UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

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

For the fiscal year ended December 31, 2008

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 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. 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. (Check one):

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 Act). Yes o No þ

The aggregate market value of the voting and non-voting common stock held by non-affiliates was approximately $21.6 billion based on the last sales price quoted as of June 30, 2008 on the New York Stock Exchange, the last business day of the registrant’s most recently completed second fiscal quarter.

As of January 31, 2009, 516,308,274 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 a definitive Proxy Statement for our Annual Meeting of Stockholders scheduled for April 30, 2009, at which directors will be elected. Portions of the 2009 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 2009 Proxy Statement where certain information required in Part III of Form 10-K may be found.

Form 10-K Item No. and Caption		Heading in 2009 Proxy Statement
10. Directors, Executive Officers and Corporate Governance		Information Regarding the Board of Directors, Independent Directors, Audit Committee, Governance Documents and Codes of Ethics, 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 Discussion and Analysis, Director Compensation, 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, and Director Independence		Certain Relationships and Related Transactions and Independent Directors
14. Principal Accountant Fees and Services		KPMG Fees for Fiscal Year 2008, KPMG Fees for Fiscal Year 2007, 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, Senior Vice President-Corporate Law and Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269-6000.

CONTENTS

				PAGE
PART I
Items 1., 1A. & 2.		Business, Risk Factors and Properties			1
		Segments			2
		Valero’s Operations			3
		Risk Factors			12
		Environmental Matters			16
		Properties			16
		Executive Officers of the Registrant			17
Item 1B.		Unresolved Staff Comments			17
Item 3.		Legal Proceedings			18
Item 4.		Submission of Matters to a Vote of Security Holders			19
PART II
Item 5.		Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			20
Item 6.		Selected Financial Data			23
Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
Item 7A.		Quantitative and Qualitative Disclosures About Market Risk			51
Item 8.		Financial Statements and Supplementary Data			57
Item 9.		Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			132
Item 9A.		Controls and Procedures			132
Item 9B.		Other Information			132
PART III
Item 10.		Directors, Executive Officers and Corporate Governance			133
Item 11.		Executive Compensation			133
Item 12.		Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			133
Item 13.		Certain Relationships and Related Transactions, and Director Independence			133
Item 14.		Principal Accountant Fees and Services			133
PART IV
Item 15.		Exhibits and Financial Statement Schedules			133
Signatures					138

PART I

The terms “Valero,” “we,” “our,” and “us,” as used in this report, may refer to Valero Energy Corporation, to one or more of our consolidated subsidiaries, or to all of them taken as a whole. In this Form 10-K, we make certain forward-looking statements, including statements regarding our plans, strategies, objectives, expectations, intentions, and resources, under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You should read our forward-looking statements together with our disclosures beginning on page 24 below 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 corporate 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, and our name was changed to Valero Energy Corporation on August 1, 1997. On January 31, 2009, we had 21,765 employees.

We own and operate 16 refineries located in the United States, Canada, and Aruba that produce conventional gasolines, distillates, jet fuel, asphalt, petrochemicals, lubricants, and other refined products as well as a slate of premium products including CBOB and RBOB ¹ , gasoline meeting the specifications of the California Air Resources Board (CARB), CARB diesel fuel, low-sulfur and ultra-low-sulfur diesel fuel, and oxygenates (liquid hydrocarbon compounds containing oxygen).

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 about 5,800 retail and wholesale branded outlets in the United States, Canada, and Aruba.

Available Information . Our internet website address is www.valero.com. Information contained on our website is not part of this annual report on Form 10-K. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, 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, soon 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 the committees of our board of directors in the same website location. Our governance documents are available in print to any stockholder that makes a written request to Jay D. Browning, Senior Vice President-Corporate Law and Secretary, Valero Energy Corporation, P.O. Box 696000, San Antonio, Texas 78269-6000.

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 Retail – Canada. Our retail operations in the United States are referred to as Retail – U.S. The financial information about our segments in Note 20 of Notes to Consolidated Financial Statements is incorporated herein by reference.

(a)		“Throughput capacity” represents estimated capacity for processing crude oil, intermediates, and other feedstocks. Total estimated crude oil capacity is approximately 2.6 million BPD.
(b)		Represents the combined capacities of two refineries – the Corpus Christi East and Corpus Christi West Refineries.

Corpus Christi East and West Refineries . Our Corpus Christi East and West Refineries are located on the Texas Gulf Coast along the Corpus Christi Ship Channel. The West Refinery specializes in processing primarily lower-cost sour crude oil and resid into premium products such as RBOB. The East Refinery processes heavy, high-sulfur crude oil into conventional gasoline, diesel, jet fuel, asphalt, aromatics, and other light products. The East and West Refineries are substantially integrated 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. Three truck racks with a total of 16 bays service local markets for gasoline, diesel, jet fuels, liquefied petroleum gases, and asphalt. The refineries distribute refined products using the Colonial, Explorer, Valley, and other major pipelines.

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 and premium gasoline and RBOB, as well as diesel, jet fuel, petrochemicals, petroleum coke, and sulfur. The refinery receives crude oil over marine docks and through crude oil pipelines, and has access to the Sunoco and Oiltanking terminals at Nederland, Texas. Finished products are distributed into the Colonial, Explorer, and TEPPCO pipelines, across the refinery docks into ships or barges, and through a local truck rack.

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 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 through the 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 receives and delivers its feedstocks and products by tanker and barge via deepwater docking facilities along the Texas City Ship Channel and uses the Colonial, Explorer, and TEPPCO pipelines for distribution of its products.

Aruba Refinery . Our Aruba Refinery is located on the island of Aruba in the Caribbean Sea. It processes primarily heavy sour crude oil and produces primarily intermediate feedstocks and finished distillate products. Significant amounts of the refinery’s intermediate feedstock production are transported and further 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 United States, the Caribbean, Europe, and South America.

Houston Refinery . Our Houston Refinery is located on the Houston Ship Channel. It processes primarily sour crude oils and low-sulfur resid into conventional gasoline and distillates. The refinery receives its feedstocks via tanker at deepwater docking facilities along the Houston Ship Channel and 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 processes primarily heavy sweet and medium sour crude oils into conventional gasoline, distillates, and aromatics. 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 with capacity of 120,000 BPD transports crude oil via connections to the Three Rivers Refinery from Corpus Christi. The refinery distributes its refined products primarily through pipelines owned by NuStar Energy L.P.

Benicia Refinery . Our Benicia Refinery is located northeast of San Francisco on the Carquinez Straits of San Francisco Bay. It processes sour crude oils into 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 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, RBOB, low-sulfur diesel, jet fuels, and asphalt. The refinery has access to crude oil from Texas, Oklahoma, Kansas, and Colorado through 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 NuStar Energy L.P.’s pipelines to markets in Texas, New Mexico, Arizona, Colorado, and Oklahoma.

Ardmore Refinery . Our Ardmore Refinery is located in Ardmore, Oklahoma, approximately 90 miles south of Oklahoma City. It processes medium sour and light sweet crude oils into conventional gasoline, low-sulfur diesel, liquefied petroleum gas products, and asphalt. Local crude oil is gathered by TEPPCO’s crude oil gathering/trunkline systems and trucking operations, and then transported to the refinery through NuStar Energy L.P.’s crude oil pipeline systems. Foreign, midland, and other domestic crude oils are received via third-party pipelines. Refined products are transported via the Magellan pipeline system, railcars, and trucks.

Quebec City Refinery . Our Quebec City Refinery is located in Lévis, Canada (near Quebec City). It 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 to its primary terminals in Quebec and Ontario primarily by train, and also uses ships and trucks extensively throughout eastern Canada.

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, CBOB, RBOB, petroleum coke, sulfur, low-sulfur diesel, home heating oil, and petrochemicals (benzene). Feedstocks and refined products are transported via pipeline, barge, and truck-rack facilities. The refinery’s production is sold primarily in the northeastern U.S.

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, petroleum coke, sulfur, fuel oil, propane, and butane. Feedstocks and refined products are typically transported by tanker and barge via refinery-owned dock facilities along the Delaware River, Buckeye Partners’ product distribution system (into western Pennsylvania and Ohio), an onsite truck rack owned by NuStar Energy L.P., 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 the Middle East, Africa, Asia, Mexico, and South America) as well as international and domestic oil companies. The term contracts generally permit the parties to amend the contracts (or terminate them), effective as of the next scheduled renewal date, by giving the other party proper notice within a prescribed period of time ( e.g ., 60 days, 6 months) before expiration of the current term. The majority of the crude oil purchased under Valero’s term contracts is purchased at the producer’s official stated price ( i.e ., the “market” price established by the seller for all purchasers) and not at a negotiated price specific to Valero. About 80% of our crude oil feedstocks under term supply agreements are imported from foreign sources and about 20% 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 Quebec City 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 the delivery date and holding 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 2008.

           Wholesale Marketing

We market branded and unbranded transportation fuels on a wholesale basis in 44 states 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 volume is sold through unbranded channels. The remainder is sold to distributors and dealers that are members of the Valero-brand family that operate approximately 3,950 branded sites. These sites are independently owned and are supplied by us under multi-year contracts. For wholesale branded sites, we promote our Valero ^® brand throughout the United States. In addition, we offer the Beacon ^® brand in California and the Shamrock ^® brand elsewhere in the United States.

           Bulk Sales and Trading

We sell a significant portion of our gasoline and distillate production through bulk sales channels in domestic and international markets. 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 provide access 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.

           Specialty Products

We also sell a variety of other products produced at our refineries, which we refer to collectively as “Specialty Products.” Our Specialty Products include asphalt, lube oils, natural gas liquids (NGLs), petroleum coke, petrochemicals, and sulfur.

	•		We produce asphalt at six of our refineries. Our asphalt products are sold for use in road construction, road repair, and roofing applications through a network of refinery and terminal loading racks.
	•		We produce lube oils at two of our refineries. We produce and market paraffinic, naphthenic, and aromatic oils suitable for use in a wide variety of lubricant and process applications.
	•		NGLs produced at our refineries include butane, isobutane, and propane. These products can be used for gasoline blending, home heating, and petrochemical plant feedstocks.
	•		We are a significant producer of petroleum coke, supplying primarily power generation customers and cement manufacturers. Petroleum coke is used largely as a substitute for coal.
	•		We produce and market a number of commodity petrochemicals including aromatic solvents (benzene, toluene, and xylene) and two grades of propylene. Aromatic solvents and propylenes are sold to customers in the chemical industry for further processing into such products as paints, plastics, and adhesives.
	•		We are a large producer of sulfur with sales primarily to customers in the agricultural sector. Sulfur is used in manufacturing fertilizer.

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 segregated geographically into two groups: Retail – U.S. and Retail – Canada.

      Retail – U.S.

Sales in Retail – U.S. represent sales of transportation fuels and convenience store merchandise through our company-operated retail sites. For the year ended December 31, 2008, total sales of refined products through Retail – U.S.’s retail sites averaged approximately 115,900 BPD. In addition to transportation fuels, our company-operated convenience stores sell snacks, candy, beer, fast foods, cigarettes, and fountain drinks. On December 31, 2008, we had 1,010 company-operated sites in Retail – U.S. (of which 79% were owned and 21% were leased). Our company-operated stores are operated primarily under the brand name Corner Store ^® . Transportation fuels sold in our Retail – U.S. stores are sold primarily under the Valero ^® brand.

      Retail – Canada

Sales in Retail – Canada 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.

Retail – Canada 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, 2008, total retail sales of refined products through Retail – Canada averaged approximately 76,000 BPD. Transportation fuels are sold under the Ultramar ^® brand through a network of 865 outlets throughout eastern Canada. On December 31, 2008, we owned or leased 412 retail stores in Retail – Canada and distributed gasoline to 453 dealers and independent jobbers. In addition, Retail – Canada operates 85 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. Retail – Canada operations also include a large home heating oil business that provides home heating oil to approximately 141,000 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 and global economic activity.

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 several 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 depend on, among other things, the availability and quantity of imports, the production levels of domestic and foreign suppliers, levels of refined product inventories, productivity and growth (or the lack thereof) of U.S. and global economies, U.S. relationships with foreign governments, political affairs, and the extent of governmental regulation. Historically, refining margins have been volatile, and we believe they will continue to be volatile in the future.

Continued economic turmoil and hostilities, including the threat of future terrorist attacks, could affect the economies of the United States and other countries. Lower levels of economic activity during periods of recession could result in declines in energy consumption, including declines in the demand for and consumption of our refined products, which could cause our revenues and margins to decline and limit our future growth prospects.

Refining margins are also significantly impacted by additional refinery conversion capacity through the expansion of existing refineries or the construction of new refineries. Worldwide refining capacity expansions may result in refining production capability far exceeding refined product demand, which would have a significant adverse effect on refining margins.

A significant portion of our profitability is derived from the ability to purchase and process crude oil feedstocks that historically have been cheaper than benchmark crude oils, such as West Texas Intermediate crude oil. These crude oil feedstock differentials vary significantly depending on overall economic conditions and trends and conditions within the markets for crude oil and refined products, and they could decline in the future, which would have a negative impact on our earnings.

Uncertainty and illiquidity in credit and capital markets can impair our ability to obtain credit and financing on acceptable terms, and can adversely affect the financial strength of our business partners.

Our ability to obtain credit and capital depends in large measure on capital markets and liquidity factors over which we exert no control. Recent disruptions in the credit and capital markets and concerns about economic growth have had a significant adverse impact on global financial markets. Our ability to access credit and capital markets may be restricted at a time when we would like, or need, to access those markets, which could have an impact on our flexibility to react to changing economic and business conditions. In addition, the cost and availability of debt and equity financing may be adversely impacted by unstable or illiquid market conditions. Protracted uncertainty and illiquidity in these markets also could have an adverse impact on our lenders, commodity hedging counterparties, or our customers, causing them to fail to meet their obligations to us. In addition, decreased returns on pension fund assets may also materially increase our pension funding requirements.

We currently maintain investment-grade ratings by Standard & Poor’s Ratings Services (S&P), Moody’s Investors Service (Moody’s), and Fitch Ratings (Fitch) on our senior unsecured debt. (Ratings from credit agencies are not recommendations to buy, sell, or hold our securities. Each rating should be evaluated independently of any other rating.) We cannot provide assurance that any of our current ratings will remain in effect for any given period of time or that a rating will not be lowered or withdrawn entirely by a rating agency if, in its judgment, circumstances so warrant. Specifically, if S&P, Moody’s,

or Fitch were to downgrade our long-term rating, particularly below investment grade, our borrowing costs would increase, which could adversely affect our ability to attract potential investors and our funding sources could decrease. In addition, we may not be able to obtain favorable credit terms from our suppliers or they may require us to provide collateral, letters of credit, or other forms of security which would increase our operating costs. As a result, a downgrade in our credit ratings could have a material adverse impact on our future operations and financial position.

From time to time, our cash needs may exceed our internally generated cash flow, and our business could be materially and adversely affected if we were unable to obtain necessary funds from financing activities. From time to time, we may need to supplement our cash generation with proceeds from financing activities. We have existing revolving credit facilities, committed letter of credit facilities, and an accounts receivable sales facility to provide us with available financing to meet our ongoing cash needs. Uncertainty and illiquidity continues to exist in the financial markets that may materially impact the ability of the participating financial institutions to fund their commitments to us under our various financing facilities. In light of these uncertainties and the volatile current market environment, we can make no assurances that we will be able to obtain the full amount of the funds available under our financing facilities to satisfy our cash requirements. Our failure to do so could have a material adverse effect on our operations and financial position.

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, greenhouse gas emissions, 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 greenhouse gas emissions and climate change ( e.g. , California’s AB-32 “Global Warming Solutions 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, material changes in operations, 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 is satisfied through supplies originating in the Middle East, Africa, Asia, North America, and South America. 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.

In addition, the U.S. government can prevent or restrict us from doing business in or with foreign countries. These restrictions, and those of foreign governments, could limit our ability to gain access to business opportunities in various countries. Actions by both the United States and foreign countries have affected our operations in the past and will continue to do so in the future.

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 many 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 or mechanical failure, encounter work stoppages relating to organized labor issues, 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. A significant interruption in one or more of our refineries could also lead to increased volatility in prices for crude oil feedstocks and refined products, and could increase instability in the financial and insurance markets, making it more difficult for us to access capital and to obtain insurance coverage that we consider adequate.

We maintain insurance against many, but not all, potential losses arising from operating hazards. Failure by one or more insurers to honor its coverage commitments for an insured event could materially and adversely affect our future cash flows, operating results, and financial condition .

Our refining and marketing operations are subject to various hazards common to the industry, including explosions, fires, toxic emissions, maritime hazards, and natural catastrophes. As protection against these hazards, we maintain insurance coverage against some, but not all, such potential losses and liabilities. 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, coverage for hurricane damage is very limited, and coverage for terrorism risks includes very broad exclusions. 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.

Our insurance program includes a number of insurance carriers. Disruptions in the U.S. financial markets have resulted in the deterioration in the financial condition of many financial institutions, including insurance companies. We are not currently aware of any information that would indicate that any of our insurers is unlikely to perform in the event of a covered incident. However, in light of this uncertainty and the volatile current market environment, we can make no assurances that we will be able to obtain the full amount of our insurance coverage for insured events.

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

We are subject to extensive tax liabilities, including United States, state, and foreign income taxes and transactional taxes such as excise, sales/use, payroll, franchise, withholding, and ad valorem taxes. New tax laws and regulations and changes in existing tax laws and regulations are continuously being enacted or proposed that could result in increased expenditures for tax liabilities in the future. Many of these liabilities are subject to periodic audits by the respective taxing authority. Subsequent changes to our tax liabilities as a result of these audits may subject us to interest and penalties.

ENVIRONMENTAL MATTERS

We 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,” and
	•		Item 8 “Financial Statements and Supplementary Data” in Note 24 of Notes to Consolidated Financial Statements under the caption “Environmental Matters.”

Capital Expenditures Attributable to Compliance with Environmental Regulations . In 2008, our capital expenditures attributable to compliance with environmental regulations were approximately $480 million, and are currently estimated to be approximately $635 million for 2009 and approximately $830 million for 2010. The estimates for 2009 and 2010 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 was elected as Valero’s Chairman of the Board in January 2007, and as Chief Executive Officer on December 31, 2005. He added the title of President in January 2008. He was Valero’s Vice-Chairman of the Board from October 31, 2005 to January 18, 2007. He previously served as Executive Vice President and Chief Operating Officer since January 2003. He served as an Executive Vice President of Valero since the date of our acquisition of Ultramar Diamond Shamrock Corporation (UDS) on December 31, 2001.

Ms. Bowers was elected Executive Vice President and General Counsel in October 2008. She previously served as Senior Vice President and General Counsel of the Company since April 2006. Before that, she was Valero’s Vice President-Legal Services from 2003 to 2006. Ms. Bowers joined Valero’s legal department in 1997.

Mr. Ciskowski was elected Executive Vice President and 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.

Mr. Edwards was elected Executive Vice President-Corporate Development and Strategic Planning in December 2005. He previously served as Senior Vice President since December 2001 with responsibilities for product supply, trading, and wholesale marketing. 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 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.

Mr. Marcogliese was elected Executive Vice President and Chief Operating Officer in October 2007. He previously held the title Executive Vice President-Operations since December 2005. Prior to that he served as Senior Vice President overseeing refining operations since July 2001.

ITEM 3. LEGAL PROCEEDINGS

           Litigation

For the legal proceedings listed below, we incorporate by reference into this Item our disclosures made in Part II, Item 8 of this report included in Note 25 of Notes to Consolidated Financial Statements under the caption “Litigation Matters.”

	•		MTBE Litigation
	•		Retail Fuel Temperature Litigation
	•		Rosolowski
	•		Other Litigation

           Environmental Enforcement Matters

While it is not possible to predict the outcome of the following environmental proceedings, if any one or more of them were decided against us, we believe that there would be no material effect on our consolidated financial position or results of operations. We are reporting these proceedings to comply with SEC regulations, which require us to disclose certain information about proceedings arising under federal, state, or local provisions regulating the discharge of materials into the environment or protecting the environment if we reasonably believe that such proceedings will result in monetary sanctions of $100,000 or more.

Bay Area Air Quality Management District (BAAQMD) (Benicia Refinery). From 2006 to 2008, the BAAQMD issued 86 violation notices (VNs) for various alleged air regulation and air permit violations at our Benicia Refinery and asphalt plant. No penalties have been specified in these VNs. We are pursuing settlement of all VNs.

Delaware Department of Natural Resources and Environmental Control (DDNREC) (Delaware City Refinery). Our Delaware City Refinery is subject to 12 outstanding notices of violation (NOVs) issued by the DDNREC. Ten of the NOVs allege unauthorized air emission events at the refinery. Two NOVs allege solid waste violations. No penalties have been specified in these NOVs. We are pursuing settlement of these NOVs.

Los Angeles Regional Water Quality Control Board (LARWQCB) (Wilmington Marine Terminal). In December 2007, as part of the National Pollutant Discharge Elimination System Permit renewal process for our Wilmington marine terminal, the LARWQCB issued an NOV and Request for Information. The NOV alleges violations of acute toxicity effluent limits between 2000 and 2006 and reporting violations between 2001 and 2005. We are currently pursuing settlement of this NOV.

New Jersey Department of Environmental Protection (NJDEP) (Paulsboro Refinery). In 2008, the NJDEP issued three air-related Administrative Order and Notice of Civil Administrative Penalty Assessments (Notices) to our Paulsboro Refinery that we reasonably believe may result in monetary sanctions of $100,000 or more. The Notices allege the refinery’s failure to comply with a number of air permit and regulatory requirements. The Notices propose penalties of approximately $780,000 in the aggregate. We are pursuing settlement of these Notices with the NJDEP.

Oklahoma Department of Environmental Quality (ODEQ) (Ardmore Refinery). We have received a penalty demand of $385,839 from the ODEQ for alleged excess air emission violations at our Ardmore Refinery occurring from 2006 to 2008. We are in settlement discussions with the ODEQ to resolve this matter.

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 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.

South Coast Air Quality Management District (SCAQMD) (Wilmington Refinery). In November 2008, the SCAQMD issued an NOV for alleged air regulation and air permit violations related to a September 2008 flaring event at our Wilmington Refinery. We are pursuing settlement of the NOV.

State of Ohio, Office of the Attorney General, Environmental Enforcement (The Premcor Refining Group Inc. former Clark Retail Enterprises, Inc. retail sites). In June 2008, the Attorney General’s office of the State of Ohio issued a penalty demand of $11,133,000 to our wholly owned subsidiary, The Premcor Refining Group Inc., for alleged environmental violations arising from a predecessor’s operation or ownership of underground storage tanks at several sites. We are in settlement discussions with the Ohio Attorney General to resolve this matter.

Texas Commission on Environmental Quality (TCEQ) (McKee Refinery). In March 2008, we received a proposed Agreed Order from the TCEQ for $101,386 to resolve nine alleged violations of air regulations at our McKee Refinery. We are currently in settlement discussions with the TCEQ to resolve this matter.

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 had originally proposed penalties of $880,240 for these events. In 2007, these enforcement actions were referred to the Texas Attorney General’s office and consolidated with TCEQ Docket No. 2005-1596-AIR-E, which assessed an additional penalty of $130,563. We recently reached a tentative agreement with the Texas Attorney General’s office to resolve this matter.

TCEQ (Texas City Refinery). In January 2008, we received a proposed Agreed Order from the TCEQ for $181,200 relating to an open valve and associated flaring at the Texas City Refinery. We agreed to the terms of the order, which was adopted by the TCEQ in February 2009, thus resolving this matter.

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 2008.

Period

Total

Average

Total Number of

Total Number of

Approximate Dollar

Number of

Price

Shares Not

Shares Purchased

Value of Shares that

Shares

Paid per

Purchased as Part

as Part of

May Yet Be Purchased

Purchased

Share

of Publicly

Publicly

Under the Plans or

Announced Plans

Announced Plans

Programs (2)

or Programs (1)

or Programs

October 2008

8,366,493

$

21.62

446,928

7,919,565

$ 3.46 billion

November 2008

20,526

$

19.61

20,526

–

$ 3.46 billion

December 2008

507

$

17.52

507

–

$ 3.46 billion

Total

8,387,526

$

21.61

467,961

7,919,565

$ 3.46 billion

The following Performance Graph is not “soliciting material,” is not deemed filed with the SEC, and is not to be incorporated by reference into any of Valero’s filings under the Securities Act of 1933 or the Securities Exchange Act of 1934, as amended, respectively .

This Performance Graph and the related textual information are based on historical data and are not indicative of future performance.

The following line graph compares the cumulative total return* on an investment in our common stock against the cumulative total return of the S&P 500 Composite Index and an index of peer companies (selected by us) for the five-year period commencing December 31, 2003 and ending December 31, 2008. The New Peer Group consists of the following 13 companies that are engaged in domestic refining operations: Alon USA Energy, Inc., Chevron Corporation, ConocoPhillips, CVR Energy, Inc., Exxon Mobil Corporation, Frontier Oil Corporation, Hess Corporation, Holly Corporation, Marathon Oil Corporation, Murphy Oil Corporation, Sunoco, Inc., Tesoro Corporation, and Western Refining, Inc. The Old Peer Group consisted of the following ten companies: Chevron Corporation, ConocoPhillips, Exxon Mobil Corporation, Frontier Oil Corporation, Hess Corporation, Marathon Oil Corporation, Murphy Oil Corporation, Occidental Petroleum Corporation, Sunoco, Inc., and Tesoro Corporation. The New Peer Group serves as an update to our Old Peer Group by including additional domestic independent refiners (Alon USA Energy, Inc., CVR Energy, Inc., Holly Corporation, and Western Refining, Inc.) and removing one energy company that does not conduct domestic refining operations (Occidental Petroleum Corporation).

ITEM 6. SELECTED FINANCIAL DATA

The selected financial data for the five-year period ended December 31, 2008 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.

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,” “could,” “should,” “may,” and similar expressions.

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

	•		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 differentials, 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, tax, 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:

	•		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 adjustments to refining capacity in response to market conditions;
	•		environmental, tax, and other regulations at the municipal, 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;
	•		delay of, 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;
	•		legislative or regulatory action, including the introduction or enactment of federal, state, municipal, 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;
	•		overall economic conditions, including the stability and liquidity of financial markets; and
	•		other factors generally described in the “Risk Factors” section included in “Items 1., 1A. & 2. – Business, Risk Factors and Properties” in this report.

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

In this overview, we describe some of the primary factors that we believe affected our results of operations during the year ended December 31, 2008. We reported a loss from continuing operations of $1.1 billion, or $2.16 per share, for the year ended December 31, 2008 compared to income from continuing operations of $4.6 billion, or $7.72 per share, for the year ended December 31, 2007. The 2008 results included a charge in the fourth quarter of 2008 of $4.1 billion ($4.0 billion after tax) resulting from the impairment of goodwill.

The goodwill impairment loss, which represented a write-off of the entire balance of our goodwill, was associated with a significant decline in our market capitalization in the fourth quarter of 2008 that resulted in large part from severe disruptions in the capital and commodities markets. In performing our goodwill impairment test under applicable accounting rules, we estimate fair value by discounting the estimated future cash flows from our refineries. The decline in our market capitalization during the fourth quarter of 2008 resulted in the use of higher, risk-adjusted discount rates in determining the fair values of our reporting units, which reflected the significant risk premium implied by our stock price as of December 31, 2008. As a result of applying these higher discount rates to the cash flows of our reporting units, the fair values in each of our reporting units were below their net book values including goodwill, thus indicating potential impairment. Due to this conclusion of potential impairment, existing accounting rules required additional analysis for each of the reporting units to determine the amount of the loss, and this additional analysis indicated that all of the goodwill in each of our reporting units should be written off.

Effective July 1, 2008, we sold our refinery in Krotz Springs, Louisiana to a subsidiary of Alon USA Energy, Inc. The sale resulted in a pre-tax gain of $305 million, or $170 million after tax, as discussed in Note 2 of Notes to Consolidated Financial Statements. Net cash proceeds from the sale were $463 million, including approximately $135 million from the sale of working capital. In addition, we received contingent consideration in the form of a three-year earn-out agreement based on certain product margins.

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.” The weakening of industry fundamentals for refined products that we experienced in the fourth quarter of 2007 continued throughout 2008. Gasoline margins declined significantly in all of our refining regions in 2008 compared to 2007. The decline in margins was primarily due to a decrease in gasoline demand and an increase in ethanol production. Margins on certain secondary refined products, such as petroleum coke and petrochemical feedstocks, also declined during 2008 due to a significant increase in the cost of crude oil and other feedstocks used to produce them. However, these decreases were partially offset by the effect of favorable diesel margins in 2008, which increased compared to 2007 primarily due to strong global demand.

Because more than 65% of our total crude oil throughput consists of sour crude oil and acidic sweet crude oil feedstocks that historically have been 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 differential.” During 2008, sour crude oil differentials remained wide and improved somewhat in 2008 compared to 2007 levels.

Regarding operations, on January 25, 2008, our Aruba Refinery was shut down due to a fire in its vacuum unit. We resumed partial operation of the refinery in mid-February, and during the second quarter of 2008 we completed the repairs and resumed full operations of the refinery. During the third quarter of 2008, certain of our refineries were shut down as a result of two hurricanes that impacted the Gulf Coast.

Although we avoided major damage from the hurricanes, repair costs and downtime attributable to the hurricanes and the Aruba downtime reduced our results of operations for 2008.

During the year ended December 31, 2008, we increased our quarterly common stock dividend from $0.12 per share to $0.15 per share and purchased 23.0 million shares of our common stock under our board-authorized programs, which represented more than 4% of our shares outstanding at the beginning of 2008. We also redeemed $350 million of 9.5% callable debt that was due in 2013 and invested $3.2 billion in capital expenditures and deferred turnaround and catalyst costs.

RESULTS OF OPERATIONS

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

		Year Ended December 31,
		2008				2007				Change
Refining (a):
Operating income (b)		$	797			$	7,355			$	(6,558	)
Throughput margin per barrel (c)		$	10.79			$	12.33			$	(1.54	)
Operating costs per barrel:
Refining operating expenses		$	4.71			$	3.93			$	0.78
Depreciation and amortization			1.37				1.20				0.17
Total operating costs per barrel		$	6.08			$	5.13			$	0.95
Throughput volumes (thousand barrels per day):
Feedstocks:
Heavy sour crude			592				638				(46	)
Medium/light sour crude			673				635				38
Acidic sweet crude			79				80				(1	)
Sweet crude			606				724				(118	)
Residuals			228				247				(19	)
Other feedstocks			149				173				(24	)
Total feedstocks			2,327				2,497				(170	)
Blendstocks and other			316				301				15
Total throughput volumes			2,643				2,798				(155	)
Yields (thousand barrels per day):
Gasolines and blendstocks			1,187				1,285				(98	)
Distillates			915				919				(4	)
Petrochemicals			71				82				(11	)
Other products (d)			463				507				(44	)
Total yields			2,636				2,793				(157	)
Retail – U.S.:
Operating income		$	260			$	154			$	106
Company-operated fuel sites (average)			973				957				16
Fuel volumes (gallons per day per site)			5,000				4,979				21
Fuel margin per gallon		$	0.229			$	0.174			$	0.055
Merchandise sales		$	1,097			$	1,024			$	73
Merchandise margin (percentage of sales)			29.9	%			29.7	%			0.2	%
Margin on miscellaneous sales		$	99			$	101			$	(2	)
Retail selling expenses		$	505			$	494			$	11
Depreciation and amortization expense		$	70			$	59			$	11
Retail – Canada:
Operating income		$	109			$	95			$	14
Fuel volumes (thousand gallons per day)			3,193				3,234				(41	)
Fuel margin per gallon		$	0.268			$	0.248			$	0.020
Merchandise sales		$	200			$	187			$	13
Merchandise margin (percentage of sales)			28.5	%			27.8	%			0.7	%
Margin on miscellaneous sales		$	36			$	37			$	(1	)
Retail selling expenses		$	263			$	256			$	7
Depreciation and amortization expense		$	35			$	31			$	4

The following notes relate to references on pages 28 through 31.
(a)		Effective July 1, 2007, we sold our Lima Refinery to Husky Refining Company (Husky). Therefore, the results of operations of the Lima Refinery for the six months of 2007 prior to its sale, as well as the gain on the sale of the refinery, are reported as discontinued operations, and all refining operating highlights, both consolidated and for the Mid-Continent region, exclude the Lima Refinery. The sale resulted in a pre-tax gain of $827 million ($426 million after tax), which is included in “Income from discontinued operations, net of income tax expense” for the year ended December 31, 2007.
(b)		Upon applying the goodwill impairment testing criteria under existing accounting rules during the fourth quarter of 2008, we determined that the goodwill in all four of our reporting units was impaired, which resulted in a goodwill impairment loss of $4.1 billion ($4.0 billion after tax). This goodwill impairment loss is included in the refining segment operating income but is excluded from the consolidated and regional throughput margins per barrel and the regional operating income amounts presented for the year ended December 31, 2008 in order to make that information comparable between periods.
(c)		Throughput margin per barrel represents operating revenues less cost of sales divided by throughput volumes.
(d)		Other products primarily include gas oils, No. 6 fuel oil, petroleum coke, and asphalt.
(e)		The regions reflected herein contain the following refineries: the Gulf Coast refining region includes the Corpus Christi East, Corpus Christi West, Texas City, Houston, Three Rivers, Krotz Springs (for periods prior to its sale effective July 1, 2008), St. Charles, Aruba, and Port Arthur Refineries; the Mid-Continent refining region includes the McKee, Ardmore, and Memphis Refineries; the Northeast refining region includes the Quebec City, Paulsboro, and Delaware City Refineries; and the West Coast refining region includes the Benicia and Wilmington Refineries.
(f)		The average market reference prices and differentials, with the exception of the propylene and lube oil differentials, are based on posted prices from Platts 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.
(g)		The market reference differential for sour crude oil is based on 50% Arab Medium and 50% Arab Light posted prices.

General

Operating revenues increased 25% for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily as a result of higher average refined product prices. Refined product prices were significantly higher in the first nine months of 2008 compared to the same period of 2007, but fourth quarter 2008 refined product prices declined to levels substantially below the fourth quarter of 2007. This resulted in a $10.1 billion decrease in fourth quarter 2008 revenues compared to 2007, which lowered the revenue increase for the year to $23.8 billion. Offsetting the higher revenues were substantially higher average feedstock costs.

Operating income decreased $6.4 billion, or 92%, and income from continuing operations decreased $5.7 billion for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to a $6.6 billion decrease in refining segment operating income. The decrease was primarily due to a goodwill impairment loss of $4.1 billion recorded in the fourth quarter of 2008 as discussed in Note 8 of Notes to Consolidated Financial Statements. Also, see “ Impairment of Assets ” under “ Critical Accounting Policies Involving Critical Accounting Estimates ” below for a detailed analysis of the methodology and assumptions used in the determination of this goodwill impairment loss. The goodwill impairment loss is included in the refining segment operating income but is excluded from the consolidated and regional throughput margins per barrel and regional operating income amounts for the year ended December 31, 2008 for comparability purposes. The refining segment operating income and income from continuing operations for the year ended December 31, 2007 exclude the operations of the Lima Refinery and the gain on its sale, which are classified as discontinued operations due to our sale of that refinery effective July 1, 2007 as discussed in Note 2 of Notes to Consolidated Financial Statements.

Refining

Operating income for our refining segment decreased from $7.4 billion for the year ended December 31, 2007 to $797 million for the year ended December 31, 2008, resulting mainly from the $4.1 billion goodwill impairment loss discussed above, a 12% decrease in throughput margin per barrel, a 12% increase in refining operating expenses (including depreciation and amortization expense), and a 6% decline in throughput volumes. These decreases were partially offset by a $305 million gain on the sale of our Krotz Springs Refinery effective July 1, 2008, which is discussed in Note 2 of Notes to Consolidated Financial Statements.

Total refining throughput margins for 2008 compared to 2007 were impacted by the following factors:

	•		Distillate margins in 2008 increased in all of our refining regions from the margins in 2007. The increase in distillate margins was primarily due to strong global demand.
	•		Gasoline margins decreased significantly in all of our refining regions in 2008 compared to the margins in 2007. The decline in gasoline margins was primarily due to a decrease in gasoline demand and an increase in ethanol production.
	•		Margins on various secondary refined products such as asphalt, fuel oils, propylene, and petroleum coke declined from 2007 to 2008 as prices for these products did not increase in proportion to the large increase in the costs of the feedstocks used to produce them.
	•		Sour crude oil feedstock differentials to WTI crude oil in 2008 remained favorable and were wider than the differentials in 2007. These favorable differentials were attributable to continued ample supplies of sour crude oils and heavy sour residual fuel oils on the world market. Differentials on sour crude oil feedstocks also continued to benefit from increased demand for sweet crude oil resulting from lower sulfur specifications for gasoline and diesel.
	•		Throughput volumes decreased 155,000 barrels per day during 2008 compared to 2007 primarily due to a fire in the vacuum unit at our Aruba Refinery in January of 2008, downtime for

			maintenance at our Port Arthur and Delaware City Refineries, unplanned downtime at our Port Arthur, Texas City, St. Charles , and Houston Refineries related to Hurricanes Ike and Gustav, the sale of our Krotz Springs Refinery, and economic decisions to reduce throughputs in certain of our refineries as a result of unfavorable market fundamentals, partially offset by the 2007 shutdown of our McKee Refinery discussed in Note 23 of Notes to Consolidated Financial Statements.
	•		Throughput margin in 2008 included approximately $100 million related to the McKee Refinery business interruption settlement discussed in Note 23 of Notes to Consolidated Financial Statements.

Refining operating expenses, excluding depreciation and amortization expense, increased $0.78 per barrel, or 20%, for the year ended December 31, 2008 compared to the year ended December 31, 2007. Per-barrel operating expenses increased mainly due to an increase in energy costs, as well as the effect of the throughput volume decline discussed above. Refining depreciation and amortization expense increased 9% from 2007 to 2008 primarily due to the implementation of new capital projects and increased turnaround and catalyst amortization.

Retail

Retail operating income was $369 million for the year ended December 31, 2008 compared to $249 million for the year ended December 31, 2007. This 48% increase in operating income was primarily attributable to a $0.055 per gallon increase in retail fuel margins and increased in-store sales in our U.S. retail operations. The significant improvement in fuel margins was largely the result of rapidly declining crude oil prices in the second half of 2008.

Corporate Expenses and Other

General and administrative expenses, including corporate depreciation and amortization expense, decreased $83 million for the year ended December 31, 2008 compared to the year ended December 31, 2007. This decrease was primarily due to lower variable incentive compensation expenses combined with the nonrecurrence of 2007 expenses related to executive retirement costs and a $13 million termination fee paid for the cancellation of our services agreement with NuStar Energy L.P.

“Other income, net” decreased for the year ended December 31, 2008 compared to the year ended December 31, 2007 primarily due to a $91 million foreign currency exchange rate gain in 2007 resulting from the repayment of a loan by a foreign subsidiary, reduced interest income resulting from lower cash balances and interest rates, and a reduction in the fair value of certain nonqualified benefit plan assets. These decreases were partially offset by income related to the Alon earn-out agreement discussed in Notes 2 and 17 of Notes to Consolidated Financial Statements, lower costs incurred under our accounts receivable sales program, an increase in earnings from our equity investment in Cameron Highway Oil Pipeline Company, and a $14 million gain in 2008 on the redemption of our 9.5% senior notes as discussed in Note 12 of Notes to Consolidated Financial Statements.

Interest and debt expense decreased primarily due to reduced interest on tax liabilities, partially offset by higher average debt balances.

Income tax expense decreased $694 million from 2007 to 2008 mainly as a result of lower operating income, excluding the effect on operating income of the $4.1 billion goodwill impairment loss discussed above that has an insignificant tax effect. Excluding this goodwill impairment loss, our effective tax rate for the year ended December 31, 2008 was comparable to the effective tax rate for the year ended December 31, 2007.

Income from discontinued operations for the year ended December 31, 2007 represents a $426 million after-tax gain on the sale of the Lima Refinery effective July 1, 2007 and net income from its operations prior to the sale.

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

		Year Ended December 31,
		2007				2006				Change
Refining (a):
Operating income		$	7,355			$	8,182			$	(827	)
Throughput margin per barrel (c)		$	12.33			$	12.47			$	(0.14	)
Operating costs per barrel:
Refining operating expenses		$	3.93			$	3.53			$	0.40
Depreciation and amortization			1.20				0.96				0.24
Total operating costs per barrel		$	5.13			$	4.49			$	0.64
Throughput volumes (thousand barrels per day):
Feedstocks:
Heavy sour crude			638				697				(59	)
Medium/light sour crude			635				618				17
Acidic sweet crude			80				65				15
Sweet crude			724				752				(28	)
Residuals			247				234				13
Other feedstocks			173				147				26
Total feedstocks			2,497				2,513				(16	)
Blendstocks and other			301				298				3
Total throughput volumes			2,798				2,811				(13	)
Yields (thousand barrels per day):
Gasolines and blendstocks			1,285				1,348				(63	)
Distillates			919				891				28
Petrochemicals			82				80				2
Other products (d)			507				491				16
Total yields			2,793				2,810				(17	)
Retail – U.S.:
Operating income		$	154			$	113			$	41
Company-operated fuel sites (average)			957				982				(25	)
Fuel volumes (gallons per day per site)			4,979				4,985				(6	)
Fuel margin per gallon		$	0.174			$	0.162			$	0.012
Merchandise sales		$	1,024			$	960			$	64
Merchandise margin (percentage of sales)			29.7	%			29.6	%			0.1	%
Margin on miscellaneous sales		$	101			$	85			$	16
Retail selling expenses		$	494			$	485			$	9
Depreciation and amortization expense		$	59			$	60			$	(1	)
Retail – Canada:
Operating income		$	95			$	69			$	26
Fuel volumes (thousand gallons per day)			3,234				3,176				58
Fuel margin per gallon		$	0.248			$	0.217			$	0.031
Merchandise sales		$	187			$	167			$	20
Merchandise margin (percentage of sales)			27.8	%			27.4	%			0.4	%
Margin on miscellaneous sales		$	37			$	32			$	5
Retail selling expenses		$	256			$	234			$	22
Depreciation and amortization expense		$	31			$	27			$	4