FORM 10-K

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

(Mark One)

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

For the fiscal year ended December 31, 2005

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

Registrant’s telephone number, including area code: (210) 345-2000

Securities registered pursuant to Section 12(b) of the Act: Common stock, $0.01 par value per share, and Preferred Share Purchase Rights, listed on the New York Stock Exchange.

Securities registered pursuant to Section 12(g) of the Act: None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule12b-2 of the Exchange Act).

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

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

The aggregate market value of the voting and non-voting common stock held by non-affiliates was approximately $20.4 billion based on the last sales price quoted as of June 30, 2005 on the New York Stock Exchange, the last business day of the registrant’s most recently completed second fiscal quarter.

As of January 31, 2006, 621,838,191 shares of the registrant’s common stock were issued and outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

We intend to file with the Securities and Exchange Commission before March 31, 2006 a definitive Proxy Statement for our Annual Meeting of Stockholders scheduled for April 27, 2006, at which our directors will be elected. Portions of the 2006 Proxy Statement are incorporated by reference in Part III of this Form 10-K and are deemed to be a part of this report.

 

 

CROSS-REFERENCE SHEET

The following table indicates the headings in the 2006 Proxy Statement where the information required in Part III of Form 10-K may be found.

Form 10-K Item No. and Caption		Heading in 2006 Proxy Statement
10. Directors and Executive Officers of the Registrant		Information Regarding the Board of Directors, Independent Directors, Audit Committee, Code of Ethics for Senior Financial Officers, Proposal No. 1 Election of Directors , Information Concerning Nominees and Other Directors and Section 16(a) Beneficial Ownership Reporting Compliance
11. Executive Compensation		Compensation Committee, Compensation of Directors, Performance Graph, Executive Compensation and Certain Relationships and Related Transactions
12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters		Beneficial Ownership of Valero Securities and Equity Compensation Plan Information
13. Certain Relationships and Related Transactions		Certain Relationships and Related Transactions
14. Principal Accountant Fees and Services		KPMG LLP Fees for Fiscal Years 2005 and 2004 and Audit Committee Pre-Approval Policy

Copies of all documents incorporated by reference, other than exhibits to such documents, will be provided without charge to each person who receives a copy of this Form 10-K upon written request to Jay D. Browning, Vice President and Corporate Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269-6000.

ii
 

CONTENTS

		PAGE
PART I
Items 1., 1A. & 2. Business, Risk Factors and Properties			1
Recent Developments			2
Segments			2
Valero’s Operations			3
Risk Factors			12
Environmental Matters			14
Properties			14
Executive Officers of the Registrant			15
Item 1B. Unresolved Staff Comments			16
Item 3. Legal Proceedings			16
Item 4. Submission of Matters to a Vote of Security Holders			17
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			18
Item 6. Selected Financial Data			20
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			45
Item 8. Financial Statements and Supplementary Data			50
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			126
Item 9A. Controls and Procedures			126
Item 9B. Other Information			126
PART III
Item 10. Directors and Executive Officers of the Registrant			127
Item 11. Executive Compensation			127
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			127
Item 13. Certain Relationships and Related Transactions			127
Item 14. Principal Accountant Fees and Services			127
PART IV
Item 15. Exhibits and Financial Statement Schedules			127
Signatures			133
Third Certificate of Amendment to Restated Certificate of Incorporation
Third Supplemental Indenture
Fourth Supplemental Indenture
Guaranty
Guaranty
2001 Executive Stock Incentive Plan
2003 Employee Stock Incentive Plan
Stock Option Plan, as Amended and Restated
Statements of Computations of Ratios of Earnings to Fixed Charges
Subsidiaries
Consent of KPMG LLP
Consent of Ernst & Young LLP
Rule 13a-14(a) Certifications
Section 1350 Certifications
Audit Committee Pre-Approval Policy

iii
 

PART I

Unless otherwise indicated, the terms “Valero,” “we,” “our” and “us” are used in this report to refer to Valero Energy Corporation, to one or more of our consolidated subsidiaries or to all of them taken as a whole. In the following Items 1, 1A and 2, “Business, Risk Factors and Properties,” we make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions and resources, that are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words “forecasts,” “intends,” “believes,” “expects,” “plans,” “scheduled,” “goal,” “may,” “anticipates,” “estimates” and similar expressions identify forward-looking statements. We do not undertake to update, revise or correct any of the forward-looking information. Our forward-looking statements should be read in conjunction with our disclosures beginning on page 21 of this report under the heading: “CAUTIONARY STATEMENT FOR THE PURPOSE OF SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.”

ITEMS 1., 1A. and 2. BUSINESS, RISK FACTORS AND PROPERTIES

Overview . We are a Fortune 500 company based in San Antonio, Texas. Our principal executive offices are at One Valero Way, San Antonio, Texas, 78249, and our telephone number is (210) 345-2000. Our common stock trades on the New York Stock Exchange under the symbol “VLO.” We were incorporated in Delaware in 1981 under the name Valero Refining and Marketing Company; our name was changed to Valero Energy Corporation on August 1, 1997. On January 31, 2006, we had 22,068 employees.

We own and operate 18 refineries located in the United States, Canada and Aruba that produce premium, environmentally clean refined products such as reformulated gasoline (RFG), gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur diesel fuel and oxygenates (liquid hydrocarbon compounds containing oxygen). We also produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants and other refined products.

We market branded and unbranded refined products on a wholesale basis in the United States and Canada through an extensive bulk and rack marketing network. We also sell refined products through a network of approximately 5,000 retail and wholesale branded outlets in the United States, Canada and Aruba.

We are the general partner of Valero L.P., a publicly traded master limited partnership (NYSE: VLI). Our ownership interest in Valero L.P. was 23.4% as of December 31, 2005, which was composed of a 2% general partner interest and a 21.4% limited partner interest. Our investment in and transactions with Valero L.P. are discussed further in Note 9 of Notes to Consolidated Financial Statements.

Available Information . Our internet website address is http://www.valero.com. Information contained on our website is not part of this report on Form 10-K. Our annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K filed with (or furnished to) the Securities and Exchange Commission (SEC) are available on our internet website (in the “Investor Relations” section), free of charge, as soon as reasonably practicable after we file or furnish such material. We also post our corporate governance guidelines, code of business conduct and ethics, code of ethics for senior financial officers and the charters of our board’s committees in the same website location. Our governance documents are available in print to any stockholder that makes a written request to Jay D. Browning, Vice President and Corporate Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269-0600.

RECENT DEVELOPMENTS

Stock Split . On September 15, 2005, our board of directors approved a two-for-one split of our common stock. The stock split was effected in the form of a stock dividend which was distributed on December 15, 2005. All share and per share data (except par value) in this Form 10-K have been adjusted to reflect the effect of the stock split for all periods presented.

Premcor Acquisition. On September 1, 2005, we completed the merger of Premcor Inc. with and into Valero Energy Corporation (the Premcor Acquisition). When used in this report, “Premcor” means Premcor Inc. or one or more of its wholly owned subsidiaries at the time of the Premcor Acquisition. Premcor was an independent petroleum refiner and supplier of unbranded transportation fuels, heating oil, petrochemical feedstocks, petroleum coke and other petroleum products with all of its operations in the United States. Premcor owned and operated refineries in Port Arthur, Texas; Lima, Ohio; Memphis, Tennessee; and Delaware City, Delaware, with a combined crude oil throughput capacity of approximately 800,000 barrels per day.

In the merger, we issued 85 million shares of Valero common stock and paid $3.4 billion of cash to Premcor stockholders. We paid the cash portion of the merger consideration from available cash and proceeds from a $1.5 billion bank term loan (which we fully repaid by December 31, 2005). In addition, we assumed Premcor’s existing debt, which had a fair value of $1.9 billion as of September 1, 2005. The Premcor Acquisition and the Premcor debt that we assumed are more fully described in Notes 2 and 12 of Notes to Consolidated Financial Statements in Item 8 of this report. We hereby incorporate by reference those disclosures into this Item.

SEGMENTS

Our business is organized into two reportable segments: refining and retail. Our refining segment includes refining operations, wholesale marketing, product supply and distribution, and transportation operations. The refining segment is segregated geographically into the Gulf Coast, Mid-Continent, West Coast and Northeast regions.

Our retail segment includes company-operated convenience stores, Canadian dealers/jobbers, truckstop facilities, cardlock facilities and home heating oil operations. The retail segment is segregated into two geographic regions. Our retail operations in eastern Canada are referred to as the Northeast System. Our retail operations in the United States are referred to as the U.S. System. The financial information about our segments in Note 21 of Notes to Consolidated Financial Statements is incorporated herein by reference.

We process a wide slate of feedstocks, including sour crude oils, intermediates and residual fuel oil (resid) which can typically be purchased at a discount to West Texas Intermediate, a benchmark crude oil. In the fourth quarter of 2005, sour crude oils, acidic sweet crude oils and resid represented 55% of our throughput volumes, sweet crude oils represented 30%, and the remaining 15% was composed of blendstocks and other feedstocks. Our ability to process significant amounts of sour crude oils enhances our competitive position in the industry relative to refiners that process primarily sweet crude oils because sour crude oils typically can be purchased at a discount to sweet crude oils.

In the fourth quarter of 2005, gasolines and blendstocks represented 47% of our refined product slate; distillates – such as home heating oil, diesel fuel and jet fuel – represented 32%; petrochemicals represented 3%; and asphalt, lubricants, gas oils, no. 6 fuel oil, petroleum coke and other products comprised the remaining 18%.

Gulf Coast

The following table presents the percentages of principal charges and yields (on a combined basis) for the nine refineries in this region for the year ended December 31, 2005. Total throughput volumes for the Gulf Coast refining region averaged 1,364,000 BPD and 1,586,600 BPD for the twelve months and three months ended December 31, 2005, respectively.

Combined Gulf Coast Region Charges and Yields *
Fiscal 2005 Actual

				Percentage
Charges:
		sour crude oil			53	%
		high-acid sweet crude oil			2	%
		sweet crude oil			16	%
		residual fuel oil			13	%
		other feedstocks			6	%
		blendstocks			10	%
Yields:
		gasolines and blendstocks			43	%
		distillates			30	%
		petrochemicals			4	%
		other products (includes vacuum gas oil, no. 6 fuel oil, petroleum coke, asphalt and other)			23	%

Corpus Christi East and West Refineries . Our Corpus Christi East and West Refineries are located along the Corpus Christi Ship Channel on the Texas Gulf Coast. The West Refinery is a highly complex refinery that specializes in processing primarily lower-cost sour crude oil and resid into premium products such as RFG and RBOB. ¹ The East Refinery is also a complex refinery that processes heavy, high-sulfur crude oil into conventional gasoline, diesel, jet fuel, asphalt, aromatics and other light products. We have operated the East Refinery since 2001 and have substantially integrated the operations of the West and East Refineries, allowing for the transfer of various feedstocks and blending components between the two refineries and the sharing of resources. The refineries typically receive and deliver feedstocks and products by tanker and barge via deepwater docking facilities along the Corpus Christi Ship Channel. An eight-bay truck rack services local markets. The refineries distribute refined products using the Colonial, Explorer, Valley and other major pipelines, including pipelines owned by Valero L.P.

Port Arthur Refinery . Our Port Arthur Refinery is located on the Texas Gulf Coast approximately 90 miles east of Houston. The refinery processes primarily heavy sour crude oils and other feedstocks into conventional, premium and reformulated gasoline as well as diesel, jet fuel, petrochemicals, petroleum coke and sulfur. The refinery receives crude oil over marine docks and has access to the Sunoco and Oiltanking terminals at Nederland, Texas. Finished products are distributed into the Colonial, Explorer and TEPPCO pipelines or across the refinery docks into ships or barges. The refinery also has convenient truck-rack access.

Aruba Refinery . Our Aruba Refinery is located on the island of Aruba in the Caribbean Sea. It generally processes heavy sour crude oil and produces primarily intermediate feedstocks and finished distillate products. Significant amounts of the refinery’s intermediate feedstock production are processed in our other refineries in the Gulf Coast, West Coast and Northeast regions. The refinery receives crude oil by ship at its two deepwater marine docks which can berth ultra-large crude carriers. The refinery’s products are delivered by ship primarily into markets in the U.S. Gulf Coast, Florida, the New York Harbor, the Caribbean and Europe.

St. Charles Refinery . Our St. Charles Refinery is located approximately 15 miles from New Orleans along the Mississippi River. The refinery processes sour crude oils and other feedstocks into a high percentage of gasoline, distillates and other light products. The refinery receives crude oil over five marine docks and has access to the Louisiana Offshore Oil Port where it can receive crude oil through a 24-inch pipeline. Finished products can be shipped over these docks or by pipeline into either the Plantation or Colonial pipeline network for distribution to the eastern United States.

Texas City Refinery . Our Texas City Refinery is located southeast of Houston on the Texas City Ship Channel. The refinery processes primarily heavy sour crude oils into a wide slate of products. The refinery typically receives and delivers its feedstocks and products by tanker and barge via deepwater docking facilities along the Texas City Ship Channel and also has access to the Colonial, Explorer and TEPPCO pipelines for distribution of its products.

Houston Refinery . Our Houston Refinery is located on the Houston Ship Channel. It generally processes sour crude oils and low-sulfur resid into conventional gasoline and distillates. The plant also produces roofing-grade asphalt. The refinery typically receives its feedstocks via tanker at deepwater docking facilities along the Houston Ship Channel and primarily delivers its products through major refined-product pipelines, including the Colonial, Explorer and TEPPCO pipelines.

Three Rivers Refinery . Our Three Rivers Refinery is located in South Texas between Corpus Christi and San Antonio. It generally processes heavy sweet and sour crude oils into conventional gasoline and distillates. The refinery has access to crude oil from foreign sources delivered to the Texas Gulf Coast at Corpus Christi as well as crude oil from domestic sources through third-party pipelines. A 70-mile pipeline that can deliver 120,000 BPD of crude oil connects the Three Rivers Refinery to Corpus Christi. The refinery distributes its refined products primarily through pipelines owned by Valero L.P.

Krotz Springs Refinery . Our Krotz Springs Refinery is located between Baton Rouge and Lafayette, Louisiana on the Atchafalaya River. It generally processes light sweet crude oils (received primarily by pipeline and barge) into conventional gasoline and distillates. The refinery’s location provides access to upriver markets on the Mississippi River, and its docking facilities along the Atchafalaya River are sufficiently deep to allow barge access. The facility also uses the Colonial pipeline to transport products to markets in the Southeast and Northeast.

Benicia Refinery . Our Benicia Refinery is located northeast of San Francisco on the Carquinez Straits of San Francisco Bay. It is a highly complex refinery that processes sour crude oils into a high percentage of premium products, primarily CARBOB gasoline. (CARBOB is a reformulated gasoline mixture that meets the specifications of the California Air Resources Board when blended with ethanol.) The refinery receives crude oil supplies via a deepwater dock that can berth large crude oil carriers and a 20-inch crude oil pipeline connected to a southern California crude oil delivery system. Most of the refinery’s products are distributed via the Kinder Morgan pipeline in California.

Wilmington Refinery . Our Wilmington Refinery is located near Los Angeles, California. The refinery processes a blend of lower-cost heavy and high-sulfur crude oils. The refinery can produce all of its gasoline as CARBOB gasoline and produces both ultra-low-sulfur diesel and CARB diesel. The refinery is connected by pipeline to marine terminals and associated dock facilities that can move and store crude oil and other feedstocks. Refined products are distributed via the Kinder Morgan pipeline system and various third-party terminals in southern California, Nevada and Arizona.

Memphis Refinery . Our Memphis Refinery is located in Tennessee along the Mississippi River’s Lake McKellar. It processes primarily light sweet crude oils. Almost all of its production is light products, including regular and premium gasoline, diesel, jet fuels and petrochemicals. Crude oil is supplied to the refinery via the Capline Pipeline and can also be received, along with other feedstocks, via barge. The refinery’s products are distributed primarily via truck racks at our three product terminals, barges, and a pipeline directly to the Memphis airport.

McKee Refinery . Our McKee Refinery is located in the Texas Panhandle. It processes primarily sweet crude oils and produces conventional gasoline, RFG, low-sulfur diesel, jet fuels and asphalt. The refinery has access to crude oil from Texas, Oklahoma, Kansas and Colorado through Valero L.P.’s pipelines and third-party pipelines. The refinery also has access at Wichita Falls, Texas to third-party pipelines that transport crude oil from the Texas Gulf Coast and West Texas to the Mid-Continent region. The refinery distributes its products primarily via Valero L.P.’s pipelines to markets in Texas, New Mexico, Arizona, Colorado and Oklahoma.

Lima Refinery . Our Lima Refinery is located in Ohio between Toledo and Dayton. It currently processes primarily light sweet crude oils. The refinery produces conventional gasoline, RFG, diesel, jet fuels and petrochemicals. Crude oils are delivered to the refinery through the Mid-Valley and Marathon pipelines. The refinery’s products are distributed through the Buckeye and Inland pipeline systems and by rail and truck to markets in Ohio, Indiana, Illinois, Michigan and western Pennsylvania.

Ardmore Refinery . Our Ardmore Refinery is located in Ardmore, Oklahoma, approximately 90 miles from Oklahoma City. It primarily processes light sweet crude oils into conventional gasoline, low-sulfur diesel and asphalt. Crude oil is delivered to the refinery through Valero L.P.’s crude oil gathering and trunkline systems, third-party pipelines and trucking operations. Refined products are transported via pipelines, railcars and trucks.

Jean Gaulin Refinery . Our Jean Gaulin Refinery is located in Lévis, Canada (near Quebec City). It generally processes sweet crude oils and lower-quality, sweet acidic crude oils into conventional gasoline, low-sulfur diesel, jet fuels, heating oil and propane. The refinery receives crude oil by ship at its deepwater dock on the St. Lawrence River. We charter large ice-strengthened, double-hulled crude oil tankers that can navigate the St. Lawrence River year-round. The refinery transports its products primarily by train to markets in Quebec and New Brunswick, and by tankers and trucks throughout Canada’s Atlantic Provinces.

Delaware City Refinery . Our Delaware City Refinery is located along the Delaware River near Wilmington, Delaware. The refinery processes primarily sour crude oils into a wide slate of products including conventional gasoline, RFG, low-sulfur diesel and home heating oil. Feedstocks and refined products are typically transported via pipeline, barge and truck-rack facilities. The refinery’s production is sold primarily in the U.S. Northeast.

Paulsboro Refinery . Our Paulsboro Refinery is located in Paulsboro, New Jersey, approximately 15 miles south of Philadelphia on the Delaware River. The refinery processes primarily sour crude oils into a wide slate of products including gasoline, distillates, lube oil basestocks, asphalt and fuel oil. Feedstocks and refined products are typically transported by tanker and barge via refinery-owned dock facilities along the Delaware River, ExxonMobil’s product distribution system, an onsite truck rack, railcars and the Colonial pipeline, which allows products to be sold into the New York Harbor market.

      Feedstock Supply

Approximately 65% of our current crude oil feedstock requirements are purchased through term contracts while the remaining requirements are generally purchased on the spot market. Our term supply agreements include arrangements to purchase feedstocks at market-related prices directly or indirectly from various foreign national oil companies (including feedstocks originating in Saudi Arabia, Mexico, Iraq, Kuwait, Venezuela, Ecuador and Africa) as well as international and domestic oil companies. About 75% of these crude oil feedstocks are imported from foreign sources and about 25% are domestic. In the event we become unable to purchase crude oil from any one of these sources, we believe that adequate alternative supplies of crude oil would be available.

The U.S. network of crude oil pipelines and terminals allows us to acquire crude oil from producing leases, domestic crude oil trading centers and ships delivering cargoes of foreign and domestic crude oil. Our Jean Gaulin and Aruba Refineries rely on foreign crude oil that is delivered to the refineries’ dock facilities by ship. We use the futures market to manage a portion of the price risk inherent in purchasing crude oil in advance of our delivery date and in maintaining our inventories of crude oils and refined products.

      Refining Segment Sales

Our refining segment includes sales of refined products in both the wholesale rack and bulk markets. These sales include refined products that are manufactured in our refining operations as well as refined products purchased or received on exchange from third parties. Most of our refineries have access to deepwater transportation facilities and interconnect with common-carrier pipeline systems, allowing us to sell products in most major geographic regions of the United States and eastern Canada. No customer accounted for more than 10% of our total operating revenues in 2005.

      Wholesale Marketing

We market branded and unbranded transportation fuels on a wholesale basis in about 40 states primarily through an extensive rack marketing network. The principal purchasers of our transportation fuels from terminal truck racks are wholesalers, distributors, retailers and truck-delivered end users throughout the United States.

The majority of our rack volumes are sold through unbranded channels. The remainder is sold to distributors and dealers that are members of the Valero-brand family that operate approximately 3,000 branded sites. These sites are independently owned and are supplied by us under multi-year contracts. For wholesale branded sites, we promote our Valero ^® and Beacon ^® brands in California. Elsewhere in the United States, we promote our Valero ^® and Shamrock ^® brands, and we are in the process of converting Diamond Shamrock ^® branded sites to the Valero ^® brand.

We also sell a variety of other products produced at our refineries including asphalt, lube base oils, petroleum coke and sulfur. These products are transported via pipelines, barges, trucks and railcars. We produce approximately 60,000 BPD of asphalt which is sold to customers in the paving and roofing industries. We are the second largest producer of asphalt in the United States. We produce asphalt at seven refineries and market asphalt in 20 states through 15 terminal facilities. We also produce packaged roofing products at four manufacturing facilities, and modified paving asphalts at nine polymer modifying plants. We are the largest producer of petroleum coke in the United States, supplying primarily power generation customers and cement manufacturers. We are also one of the largest producers of sulfur in the United States with sales primarily to customers in the agricultural sector.

We produce and market a variety of commodity petrochemicals including aromatic solvents (benzene, toluene and xylene), refinery- and chemical-grade propylene and anhydrous ammonia. Aromatic solvents and propylene are sold to customers in the chemical industry for further processing into such products as paints, plastics and adhesives. Ammonia is sold to customers in the agriculture industry to be used as fertilizer.

      Bulk Sales and Trading

We sell a significant portion of our gasoline and distillate production through bulk sales channels. Our bulk sales are made to various oil companies and traders as well as certain bulk end-users such as railroads, airlines and utilities. Our bulk sales are transported primarily by pipeline, barges and tankers to major tank farms and trading hubs.

We also enter into refined product exchange and purchase agreements. These agreements help to minimize transportation costs, optimize refinery utilization, balance refined product availability, broaden geographic distribution and make sales to markets not connected to our refined product pipeline systems. Exchange agreements provide for the delivery of refined products by us to unaffiliated companies at our and third parties’ terminals in exchange for delivery of a similar amount of refined products to us by these unaffiliated companies at specified locations. Purchase agreements involve our purchase of refined products from third parties with delivery occurring at specified locations.

RETAIL

Our retail segment operations include the following:

	•		sales of transportation fuels at retail stores and unattended self-service cardlocks,
	•		sales of convenience store merchandise in retail stores, and
	•		sales of home heating oil to residential customers.

We are one of the largest independent retailers of refined products in the central and southwest United States and eastern Canada. Our retail operations are supported by our proprietary credit card program which had approximately 700,000 accounts as of December 31, 2005. Our retail operations are segregated geographically into two groups: the U.S. System and the Northeast System.

      U.S. System

Sales in the U.S. System represent sales of transportation fuels and convenience store merchandise through our company-operated retail sites. For the year ended December 31, 2005, total sales of refined products through the U.S. System’s retail sites averaged approximately 118,000 BPD. In addition to transportation fuels, our company-operated convenience stores sell snacks, candy, beer, fast foods, cigarettes and fountain drinks. On December 31, 2005, we had 1,008 company-operated sites in our U.S. System (of which approximately 75% were owned and 25% were leased). Our company-operated stores are operated primarily under the brand names Corner Store ^® and Stop N Go ^® . Transportation fuels sold in our U.S. System stores are sold primarily under the Valero ^® brand, with some sites selling under the Diamond Shamrock ^® brand pending their conversion to the Valero ^® brand.

      Northeast System

Sales in our Northeast System include the following:

	•		sales of refined products and convenience store merchandise through our company-operated retail sites and cardlocks,
	•		sales of refined products through sites owned by independent dealers and jobbers, and
	•		sales of home heating oil to residential customers.

Our Northeast System includes retail operations in eastern Canada where we are a major supplier of refined products serving Quebec, Ontario and the Atlantic Provinces of Newfoundland, Nova Scotia, New Brunswick and Prince Edward Island. For the year ended December 31, 2005, total retail sales of refined products through the Northeast System averaged approximately 76,300 BPD. Transportation fuels are sold under the Ultramar ^® brand through a network of 987 outlets throughout eastern Canada. On December 31, 2005, we owned or leased 455 retail stores in the Northeast System and distributed gasoline to 532 dealers and independent jobbers. In addition, the Northeast System operates 89 cardlocks, which are card- or key-activated, self-service, unattended stations that allow commercial, trucking and governmental fleets to buy transportation fuel 24 hours a day. The Northeast System operations also include a large home heating oil business that provides home heating oil to approximately 161,000 households in eastern Canada. Our home heating oil business tends to be seasonal to the extent of increased demand for home heating oil during the winter.

RISK FACTORS

Our financial results are affected by volatile refining margins.

Our financial results are primarily affected by the relationship, or margin, between refined product prices and the prices for crude oil and other feedstocks. Our cost to acquire feedstocks and the price at which we can ultimately sell refined products depend upon numerous factors beyond our control, including regional and global supply of and demand for crude oil, gasoline, diesel and other feedstocks and refined products. These in turn are dependent upon, among other things, the availability and quantity of imports, the production levels of domestic and foreign suppliers, levels of refined product inventories, U.S. relationships with foreign governments, political affairs and the extent of governmental regulation.

Historically, refining margins have been volatile, and they are likely to continue to be volatile in the future. Earnings on a diluted basis for 2003, 2004 and 2005 were $1.27 per share, $3.27 per share and $6.10 per share, respectively. Refining margins were a significant contributing factor to the increase in our earnings between 2003 and 2005. The increase in our earnings for these periods is more fully described in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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

The principal environmental risks associated with our operations are emissions into the air and releases into the soil, surface water or groundwater. Our operations are subject to extensive federal, state and local environmental laws and regulations, including those relating to the discharge of materials into the environment, waste management, pollution prevention measures and characteristics and composition of gasoline and diesel fuels. If we violate or fail to comply with these laws and regulations, we could be fined or otherwise sanctioned. Because environmental laws and regulations are becoming more stringent and new environmental laws and regulations are continuously being enacted or proposed, such as those relating to methyl tertiary butyl ether, or “MTBE,” CARB gasoline, the Tier II gasoline and distillate standards and the Maximum Available Control Technology rule under the Clean Air Act, the level of expenditures required for environmental matters could increase in the future. Future legislative action and regulatory initiatives could result in changes to operating permits, additional remedial actions or increased capital expenditures and operating costs that cannot be assessed with certainty at this time. In addition, any major upgrades in any of our refineries could require material additional expenditures to comply with environmental laws and regulations.

Disruption of our ability to obtain crude oil could adversely affect our operations .

A significant portion of our feedstock requirements are satisfied through supplies originating in Saudi Arabia, Mexico, Iraq, Kuwait, Venezuela, Ecuador and Africa. We are, therefore, subject to the political, geographic and economic risks attendant to doing business with suppliers located in, and supplies originating from, those areas. If one or more of our supply contracts were terminated, or if political events disrupt our traditional crude oil supply, we believe that adequate alternative supplies of crude oil would be available, but it is possible that we would be unable to find alternative sources of supply. If we are unable to obtain adequate crude oil volumes or are able to obtain such volumes only at unfavorable prices, our results of operations could be materially adversely affected, including reduced sales volumes of refined products or reduced margins as a result of higher crude oil costs.

Competitors that produce their own supply of feedstocks, have more extensive retail outlets, or have greater financial resources may have a competitive advantage .

The refining and marketing industry is highly competitive with respect to both feedstock supply and refined product markets. We compete with numerous other companies for available supplies of crude oil and other feedstocks and for outlets for our refined products. We do not produce any of our crude oil feedstocks. Many of our competitors, however, obtain a significant portion of their feedstocks from company-owned production and some have more extensive retail outlets than we have. Competitors that have their own production or extensive retail outlets (and greater brand-name recognition) are at times able to offset losses from refining operations with profits from producing or retailing operations, and may be better positioned to withstand periods of depressed refining margins or feedstock shortages.

Some of our competitors also have materially greater financial and other resources than we have. Such competitors have a greater ability to bear the economic risks inherent in all phases of our industry. In addition, we compete with other industries that provide alternative means to satisfy the energy and fuel requirements of our industrial, commercial and individual consumers.

A significant interruption in one or more of our refineries could adversely affect our business.

Our refineries are our principal operating assets. As a result, our operations could be subject to significant interruption if one or more of our refineries were to experience a major accident, be damaged by severe weather or other natural or man-made disaster, such as an act of terrorism, or otherwise be forced to shut down. If any refinery were to experience an interruption in operations, earnings from the refinery could be materially adversely affected (to the extent not recoverable through insurance) because of lost production and repair costs.

Our operations expose us to many operating risks, not all of which are insured .

Our refining and marketing operations are subject to various hazards common to the industry, including explosions, fires, toxic emissions, maritime hazards and uncontrollable flows of oil and gas. They are also subject to the additional hazards of loss from severe weather conditions. As protection against operating hazards, we maintain insurance coverage against some, but not all, such potential losses. We may not be able to maintain or obtain insurance of the type and amount we desire at reasonable rates. As a result of market conditions, premiums and deductibles for certain of our insurance policies have increased substantially, and could escalate further. In some instances, certain insurance could become unavailable or available only for reduced amounts of coverage. For example, insurance carriers are now requiring broad exclusions for losses due to war risk and terrorist acts. If we were to incur a significant liability for which we were not fully insured, it could have a material adverse effect on our financial position.

ENVIRONMENTAL MATTERS

We hereby incorporate by reference into this Item the environmental disclosures contained in the following sections of this report:

	•		Item 1 under the caption “Risk Factors – Compliance with and changes in environmental laws could adversely affect our performance,”
	•		Item 3 “Legal Proceedings” under the caption “Environmental Enforcement Matters,”
	•		Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Environmental Matters,” and
	•		Item 8 “Financial Statements” in Note 24 of Notes to Consolidated Financial Statements.

Capital Expenditures Attributable to Compliance with Environmental Regulations . In 2005, our capital expenditures attributable to compliance with environmental regulations were approximately $1.1 billion, and are currently estimated to be approximately $1.3 billion for 2006 and approximately $660 million for 2007. The estimates for 2006 and 2007 do not include amounts related to capital investments at our facilities that management has deemed to be strategic investments rather than expenditures relating to environmental regulatory compliance.

Mr. Klesse became Chief Executive Officer and Vice-Chairman of the Board on December 31, 2005. He previously served as Executive Vice President and Chief Operating Officer since January 2003. He has served as an Executive Vice President of Valero since the closing of our acquisition of Ultramar Diamond Shamrock Corporation (UDS) on December 31, 2001. He had served as an Executive Vice President of UDS since February 1995, overseeing operations, refining, product supply and logistics. Mr. Klesse is also a director of the general partner of Valero L.P.

Mr. King was elected President in January 2003. He previously served as Executive Vice President and General Counsel since September 2001, and prior to that served as Executive Vice President and Chief Operating Officer since January 2001. Mr. King was Senior Vice President and Chief Operating Officer from 1999 to January 2001. He was elected Vice President and General Counsel of Valero in 1997. He joined our former parent in 1993. Mr. King is also a director of the general partner of Valero L.P.

Mr. Ciskowski was elected Chief Financial Officer in August 2003. Before that, he served as Executive Vice President - Corporate Development since April 2003, and Senior Vice President in charge of business and corporate development since 2001. He was elected Vice President of Valero in 1998. He joined our former parent in 1985.

Mr. Edwards was elected Executive Vice President - Corporate Development and Strategic Planning in December 2005. Prior to that he had served as a Senior Vice President of Valero since December 2001 with responsibilities for product supply, trading and wholesale marketing. He was first elected Vice President in 1998. He has held several positions in the company with responsibility for planning and economics, business development, risk management and marketing.

Mr. Gorder was elected Executive Vice President - Marketing and Supply in December 2005. He had previously served as Senior Vice President – Corporate Development since August 2003. Prior to that, he held several positions with Valero and UDS with responsibilities for corporate development and marketing. From October 2000 to May 2002, Mr. Gorder was Executive Vice President and Chief Financial Officer of Calling Solutions, Inc., a telecommunications and customer service provider. He served as President of Duncan-Smith Company, an investment banking firm in San Antonio, from April 1999 to October 2000.

Mr. Marcogliese was elected Executive Vice President - Operations in December 2005. He had previously served as Senior Vice President overseeing refining operations since July 2001. He joined Valero in May 2000 as the Vice President and General Manager of our Benicia Refinery. He then transferred to our corporate office in June 2001 as head of Strategic Planning. Prior to that, he held numerous management positions in engineering and operations with ExxonMobil, including work at its headquarters office in Houston and its Baton Rouge and Bayway refineries.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

New Jersey Department of Environmental Protection (NJDEP) (Paulsboro Refinery). We are subject to six outstanding air-related Administrative Order and Notice of Civil Administrative Penalty Assessments (Notices) issued by the NJDEP relating to our Paulsboro Refinery. The Notices propose an aggregate penalty of $139,500. We have appealed these Notices. In the fourth quarter of 2005, we settled the NJDEP’s prior demands for stipulated penalties relating to alleged failures of a stack test required by an Administrative Consent Order entered in May 2000.

People of the State of Illinois, ex rel. v. The Premcor Refining Group Inc., et al. , Third Judicial Circuit Court, Madison County (Case No. 03-CH-00459, filed May 29, 2003) (Hartford refinery and terminal). The Illinois Environmental Protection Agency (Illinois EPA) has issued several NOVs alleging violations of air and waste regulations at Premcor’s Hartford, Illinois terminal and now-closed refinery. We are negotiating the terms of a consent order for corrective action.

People of the State of Illinois, ex rel. v. The Premcor Refining Group Inc., et al. , Chancery Division, Circuit Court, Cook County (Case No. 05-CH-07694, filed May 3, 2005) (former Clark retail sites). The Illinois EPA has issued NOVs to Premcor pertaining to reported releases from underground storage tanks at certain retail sites alleging that Premcor was either the operator or landlord/owner at the time of the releases. The Illinois Attorney General’s office on behalf of Illinois EPA is seeking a consent order requiring a penalty and corrective action at 54 retail sites. The State filed its complaint against Premcor in May 2005, and made an initial penalty demand of $1.2 million.

South Coast Air Quality Management District ( SCAQMD ) (Wilmington Refinery). The SCAQMD has issued 24 VNs to our Wilmington Refinery since May 2003 for alleged excess emissions and one permitting discrepancy. No penalties have been assessed for the alleged violations; however, the SCAQMD has made a settlement offer to resolve 17 of the violations (issued through June 2004). We are continuing to negotiate with the SCAQMD to resolve these issues.

Texas Commission on Environmental Quality (TCEQ) (Port Arthur Refinery). In September 2005, we received two enforcement actions from the TCEQ relating to alleged Texas Clean Air Act violations at the Port Arthur Refinery dating back to 2002. The TCEQ has proposed penalties totaling $880,240 for these events. We have generally denied the allegations.

PART II

The following table discloses purchases of shares of Valero’s common stock made by us or on our behalf during the fourth quarter of 2005.

														Maximum Number (or
										Total Number of				Approximate Dollar
										Shares Purchased as				Value) of Shares
		Total Number of								Part of Publicly				that May Yet Be
		Shares Purchased				Average Price Paid				Announced Plans or				Purchased Under the
Period		(1)				per Share				Programs (2)				Plans or Programs
October 2005			1,000,600			$	51.82				0			$361 million
November 2005			1,704,400			$	50.07				0			$361 million
December 2005			5,274,200			$	52.55				0			$361 million
Total (3)			7,979,200			$	51.93				0			$361 million

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data for the five-year period ended December 31, 2005 was derived from our audited consolidated financial statements. The following table should be read together with the historical consolidated financial statements and accompanying notes included in Item 8, “Financial Statements and Supplementary Data” and with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The following summaries are in millions of dollars except for per share amounts:

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following review of our results of operations and financial condition should be read in conjunction with Items 1, 1A and 2, “Business, Risk Factors and Properties,” and Item 8, “Financial Statements and Supplementary Data,” included in this report. In the discussions that follow, all per-share amounts assume dilution.

On September 15, 2005, our board of directors approved a two-for-one split of our common stock, the second such split in the last two years, which was distributed in the form of a stock dividend on December 15, 2005 to stockholders of record on December 2, 2005. All previously reported share and per share data (except par value) in this Form 10-K have been adjusted to reflect the effect of this stock split for all periods presented.

CAUTIONARY STATEMENT FOR THE PURPOSE OF SAFE HARBOR PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This report, including without limitation our disclosures below under the heading “Results of Operations — Outlook,” includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. You can identify our forward-looking statements by the words “anticipate,” “believe,” “expect,” “plan,” “intend,” “estimate,” “project,” “projection,” “predict,” “budget,” “forecast,” “goal,” “guidance,” “target,” “will,” “could,” “should,” “may” and similar expressions.

These forward-looking statements include, among other things, statements regarding:

	•		the synergies and accretion to reported earnings estimated to result from the Premcor Acquisition and level of costs and expenses to be incurred by us in connection with the Premcor Acquisition;
	•		various actions to be taken or requirements to be met in connection with integrating Valero and Premcor after the Premcor Acquisition;
	•		our revenue, income and operations after the Premcor Acquisition;
	•		future refining margins, including gasoline and distillate margins;
	•		future retail margins, including gasoline, diesel, home heating oil and convenience store merchandise margins;
	•		expectations regarding feedstock costs, including crude oil discounts, and operating expenses;
	•		anticipated levels of crude oil and refined product inventories;
	•		our anticipated level of capital investments, including deferred refinery turnaround and catalyst costs and capital expenditures for environmental and other purposes, and the effect of those capital investments on our results of operations;
	•		anticipated trends in the supply of and demand for crude oil and other feedstocks and refined products in the United States, Canada and elsewhere;
	•		expectations regarding environmental and other regulatory initiatives; and
	•		the effect of general economic and other conditions on refining and retail industry fundamentals.

We based our forward-looking statements on our current expectations, estimates and projections about ourselves and our industry. We caution that these statements are not guarantees of future performance and involve risks, uncertainties and assumptions that we cannot predict. In addition, we based many of these forward-looking statements on assumptions about future events that may prove to be inaccurate. Accordingly, our actual results may differ materially from the future performance that we have expressed or forecast in the forward-looking statements. Differences between actual results and any future performance suggested in these forward-looking statements could result from a variety of factors, including the following:

	•		expected cost savings from the Premcor Acquisition may not be fully realized or realized within the expected time frame, and costs or expenses relating to the Premcor Acquisition may be higher than expected;
	•		revenues or margins following the Premcor Acquisition may be lower than expected;
	•		costs or difficulties related to the integration of the businesses of Valero and Premcor may be greater than expected;
	•		acts of terrorism aimed at either our facilities or other facilities that could impair our ability to produce or transport refined products or receive feedstocks;
	•		political and economic conditions in nations that consume refined products, including the United States, and in crude oil producing regions, including the Middle East and South America;
	•		the domestic and foreign supplies of refined products such as gasoline, diesel fuel, jet fuel, home heating oil and petrochemicals;
	•		the domestic and foreign supplies of crude oil and other feedstocks;
	•		the ability of the members of the Organization of Petroleum Exporting Countries (OPEC) to agree on and to maintain crude oil price and production controls;
	•		the level of consumer demand, including seasonal fluctuations;
	•		refinery overcapacity or undercapacity;
	•		the actions taken by competitors, including both pricing and the expansion and retirement of refining capacity in response to market conditions;
	•		environmental and other regulations at both the state and federal levels and in foreign countries;
	•		the level of foreign imports of refined products;
	•		accidents or other unscheduled shutdowns affecting our refineries, machinery, pipelines or equipment, or those of our suppliers or customers;
	•		changes in the cost or availability of transportation for feedstocks and refined products;
	•		the price, availability and acceptance of alternative fuels and alternative-fuel vehicles;
	•		cancellation of or failure to implement planned capital projects and realize the various assumptions and benefits projected for such projects or cost overruns in constructing such planned capital projects;
	•		earthquakes, hurricanes, tornadoes and irregular weather, which can unforeseeably affect the price or availability of natural gas, crude oil and other feedstocks and refined products;
	•		rulings, judgments or settlements in litigation or other legal or regulatory matters, including unexpected environmental remediation costs in excess of any reserves or insurance coverage;
	•		legislation or regulatory action, including the introduction or enactment of federal, state or foreign legislation or rulemakings, which may adversely affect our business or operations;
	•		changes in the credit ratings assigned to our debt securities and trade credit;
	•		changes in currency exchange rates, including the value of the Canadian dollar relative to the U.S. dollar; and
	•		overall economic conditions.

Any one of these factors, or a combination of these factors, could materially affect our future results of operations and whether any forward-looking statements ultimately prove to be accurate. Our forward-looking statements are not guarantees of future performance, and actual results and future performance may differ materially from those suggested in any forward-looking statements. We do not intend to update these statements unless we are required by the securities laws to do so.

All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing. We undertake no obligation to publicly release the results of any revisions to any such forward-looking statements that may be made to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events.

OVERVIEW

As of December 31, 2005, we owned and operated 18 refineries in the United States, Canada and Aruba with a combined throughput capacity, including crude oil and other feedstocks, of approximately 3.3 million barrels per day.

We market refined products through an extensive bulk and rack marketing network and a network of approximately 5,000 retail and wholesale branded outlets in the United States, Canada and Aruba under various brand names including primarily Valero â , Diamond Shamrock â , Shamrock â , Ultramar â and Beacon â . During the second quarter of 2005, we announced our plan to retire the Diamond Shamrock brand and convert those U.S. retail and wholesale sites to the Valero brand. This program is progressing well, with 385 sites having been converted to the Valero brand by the end of 2005 and 894 sites remaining to be rebranded during 2006 and early 2007.

Our operations are affected by:

	•		company-specific factors, primarily refinery utilization rates and refinery maintenance turnarounds;
	•		seasonal factors, such as the demand for refined products; and
	•		industry factors, such as movements in and the level of crude oil prices including the effect of quality differential between grades of crude oil, the demand for and prices of refined products, industry supply capacity and competitor refinery maintenance turnarounds.
Our profitability is substantially determined by the spread between the price of refined products and the price of crude oil, referred to as the “refined product margin.” Since almost 70% of our total crude oil throughput represents sour crude oil and acidic sweet crude oil feedstocks that are purchased at prices less than sweet crude oil, our profitability is also significantly affected by the spread between sweet crude oil and sour crude oil prices, referred to as the “sour crude oil discount.” During 2005, we benefited from even stronger industry fundamentals than the already strong industry fundamentals experienced in 2004. In reporting our results for 2004, we indicated that both refined product margins and sour crude oil discounts were the best we had ever experienced. During 2005, gasoline and distillate margins improved in all four of our refining regions, with overall distillate margins more than double the 2004 margins. In addition, the sour crude oil discount increased more than 30%. This improvement in gasoline and distillate margins combined with the strong sour crude oil discounts contributed to a significant increase in operating results in 2005 compared to the prior year, resulting in earnings per share of $6.10 for 2005, or an 87% increase over the $3.27 earnings per share reported for 2004.
On September 1, 2005, we completed our acquisition of Premcor. Premcor owned and operated refineries in Port Arthur, Texas, Lima, Ohio, Memphis, Tennessee, and Delaware City, Delaware, with a combined crude oil throughput capacity of approximately 800,000 barrels per day. We benefited from the addition of the four former Premcor refineries, which generated approximately $810 million of operating income during the last four months of 2005.
The positive industry fundamentals experienced during the year ended December 31, 2005, combined with the incremental operating income generated from the Premcor Acquisition, resulted in net income for the year ended December 31, 2005 that was approximately double the net income reported for the year ended December 31, 2004. We reported net income of $3.6 billion for 2005, compared to $1.8 billion for 2004. Our debt-to-capitalization ratio (net of cash) decreased approximately 6% during 2005 to 24.8%.

RESULTS OF OPERATIONS

Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)

		Year Ended December 31,
		2005 (a)				2004 (b)				Change
Refining:
Operating income		$	5,846			$	3,225			$	2,621
Throughput margin per barrel (d)		$	11.14			$	7.44			$	3.70
Operating costs per barrel:
Refining operating expenses		$	3.22			$	2.70			$	0.52
Depreciation and amortization			0.80				0.66				0.14
Total operating costs per barrel		$	4.02			$	3.36			$	0.66
Throughput volumes (thousand barrels per day) (e):
Feedstocks:
Heavy sour crude			548				485				63
Medium/light sour crude			610				575				35
Acidic sweet crude			103				92				11
Sweet crude			670				531				139
Residuals			181				136				45
Other feedstocks			132				128				4
Total feedstocks			2,244				1,947				297
Blendstocks and other			244				215				29
Total throughput volumes			2,488				2,162				326
Yields (thousand barrels per day):
Gasolines and blendstocks			1,174				1,034				140
Distillates			763				650				113
Petrochemicals			72				71				1
Other products (f)			481				417				64
Total yields			2,490				2,172				318
Retail – U.S.:
Operating income		$	72			$	87			$	(15	)
Company-operated fuel sites (average)			1,024				1,106				(82	)
Fuel volumes (gallons per day per site)			4,830				4,644				186
Fuel margin per gallon		$	0.154			$	0.142			$	0.012
Merchandise sales		$	934			$	925			$	9
Merchandise margin (percentage of sales)			29.7	%			28.4	%			1.3	%
Margin on miscellaneous sales		$	126			$	100			$	26
Retail selling expenses		$	549			$	505			$	44
Depreciation and amortization expense		$	60			$	37			$	23
Retail – Northeast:
Operating income		$	69			$	88			$	(19	)
Fuel volumes (thousand gallons per day)			3,204				3,250				(46	)
Fuel margin per gallon		$	0.211			$	0.211			$	—
Merchandise sales		$	150			$	140			$	10
Merchandise margin (percentage of sales)			25.6	%			23.8	%			1.8	%
Margin on miscellaneous sales		$	30			$	24			$	6
Retail selling expenses		$	222			$	200			$	22
Depreciation and amortization expense		$	23			$	21			$	2

The following notes relate to references on pages 24 through 27.

(a)		Includes the operations related to the Premcor Acquisition commencing on September 1, 2005. A $621 million LIFO charge related to the difference between the fair market value recorded for the inventories acquired in the Premcor Acquisition under purchase accounting and the amounts required to be recorded under our LIFO accounting policy was excluded from the consolidated and regional throughput margins per barrel and the regional operating income amounts presented herein in order to make the information presented comparable between periods.
(b)		Includes the operations related to the Aruba Acquisition commencing on March 5, 2004.
(c)		Operating revenues and cost of sales both include approximately $7.8 billion for the year ended December 31, 2005 and approximately $4.9 billion for the year ended December 31, 2004 related to certain crude oil buy/sell arrangements, which involve linked purchases and sales related to crude oil contracts entered into to address location, quality or grade requirements. For further explanation of this accounting treatment, see the discussion about EITF No. 04-13 in Note 1 of Notes to Consolidated Financial Statements.
(d)		Throughput margin per barrel represents operating revenues less cost of sales divided by throughput volumes.
(e)		Total throughput volumes and throughput volumes for the Gulf Coast region for the year ended December 31, 2004 are based on 366 days, which results in 183,000 barrels per day being included for the Aruba Refinery for the year ended December 31, 2004. Throughput volumes for the Aruba Refinery for the 302 days of its operations during 2004 averaged 221,000 barrels per day.
(f)		Other products primarily include gas oils, No. 6 fuel oil, petroleum coke and asphalt.
(g)		The regions reflected herein contain the following refineries subsequent to the Premcor Acquisition: the Gulf Coast refining region includes the Corpus Christi East, Corpus Christi West, Texas City, Houston, Three Rivers, Krotz Springs, St. Charles, Aruba and Port Arthur Refineries; the Mid-Continent refining region includes the McKee, Ardmore, Memphis and Lima Refineries; the Northeast refining region includes the Quebec, Paulsboro and Delaware City Refineries; and the West Coast refining region includes the Benicia and Wilmington Refineries.
(h)		Throughput volumes for the Gulf Coast, Mid-Continent and Northeast regions for the year ended December 31, 2005 include 78,000, 106,000 and 63,000 barrels per day, respectively, related to the operations of the refineries acquired from Premcor commencing on September 1, 2005. Throughput volumes for those acquired refineries for the 122 days of their operations subsequent to the acquisition date of September 1, 2005 were 234,000, 317,000, and 187,000 barrels per day, respectively, for the Gulf Coast, Mid-Continent and Northeast regions.
(i)		The information presented for the Mid-Continent region includes the operations of the Denver Refinery through May 31, 2005, the date of our sale of this facility to Suncor Energy (U.S.A.) Inc. (Suncor). Throughput volumes for the Mid-Continent region

		include 15,000 and 37,000 barrels per day related to the Denver Refinery for the years ended December 31, 2005 and 2004, respectively.
(j)		The average market reference prices and differentials, with the exception of the propylene and lube oil differentials, are based on posted prices from Platt’s Oilgram. The propylene differential is based on posted propylene prices in Chemical Market Associates, Inc. and the lube oil differential is based on Exxon Mobil Corporation postings provided by Independent Commodity Information Services-London Oil Reports. The average market reference prices and differentials are presented to provide users of the consolidated financial statements with economic indicators that significantly affect our operations and profitability.
(k)		The market reference differential for sour crude oil is based on 50% Arab Medium and 50% Arab Light posted prices.

General

Operating revenues increased 50% for the year ended December 31, 2005 compared to the year ended December 31, 2004 primarily as a result of significantly higher refined product prices combined with additional throughput volumes from refinery operations. Operating income and net income for the year ended December 31, 2005 increased significantly compared to the year ended December 31, 2004. Operating income increased $2.5 billion, or 83%, from 2004 to 2005 due primarily to a $2.6 billion increase in the refining segment, partially offset by a $34 million decrease in the retail segment and a $107 million increase in general and administrative expenses (including corporate depreciation and amortization expense).

Refining

Operating income for our refining segment increased from $3.2 billion for the year ended December 31, 2004 to $5.8 billion for the year ended December 31, 2005, resulting mainly from an increase in refining throughput margin of $3.70 per barrel, or 50%, and a 15% increase in throughput volumes, partially offset by an increase in refining operating expenses (including depreciation and amortization expense) of $989 million.

Refining total throughput margin for 2005 increased primarily due to the following factors:

	•		Distillate margins increased significantly in all of our refining regions during 2005 compared to 2004, with margins in the Gulf Coast region almost triple the margins in 2004 and margins in the Mid-Continent and Northeast regions more than double 2004 margins. The improvement in distillate margins was due to increased foreign and U.S. demand, resulting from improved U.S. and global economies and higher demand for on-road diesel and jet fuel. In addition, both gasoline and distillate margins increased significantly in September and October of 2005 due to the impact of Hurricanes Katrina and Rita, which reduced the supply of refined products as refineries along the Gulf Coast reduced or shut down their operations because of the hurricanes.
	•		Discounts on our sour crude oil feedstocks improved during 2005 compared to 2004 due to ample supplies of sour crude oils and heavy sour residual fuel oils on the world market. In addition, discounts on sour crude oil feedstocks benefited from increased demand for sweet crude oil resulting from several factors, including (i) the global movement to cleaner fuels, which has required most refineries to lower the sulfur content of the gasoline they produce, and (ii) a global increase in refined product demand, particularly in Asia, which has resulted in higher utilization rates by refineries that require sweet crude oil as feedstock.
	•		Throughput volumes increased 326,000 barrels per day in 2005 compared to 2004 due mainly to throughput of 247,000 barrels per day at the four refineries acquired from Premcor on September 1, 2005, incremental throughput of 40,000 barrels per day at the Aruba Refinery, which was acquired in March 2004, and lower volumes in 2004 due to turnarounds at the St. Charles, Benicia and Wilmington Refineries.

The above increases in throughput margin for 2005 were partially offset by the effects of:

•

lower margins on other refined products such as petroleum coke, sulfur, No. 6 fuel oil, asphalt and propylene due to a significant increase in the price of crude oil from 2004 to 2005, and

•

increased pre-tax losses of approximately $295 million on hedges related to forward sales of distillates and associated forward purchases of crude oil.

Refining operating expenses, excluding depreciation and amortization expense, were 37% higher for the year ended December 31, 2005 compared to the year ended December 31, 2004 due mainly to $420 million of expenses related to the refineries acquired in the Premcor Acquisition, a full year of operations of the Aruba Refinery, and increases in energy costs, employee compensation expense and maintenance expense. Refining depreciation and amortization expense increased 39% from 2004 to 2005 due mainly to depreciation expense resulting from the Premcor Acquisition on September 1, 2005, implementation of new capital projects, increased turnaround and catalyst amortization, a $15 million gain in 2004 on the sale of certain property discussed in Note 6 of Notes to Consolidated Financial Statements, and the write-off of costs in 2005 resulting from the decision to convert wholesale sites marketing under the Diamond Shamrock brand to the Valero brand.

Retail

Retail operating income was $141 million for the year ended December 31, 2005 compared to $175 million for the year ended December 31, 2004, a decrease of 19% between the periods. The decrease was primarily attributable to increased selling expenses in the U.S. and Northeast as higher retail fuel prices resulted in higher credit card processing fees. In addition, Northeast selling expenses increased $15 million due to an increase in the Canadian dollar exchange rate.

Corporate Expenses and Other

General and administrative expenses, including corporate depreciation and amortization expense, increased $107 million for the year ended December 31, 2005 compared to the year ended December 31, 2004, primarily due to increases in employee compensation and benefits. These increases were mainly related to the recognition of increased variable compensation expense, resulting in large part from a significant increase in our common stock price during 2005, and expenses attributable to Premcor headquarters personnel. These increases were partially offset by the successful resolution in the first quarter of 2005 of a California excise tax dispute.

“Other income (expense), net” improved $101 million for the year ended December 31, 2005 compared to the year ended December 31, 2004 primarily due to the combined effect of a $55 million gain realized on the sale of our equity interests in Javelina Company and Javelina Pipeline Company in November 2005 and a 2004 impairment charge of $57 million to write off the carrying amount of our equity investment in Clear Lake Methanol Partners, L.P. This combined effect, as well as an increase in bank interest income due to higher cash balances, was partially offset by our 50% interest in certain debt refinancing costs incurred in 2005 by the Cameron Highway Oil Pipeline joint venture and increased costs related to our accounts receivable sales program.

Interest and debt expense incurred increased from 2004 to 2005 due to interest incurred in 2005 on the debt resulting from the Premcor Acquisition. However, the increased interest incurred was almost entirely offset by increased capitalized interest due to an increase in capital projects, including those at the four former Premcor refineries.

Income tax expense increased $791 million from 2004 to 2005 mainly as a result of a 95% increase in income before income tax expense. Our effective tax rate for the year ended December 31, 2005, however, decreased from the year ended December 31, 2004 primarily as a result of a change in permanent book-to-tax differences,

which included a deduction from income in 2005 for qualified domestic manufacturing activities, as allowed under the American Jobs Creation Act of 2004.

Operating Highlights
(millions of dollars, except per barrel and per gallon amounts)

		Year Ended December 31,
		2004 (a)				2003 (b)				Change
Refining:
Operating income		$	3,225			$	1,363			$	1,862
Throughput margin per barrel (e)		$	7.44			$	5.13			$	2.31
Operating costs per barrel:
Refining operating expenses		$	2.70			$	2.47			$	0.23
Depreciation and amortization			0.66				0.63				0.03
Total operating costs per barrel		$	3.36			$	3.10			$	0.26
Throughput volumes (thousand barrels per day) (f):
Feedstocks:
Heavy sour crude			485				199				286
Medium/light sour crude			575				595				(20	)
Acidic sweet crude			92				94				(2	)
Sweet crude			531				562				(31	)
Residuals			136				79				57
Other feedstocks			128				166				(38	)
Total feedstocks			1,947				1,695				252
Blendstocks and other			215				140				75
Total throughput volumes			2,162				1,835				327
Yields (thousand barrels per day):
Gasolines and blendstocks			1,034				975				59
Distillates			650				536				114
Petrochemicals			71				61				10
Other products (g)			417				270				147
Total yields			2,172				1,842				330
Retail – U.S.:
Operating income		$	87			$	115			$	(28	)
Company-operated fuel sites (average)			1,106				1,201				(95	)
Fuel volumes (gallons per day per site)			4,644				4,512				132
Fuel margin per gallon		$	0.142			$	0.148			$	(0.006	)
Merchandise sales		$	925			$	939			$	(14	)
Merchandise margin (percentage of sales)			28.4	%			28.1	%			0.3	%
Margin on miscellaneous sales		$	100			$	90			$	10
Retail selling expenses		$	505			$	508			$	(3	)
Depreciation and amortization expense		$	37			$	23			$	14
Retail – Northeast:
Operating income		$	88			$	97			$	(9	)
Fuel volumes (thousand gallons per day)			3,250				3,328				(78	)
Fuel margin per gallon		$	0.211			$	0.209			$	0.002
Merchandise sales		$	140			$	122			$	18
Merchandise margin (percentage of sales)			23.8	%			22.9	%			0.9	%
Margin on miscellaneous sales		$	24			$	19			$	5
Retail selling expenses		$	200			$	186			$	14
Depreciation and amortization expense		$	21			$	17			$	4