portion of debt and capital lease obligations;

•

the amounts shown above exclude the current assets and current liabilities acquired in connection with the VeraSun Acquisition;

•

amounts accrued for capital expenditures, deferred turnaround and catalyst costs, and contingent earn-out payments are reflected in investing activities in the consolidated statements of cash flows when such amounts are paid;

•

amounts accrued for common stock purchases in the open market that are not settled as of the balance sheet date are reflected in financing activities in the consolidated statements of cash flows when the purchases are settled and paid;

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•

changes in assets held for sale and liabilities related to assets held for sale pertaining to the operations of the Krotz Springs Refinery prior to its sale to Alon in July 2008 are reflected in the line items to which the changes relate in the table above; and

•

certain differences between consolidated balance sheet changes and consolidated statement of cash flow changes reflected above result from translating foreign currency denominated amounts at different exchange rates.

There were no significant noncash investing or financing activities for the nine months ended September 30, 2009 and 2008.

Cash flows related to interest and income taxes were as follows (in millions):

		Nine Months Ended September 30,
		2009				2008
Interest paid in excess of amount capitalized		$	232			$	187
Income taxes paid (net of tax refunds received)			(134	)			1,092

10. FAIR VALUE MEASUREMENTS

A fair value hierarchy (Level 1, Level 2, or Level 3) is used to categorize fair value amounts based on the quality of inputs used to measure fair value. Accordingly, fair values determined by Level 1 inputs utilize quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs are based on quoted prices for similar assets and liabilities in active markets, and inputs other than quoted prices that are observable for the asset or liability. Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability. We use appropriate valuation techniques based on the available inputs to measure the fair values of our applicable assets and liabilities. When available, we measure fair value using Level 1 inputs because they generally provide the most reliable evidence of fair value.

The tables below present information (dollars in millions) about our financial assets and liabilities measured and recorded at fair value on a recurring basis and indicate the fair value hierarchy of the inputs utilized by us to determine the fair values as of September 30, 2009 and December 31, 2008.

Fair Value Measurements Using

Quoted

Significant

Prices

Other

Significant

in Active

Observable

Unobservable

Total as of

Markets

Inputs

Inputs

September 30,

(Level 1)

(Level 2)

(Level 3)

2009

Assets:

Commodity derivative contracts

$

44

$

490

$

–

$

534

Nonqualified benefit plans

106

–

–

106

Liabilities:

Commodity derivative contracts

149

11

–

160

Certain nonqualified benefit plans

32

–

–

32

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Fair Value Measurements Using

Quoted

Significant

Prices

Other

Significant

in Active

Observable

Unobservable

Total as of

Markets

Inputs

Inputs

December 31,

(Level 1)

(Level 2)

(Level 3)

2008

Assets:

Commodity derivative contracts

$

40

$

610

$

–

$

650

Nonqualified benefit plans

98

–

–

98

Alon earn-out agreement

–

–

13

13

Liabilities:

Commodity derivative contracts

–

7

–

7

Certain nonqualified benefit plans

26

–

–

26

The valuation methods used to measure our financial instruments at fair value are as follows:

•

Commodity derivative contracts, consisting primarily of exchange-traded futures and swaps, are measured at fair value using the market approach. Exchange-traded futures are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy. Swaps are priced using third-party broker quotes, industry pricing services, and exchange-traded curves, with appropriate consideration of counterparty credit risk, but since they have contractual terms that are not identical to exchange-traded futures instruments with a comparable market price, these financial instruments are categorized in Level 2 of the fair value hierarchy.

•

Nonqualified benefit plan assets and certain nonqualified benefit plan liabilities are measured at fair value using a market approach based on quotations from national securities exchanges and are categorized in Level 1 of the fair value hierarchy.

•

The Alon earn-out agreement, which we received as partial consideration for the sale of our Krotz Springs Refinery in July 2008, was measured at fair value using a discounted cash flow model and was categorized in Level 3 of the fair value hierarchy through July 2009. Significant inputs to the model included expected payments and discount rates that considered the effects of both credit risk and the time value of money. On August 27, 2009, we settled the Alon earn-out agreement as discussed in Note 3. We have elected not to apply the fair value option to this settlement receivable.

Cash received from brokers of $41 million, resulting from the equity in broker accounts covered by master netting arrangements exceeding the minimum margin requirements for such accounts, is netted against the fair value of the commodity derivatives reflected in Level 1. Certain of our commodity derivative contracts under master netting arrangements include both asset and liability positions. We have elected to offset the fair value amounts recognized for multiple similar derivative instruments executed with the same counterparty, including any related cash collateral asset or obligation.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following is a reconciliation of the beginning and ending balances (in millions) for fair value measurements developed using significant unobservable inputs for the three and nine months ended September 30, 2009.

		Three Months Ended September 30,								Nine Months Ended September 30,
		2009				2008				2009				2008
Balance at beginning of period		$	38			$	–			$	13			$	–
Alon earn-out agreement (see Note 3)			(33	)			171				(33	)			171
Net realized and unrealized gains (losses) included in earnings			(5	)			(14	)			20				(14	)
Transfers in and/or out of Level 3			–				–				–				–
Balance at end of period		$	–			$	157			$	–			$	157

The above realized and unrealized gains and losses, which are reported in “other income (expense), net” in the consolidated statements of income, related to the Alon earn-out agreement that was settled in August 2009, as discussed above. These gains and losses were offset by the recognition in “other income (expense), net” of losses and gains on derivative instruments entered into to hedge the risk of changes in the fair value of the Alon earn-out agreement. The derivative instruments used to hedge the Alon earn-out agreement prior to the settlement are included in the “commodity derivative contracts” amounts reflected in the fair value table as of December 31, 2008 above.

The table below presents information (dollars in millions) about our nonfinancial liabilities measured and recorded at fair value on a nonrecurring basis that arose on or after January 1, 2009, and indicates the fair value hierarchy of the inputs utilized by us to determine the fair values as of September 30, 2009.

Fair Value Measurements Using

Quoted

Significant

Prices

Other

Significant

in Active

Observable

Unobservable

Total as of

Markets

Inputs

Inputs

September 30,

(Level 1)

(Level 2)

(Level 3)

2009

Liabilities:

Asset retirement obligations

$

–

$

–

$

13

$

13

Asset retirement obligations in the table above are calculated based on the present value of estimated removal and other closure costs using our internal risk-free rate of return or appropriate equivalent.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

11. PRICE RISK MANAGEMENT ACTIVITIES

We enter into derivative instruments to manage our exposure to commodity price risk, interest rate risk, and foreign currency risk, and to hedge price risk on other contractual derivatives that we have entered into. In addition, we use derivative instruments for trading purposes based on our fundamental and technical analysis of market conditions. All derivative instruments are recorded on our balance sheet as either assets or liabilities measured at their fair values. When we enter into a derivative instrument, it is designated as a fair value hedge, a cash flow hedge, an economic hedge, or a trading activity. The gain or loss on a derivative instrument designated and qualifying as a fair value hedge, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk, are recognized currently in income in the same period. The effective portion of the gain or loss on a derivative instrument designated and qualifying as a cash flow hedge is initially reported as a component of other comprehensive income and is then recorded in income in the period or periods during which the hedged forecasted transaction affects income. The ineffective portion of the gain or loss on the cash flow derivative instrument, if any, is recognized in income as incurred. For our economic hedging relationships (hedges not designated as fair value or cash flow hedges) and for derivative instruments entered into by us for trading purposes, the derivative instrument is recorded at fair value and changes in the fair value of the derivative instrument are recognized currently in income. The cash flow effects of all of our derivative contracts are reflected in operating activities in the consolidated statements of cash flows for all periods presented.

Commodity Price Risk
We are exposed to market risks related to the volatility of crude oil and refined product prices, as well as volatility in the price of natural gas used in our refining operations. To reduce the impact of this price volatility on our results of operations and cash flows, we use commodity derivative instruments, including swaps, futures, and options, to manage our exposure to commodity price risks. For such risk management purposes, we use fair value hedges, cash flow hedges, and economic hedges.

In addition to the use of derivative instruments to manage commodity price risk, we also enter into certain commodity derivative instruments for trading purposes. Our objectives for entering into each of these types of derivative instruments and the level of activity of each as of September 30, 2009 are described below.

Fair Value Hedges
Fair value hedges are used to hedge certain refining inventories and firm commitments to purchase inventories. The level of activity for our fair value hedges is based on the level of our operating inventories, and normally represents the amount by which our inventories differ from our previous year-end LIFO inventory levels.

As of September 30, 2009, we had the following outstanding commodity derivative instruments that were entered into to hedge crude oil and refined product inventories. The information presents the volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels).

Derivative Instrument / Maturity		Contract Volumes
Futures – short (2009)			5,133

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Cash Flow Hedges
Cash flow hedges are used to hedge certain forecasted feedstock and product purchases, refined product sales, and natural gas purchases. The purpose of our cash flow hedges is to lock in the price of forecasted feedstock or natural gas purchases or refined product sales at existing market prices that are deemed favorable by management.

As of September 30, 2009, we had the following outstanding commodity derivative instruments that were entered into to hedge forecasted purchases or sales of crude oil and refined products. The information presents the volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels).

Derivative Instrument / Maturity		Contract Volumes
Swaps – long:
2009			10,722
2010			24,810
Swaps – short:
2009			10,722
2010			24,810
Futures – long (2009)			1,218

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Economic Hedges
Economic hedges are hedges not designated as fair value or cash flow hedges that are used to (i) manage price volatility in certain refinery feedstock, refined product, and grain inventories, and (ii) manage price volatility in certain forecasted refinery feedstock, product, and grain purchases, refined product sales, and natural gas purchases. In addition, through August 2009, we used economic hedges to manage price volatility in the referenced product margins associated with the Alon earn-out agreement, which was a separate contractual derivative that we entered into with the sale of our Krotz Springs Refinery but which was settled in August 2009, as further discussed in Note 3. Our objective in entering into economic hedges is consistent with the objectives discussed above for fair value hedges and cash flow hedges. However, the economic hedges are not designated as a fair value hedge or a cash flow hedge for accounting purposes, usually due to the difficulty of establishing the required documentation at the date that the derivative instrument is entered into that would allow us to achieve “hedge deferral accounting.” As of September 30, 2009, we had the following outstanding commodity derivative instruments that were entered into as economic hedges. The information presents the volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels, except those identified as grain contracts that are presented in thousands of bushels).

Derivative Instrument / Maturity		Contract Volumes
Swaps – long:
2009			45,030
2010			107,194
2011			26,275
Swaps – short:
2009			20,458
2010			63,633
2011			11,025
Futures – long:
2009			222,053
2010			102,235
2009 (grain)			3,705
2010 (grain)			75
Futures – short:
2009			216,315
2010			101,388
2009 (grain)			10,585
2010 (grain)			4,495
Options – long:
2009			6
2010			511
Options – short:
2010			500

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Trading Activities

These represent commodity derivative instruments held or issued for trading purposes. Our objective in entering into commodity derivative instruments for trading purposes is to take advantage of existing market conditions related to crude oil and refined products that management perceives as opportunities to benefit our results of operations and cash flows, but for which there are no related physical transactions. As of September 30, 2009, we had the following outstanding commodity derivative instruments that were entered into for trading purposes. The information presents the volume of outstanding contracts by type of instrument and year of maturity (volumes represent thousands of barrels, except those identified as natural gas contracts that are presented in billions of British thermal units).

Derivative Instrument / Maturity		Contract Volumes
Swaps – long:
2009			6,502
2010			23,589
2011			3,000
Swaps – short:
2009			5,679
2010			27,946
2011			3,900
Futures – long:
2009			25,809
2010			4,318
2009 (natural gas)			3,750
2010 (natural gas)			100
Futures – short:
2009			25,859
2010			4,268
2009 (natural gas)			3,750
2010 (natural gas)			100
Options – long:
2009			40
Options – short:
2009			40

Interest Rate Risk
Our primary market risk exposure for changes in interest rates relates to our debt obligations. We manage our exposure to changing interest rates through the use of a combination of fixed-rate and floating-rate debt. In addition, we have at times used interest rate swap agreements to manage our fixed to floating interest rate position by converting certain fixed-rate debt to floating-rate debt. These interest rate swap agreements are generally accounted for as fair value hedges. However, we have not had any outstanding interest rate swap agreements since 2006.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Foreign Currency Risk
We are exposed to exchange rate fluctuations on transactions related to our Canadian operations. To manage our exposure to these exchange rate fluctuations, we use foreign currency exchange and purchase contracts. These contracts are not designated as hedging instruments for accounting purposes, and therefore they are classified as economic hedges. As of September 30, 2009, we had commitments to purchase $248 million of U.S. dollars. These commitments matured on or before November 2, 2009, resulting in a $5 million loss in the fourth quarter of 2009.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Fair Values of Derivative Instruments
The following tables provide information about the fair values of our derivative instruments as of September 30, 2009 (in millions) and the line items in the balance sheet in which the fair values are reflected. See Note 10 for additional information related to the fair values of our derivative instruments. As indicated in Note 10, we net fair value amounts recognized for multiple similar derivative instruments executed with the same counterparty under master netting arrangements. The table below, however, is presented on a gross asset and gross liability basis, which results in the reflection of certain assets in liability accounts and certain liabilities in asset accounts. In addition, in Note 10 we netted cash received from brokers attributable to excess margin against the fair value of the commodity derivatives; this cash receipt is not reflected in the table below.

Asset Derivatives

Liability Derivatives

Balance Sheet

Balance Sheet

Location

Fair Value

Location

Fair Value

Derivatives designated as hedging instruments

Commodity contracts:

Futures

Receivables, net

$

12

Receivables, net

$

5

Futures

Accrued expenses

60

Accrued expenses

52

Swaps

Receivables, net

315

Receivables, net

267

Swaps

Prepaid expenses and other current assets

1,025

Prepaid expenses and other current assets

902

Swaps

Accrued expenses

3

Accrued expenses

4

Total derivatives designated as hedging instruments

$

1,415

$

1,230

Derivatives not designated as hedging instruments

Commodity contracts:

Futures

Receivables, net

$

23

Receivables, net

$

26

Futures

Accrued expenses

2,273

Accrued expenses

2,349

Swaps

Receivables, net

575

Receivables, net

430

Swaps

Prepaid expenses and other current assets

1,254

Prepaid expenses and other current assets

1,079

Swaps

Accrued expenses

13

Accrued expenses

24

Options

Prepaid expenses and other current assets

1

Prepaid expenses and other current assets

1

Options

Accrued expenses

–

Accrued expenses

–

Foreign currency contracts

Receivables, net

–

Accounts payable

–

Total derivatives not designated as hedging instruments

$

4,139

$

3,909

Total derivatives

$

5,554

$

5,139

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Market and Counterparty Risk
Our price risk management activities involve the receipt or payment of fixed price commitments into the future. These transactions give rise to market risk, the risk that future changes in market conditions may make an instrument less valuable. We closely monitor and manage our exposure to market risk on a daily basis in accordance with policies approved by our board of directors. Market risks are monitored by a risk control group to ensure compliance with our stated risk management policy. Concentrations of customers in the refining industry may impact our overall exposure to counterparty risk, in that these customers may be similarly affected 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 may be adversely affected by periods of uncertainty and illiquidity in the credit and capital markets.

As of September 30, 2009, we had net receivables related to derivative instruments of $27 million from counterparties in the refining industry and $271 million from counterparties in the financial services industry. These amounts represent the aggregate receivables from companies in those industries, reduced by payables from us to those companies under master netting arrangements that allow for the setoff of amounts receivable from and payable to the same party. We do not require any collateral or other security to support derivative instruments that we enter into. We also do not have any derivative instruments that require us to maintain a minimum investment-grade credit rating.

Effect of Derivative Instruments on Statements of Income and Other Comprehensive Income
The following tables provide information about the gain or loss recognized in income and other comprehensive income on our derivative instruments for the three and nine months ended September 30, 2009 (in millions), and the line items in the financial statements in which such gains and losses are reflected.

Location

Location

Amount

of Gain or

of Gain or

Amount

of Gain or

(Loss)

Amount of

(Loss)

of Gain or

(Loss)

Derivatives in

Recognized

Gain or (Loss)

Recognized

(Loss)

Recognized

Fair Value

in Income

Recognized in

in Income

Recognized

in Income for

Hedging

on

Income

on

in Income

Ineffective Portion

Relationships

Derivatives

on Derivatives

Hedged Item

on Hedged Item

of Derivative (1)

Three

Nine

Three

Nine

Three

Nine

Months

Months

Months

Months

Months

Months

Ended

Ended

Ended

Ended

Ended

Ended

September 30, 2009

September 30, 2009

September 30, 2009

Commodity contracts

Cost of sales

$

(5

)

$

(94

)

Cost of sales

$

(3

)

$

87

$

(8

)

$

(7

)

Total

$

(5

)

$

(94

)

$

(3

)

$

87

$

(8

)

$

(7

)

(1)

For fair value hedges, no component of the derivative instruments’ gains or losses was excluded from the assessment of hedge effectiveness. No amounts were recognized in income for hedged firm commitments that no longer qualify as fair value hedges.

VALERO ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amount of

Location of

Amount of

Location of

Amount of

Gain or (Loss)

Gain or (Loss)

Gain or (Loss)

Gain or (Loss)

Gain or (Loss)

Derivatives in

Recognized in

Reclassified from

Reclassified

Recognized in

Recognized in

Cash Flow

OCI on

Accumulated OCI

from Accumulated

Income on

Income on

Hedging

Derivatives

into Income

OCI into Income

Derivatives

Derivatives

Relationships

(Effective Portion)

(Effective Portion)

(Effective Portion)

(Ineffective Portion)

(Ineffective Portion) (1)

Three

Nine

Three

Nine

Three

Nine

Months

Months

Months

Months

Months

Months

Ended

Ended

Ended

Ended

Ended

Ended

September 30, 2009

September 30, 2009

September 30, 2009

Commodity contracts (2)

$

36

$

133

Cost of sales

$

83

$

255

Cost of sales

$

6

$

5

Total

$

36

$

133

$

83

$

255

$

6

$

5