Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Our management is responsible for establishing and maintaining adequate “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934) for Valero Energy Corporation. Our management evaluated the effectiveness of Valero’s internal control over financial reporting as of December 31, 2018. In its evaluation, management used the criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Management believes that as of December 31, 2018, our internal control over financial reporting was effective based on those criteria.

Our independent registered public accounting firm has issued an attestation report on the effectiveness of our internal control over financial reporting, which begins on page 64 of this report.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Valero Energy Corporation and subsidiaries:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated balance sheets of Valero Energy Corporation and subsidiaries (the Company) as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2018 and 2017, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2018, in conformity with U.S. generally accepted accounting principles.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 28, 2019 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP

We have served as the Company’s auditor since 2004.

San Antonio, Texas

February 28, 2019

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Stockholders

Valero Energy Corporation and subsidiaries:

Opinion on Internal Control Over Financial Reporting

We have audited Valero Energy Corporation’s (the Company) internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2018, based on criteria established in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2018 and 2017, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the years in the three-year period ended December 31, 2018, and the related notes (collectively, the consolidated financial statements), and our report dated February 28, 2019 expressed an unqualified opinion on those consolidated financial statements.

Basis for Opinion

The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial

statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ KPMG LLP

San Antonio, Texas

February 28, 2019

VALERO ENERGY CORPORATION

CONSOLIDATED BALANCE SHEETS

(millions of dollars, except par value)



	December 31,
	2018			2017
ASSETS
Current assets:
Cash and cash equivalents	$	2,982		$	5,850
Receivables, net	7,345			6,922
Inventories	6,532			6,384
Prepaid expenses and other	816			156
Total current assets	17,675			19,312
Property, plant, and equipment, at cost	42,473			40,010
Accumulated depreciation	(13,625		)	(12,530		)
Property, plant, and equipment, net	28,848			27,480
Deferred charges and other assets, net	3,632			3,366
Total assets	$	50,155		$	50,158
LIABILITIES AND EQUITY
Current liabilities:
Current portion of debt and capital lease obligations	$	238		$	122
Accounts payable	8,594			8,348
Accrued expenses	630			712
Taxes other than income taxes payable	1,213			1,321
Income taxes payable	49			568
Total current liabilities	10,724			11,071
Debt and capital lease obligations, less current portion	8,871			8,750
Deferred income tax liabilities	4,962			4,708
Other long-term liabilities	2,867			2,729
Commitments and contingencies
Equity:
Valero Energy Corporation stockholders’ equity:
Common stock, $0.01 par value; 1,200,000,000 shares authorized; 673,501,593 and 673,501,593 shares issued	7			7
Additional paid-in capital	7,048			7,039
Treasury stock, at cost; 255,905,051 and 239,603,534 common shares	(14,925		)	(13,315		)
Retained earnings	31,044			29,200
Accumulated other comprehensive loss	(1,507		)	(940		)
Total Valero Energy Corporation stockholders’ equity	21,667			21,991
Noncontrolling interests	1,064			909
Total equity	22,731			22,900
Total liabilities and equity	$	50,155		$	50,158

See Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(millions of dollars, except per share amounts)



	Year Ended December 31,
	2018			2017			2016
Revenues (a)	$	117,033		$	93,980		$	75,659
Cost of sales:
Cost of materials and other	104,732			83,037			65,962
Operating expenses (excluding depreciation and amortization expense reflected below)	4,690			4,504			4,251
Depreciation and amortization expense	2,017			1,934			1,846
Lower of cost or market inventory valuation adjustment	—			—			(747		)
Total cost of sales	111,439			89,475			71,312
Other operating expenses	45			61			—
General and administrative expenses (excluding depreciation and amortization expense reflected below)	925			829			709
Depreciation and amortization expense	52			52			48
Asset impairment loss	—			—			56
Operating income	4,572			3,563			3,534
Other income, net	130			112			94
Interest and debt expense, net of capitalized interest	(470		)	(468		)	(446		)
Income before income tax expense (benefit)	4,232			3,207			3,182
Income tax expense (benefit)	879			(949		)	765
Net income	3,353			4,156			2,417
Less: Net income attributable to noncontrolling interests	231			91			128
Net income attributable to Valero Energy Corporation stockholders	$	3,122		$	4,065		$	2,289

Earnings per common share	$	7.30		$	9.17		$	4.94
Weighted-average common shares outstanding (in millions)	426			442			461

Earnings per common share – assuming dilution	$	7.29		$	9.16		$	4.94
Weighted-average common shares outstanding – assuming dilution (in millions)	428			444			464
_______________________________________________
Supplemental information:
(a) Includes excise taxes on sales by certain of our international operations	$	5,626		$	5,573		$	5,493

See Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(millions of dollars)



	Year Ended December 31,
	2018			2017			2016
Net income	$	3,353		$	4,156		$	2,417
Other comprehensive income (loss):
Foreign currency translation adjustment	(517		)	514			(415		)
Net gain (loss) on pension and other postretirement benefits	49			(65		)	(98		)
Other comprehensive income (loss) before income tax expense (benefit)	(468		)	449			(513		)
Income tax expense (benefit) related to items of other comprehensive income (loss)	10			(21		)	(37		)
Other comprehensive income (loss)	(478		)	470			(476		)
Comprehensive income	2,875			4,626			1,941
Less: Comprehensive income attributable to noncontrolling interests	229			91			129
Comprehensive income attributable to Valero Energy Corporation stockholders	$	2,646		$	4,535		$	1,812

See Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF EQUITY

(millions of dollars)



	Valero Energy Corporation Stockholders’ Equity
	Common Stock		Additional Paid-in Capital			Treasury Stock			Retained Earnings			Accumulated Other Comprehensive Loss			Total			Non- controlling Interests			Total Equity
Balance as of December 31, 2015	$	7	$	7,064		$	(10,799	)	$	25,188		$	(933	)	$	20,527		$	827		$	21,354
Net income	—		—			—			2,289			—			2,289			128			2,417
Dividends on common stock ($2.40 per share)	—		—			—			(1,111		)	—			(1,111		)	—			(1,111		)
Stock-based compensation expense	—		68			—			—			—			68			—			68
Transactions in connection with stock-based compensation plans	—		(89		)	34			—			—			(55		)	—			(55		)
Stock purchases under purchase program	—		—			(1,262		)	—			—			(1,262		)	—			(1,262		)
Issuance of Valero Energy Partners LP common units	—		—			—			—			—			—			11			11
Distributions to noncontrolling interests	—		—			—			—			—			—			(65		)	(65		)
Other	—		45			—			—			—			45			(72		)	(27		)
Other comprehensive income (loss)	—		—			—			—			(477		)	(477		)	1			(476		)
Balance as of December 31, 2016	7		7,088			(12,027		)	26,366			(1,410		)	20,024			830			20,854
Net income	—		—			—			4,065			—			4,065			91			4,156
Dividends on common stock ($2.80 per share)	—		—			—			(1,242		)	—			(1,242		)	—			(1,242		)
Stock-based compensation expense	—		68			—			—			—			68			—			68
Transactions in connection with stock-based compensation plans	—		(82		)	19			—			—			(63		)	—			(63		)
Stock purchases under purchase programs	—		—			(1,307		)	—			—			(1,307		)	—			(1,307		)
Issuance of Valero Energy Partners LP common units	—		—			—			—			—			—			33			33
Contributions from noncontrolling interests	—		—			—			—			—			—			30			30
Distributions to noncontrolling interests	—		—			—			—			—			—			(67		)	(67		)
Other	—		(35		)	—			11			—			(24		)	(8		)	(32		)
Other comprehensive income	—		—			—			—			470			470			—			470
Balance as of December 31, 2017	7		7,039			(13,315		)	29,200			(940		)	21,991			909			22,900
Reclassification of stranded income tax effects of Tax Reform per ASU 2018-02 (see Note 1)	—		—			—			91			(91		)	—			—			—
Net income	—		—			—			3,122			—			3,122			231			3,353
Dividends on common stock ($3.20 per share)	—		—			—			(1,369		)	—			(1,369		)	—			(1,369		)
Stock-based compensation expense	—		82			—			—			—			82			—			82
Transactions in connection with stock-based compensation plans	—		(70		)	(99		)	—			—			(169		)	—			(169		)
Stock purchases under purchase programs	—		—			(1,511		)	—			—			(1,511		)	—			(1,511		)
Contributions from noncontrolling interests	—		—			—			—			—			—			32			32
Distributions to noncontrolling interests	—		—			—			—			—			—			(116		)	(116		)
Other	—		(3		)	—			—			—			(3		)	10			7
Other comprehensive loss	—		—			—			—			(476		)	(476		)	(2		)	(478		)
Balance as of December 31, 2018	$	7	$	7,048		$	(14,925	)	$	31,044		$	(1,507	)	$	21,667		$	1,064		$	22,731

See Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(millions of dollars)



	Year Ended December 31,
	2018			2017			2016
Cash flows from operating activities:
Net income	$	3,353		$	4,156		$	2,417
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization expense	2,069			1,986			1,894
Lower of cost or market inventory valuation adjustment	—			—			(747		)
Asset impairment loss	—			—			56
Deferred income tax expense (benefit)	203			(2,543		)	230
Changes in current assets and current liabilities	(1,297		)	1,289			976
Changes in deferred charges and credits and other operating activities, net	43			594			(6		)
Net cash provided by operating activities	4,371			5,482			4,820
Cash flows from investing activities:
Capital expenditures	(1,628		)	(1,353		)	(1,278		)
Deferred turnaround and catalyst costs	(915		)	(523		)	(718		)
Investments in joint ventures	(181		)	(406		)	(4		)
Capital expenditures of certain variable interest entities (VIEs)	(124		)	(26		)	—
Peru Acquisition, net of cash acquired	(468		)	—			—
Acquisition of ethanol plants	(320		)	—			—
Acquisitions of undivided interests	(212		)	(72		)	—
Minor acquisitions	(88		)	—			—
Other investing activities, net	8			(2		)	(6		)
Net cash used in investing activities	(3,928		)	(2,382		)	(2,006		)
Cash flows from financing activities:
Proceeds from debt issuances and borrowings (excluding borrowings of certain VIEs)	1,258			380			2,153
Proceeds from borrowings of certain VIEs	109			—			—
Repayments of debt and capital lease obligations	(1,359		)	(21		)	(1,475		)
Purchases of common stock for treasury	(1,708		)	(1,372		)	(1,336		)
Common stock dividends	(1,369		)	(1,242		)	(1,111		)
Contributions from noncontrolling interests	32			30			—
Distributions to noncontrolling interests	(116		)	(67		)	(65		)
Other financing activities, net	(15		)	20			(178		)
Net cash used in financing activities	(3,168		)	(2,272		)	(2,012		)
Effect of foreign exchange rate changes on cash	(143		)	206			(100		)
Net increase (decrease) in cash and cash equivalents	(2,868		)	1,034			702
Cash and cash equivalents at beginning of year	5,850			4,816			4,114
Cash and cash equivalents at end of year	$	2,982		$	5,850		$	4,816

See Notes to Consolidated Financial Statements.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.	DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, AND SIGNIFICANT ACCOUNTING POLICIES

Description of Business

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

We are an independent petroleum refiner and ethanol producer. We own 15 petroleum refineries located in the United States (U.S.), Canada, and the United Kingdom (U.K.) with a combined throughput capacity of approximately 3.1 million barrels per day as of December 31, 2018. We sell our refined petroleum products in both the wholesale rack and bulk markets, and approximately 7,000 outlets carry our brand names in the U.S., Canada, the U.K., and Ireland. Most of our logistics assets support our refining operations, and some of these assets are owned by Valero Energy Partners LP (VLP). See Note 12 for further information about VLP. We also own 14 ethanol plants in the Mid-Continent region of the U.S. with a combined production capacity of approximately 1.73 billion gallons per year as of December 31, 2018. We sell our ethanol in the wholesale bulk market, and some of our logistics assets support our ethanol operations.

Basis of Presentation

General

These consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles (GAAP) and with the rules and regulations of the U.S. Securities and Exchange Commission (SEC).

Reclassifications

Certain prior year amounts have been reclassified to conform to the 2018 presentation. The changes were primarily due to our retrospective adoption on January 1, 2018 of Accounting Standards Update (ASU) No. 2017-07, “Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost.” This ASU requires employers to report the service cost component of net periodic pension cost and net periodic postretirement benefit cost in the same line item as other compensation costs arising from services rendered by the pertinent employees during the period. It also requires the other components of net periodic pension cost and net periodic postretirement benefit cost (non-service cost components) to be presented in the income statement separately from the service cost component and outside a subtotal of income from operations. The adoption of this ASU did not affect our financial position or results of operations, but resulted in the reclassification of the non-service components of pension and postretirement benefit costs from operating expenses (excluding depreciation and amortization expense) and general and administrative expenses (excluding depreciation and amortization expense) to other income, net. This resulted in an increase of $42 million and $44 million in operating expenses (excluding depreciation and amortization expense) and a decrease of $6 million and $6 million in general and administrative expenses (excluding depreciation and amortization expense) for the years ended December 31, 2017 and 2016, respectively.

Significant Accounting Policies

Principles of Consolidation

These financial statements include those of Valero, our wholly owned subsidiaries, and VIEs in which we have a controlling interest. Our VIEs are described in Note 12. The ownership interests held by others in the VIEs are recorded as noncontrolling interests. Intercompany items and transactions have been eliminated in

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

consolidation. Investments in less than wholly owned entities where we have significant influence are accounted for using the equity method.

Use of Estimates

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

Cash Equivalents

Our cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and have a maturity of three months or less when acquired.

Receivables

Trade receivables are carried at original invoice amount. We maintain an allowance for doubtful accounts, which is adjusted based on management’s assessment of our customers’ historical collection experience, known credit risks, and industry and economic conditions.

Inventories

The cost of refinery feedstocks, refined petroleum products, and grain and ethanol inventories is determined under the last-in, first-out (LIFO) method using the dollar-value LIFO approach, with any increments valued based on average purchase prices during the year. Our LIFO inventories are carried at the lower of cost or market. The cost of products purchased for resale and the cost of materials and supplies are determined principally under the weighted-average cost method. Our non-LIFO inventories are carried at the lower of cost or net realizable value. If the aggregate market value of our LIFO inventories or the aggregate net realizable value of our non-LIFO inventories is less than the related aggregate cost, we recognize a loss for the difference in our statements of income.

Property, Plant, and Equipment

The cost of property, plant, and equipment (property assets) purchased or constructed, including betterments of property assets, is capitalized. However, the cost of repairs to and normal maintenance of property assets is expensed as incurred. Betterments of property assets are those that extend the useful life, increase the capacity or improve the operating efficiency of the asset, or improve the safety of our operations. The cost of property assets constructed includes interest and certain overhead costs allocable to the construction activities.

Our operations, especially those of our refining segment, are highly capital intensive. Each of our refineries comprises a large base of property assets, consisting of a series of interconnected, highly integrated and interdependent crude oil processing facilities and supporting logistical infrastructure (Units), and these Units are continuously improved. Improvements consist of the addition of new Units and betterments of existing Units. We plan for these improvements by developing a multi-year capital program that is updated and revised based on changing internal and external factors.

Depreciation of property assets used in our refining segment is recorded on a straight-line basis over the estimated useful lives of these assets primarily using the composite method of depreciation. We maintain a

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

separate composite group of property assets for each of our refineries. We estimate the useful life of each group based on an evaluation of the property assets comprising the group, and such evaluations consist of, but are not limited to, the physical inspection of the assets to determine their condition, consideration of the manner in which the assets are maintained, assessment of the need to replace assets, and evaluation of the manner in which improvements impact the useful life of the group. The estimated useful lives of our composite groups range primarily from 25 to 30 years.

Under the composite method of depreciation, the cost of an improvement is added to the composite group to which it relates and is depreciated over that group’s estimated useful life. We design improvements to our refineries in accordance with engineering specifications, design standards, and practices accepted in our industry, and these improvements have design lives consistent with our estimated useful lives. Therefore, we believe the use of the group life to depreciate the cost of improvements made to the group is reasonable because the estimated useful life of each improvement is consistent with that of the group.

Also under the composite method of depreciation, the historical cost of a minor property asset (net of salvage value) that is retired or replaced is charged to accumulated depreciation and no gain or loss is recognized in income. However, a gain or loss is recognized in income for a major property asset that is retired, replaced, sold, or for an abnormal disposition of a property asset (primarily involuntary conversions). Gains and losses are reflected in depreciation and amortization expense, unless such amounts are reported separately due to materiality.

Depreciation of property assets used in our ethanol segment is recorded on a straight-line basis over the estimated useful lives of the related assets.

Leasehold improvements are amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the related asset. Assets acquired under capital leases are amortized on a straight-line basis over (i) the lease term if transfer of ownership does not occur at the end of the lease term or (ii) the estimated useful life of the asset if transfer of ownership does occur at the end of the lease term.

Deferred Charges and Other Assets

“Deferred charges and other assets, net” primarily include the following:


•	turnaround costs, which are incurred in connection with planned major maintenance activities at our refineries and ethanol plants and which are deferred when incurred and amortized on a straight-line basis over the period of time estimated to lapse until the next turnaround occurs;


•	fixed-bed catalyst costs, representing the cost of catalyst that is changed out at periodic intervals when the quality of the catalyst has deteriorated beyond its prescribed function, which are deferred when incurred and amortized on a straight-line basis over the estimated useful life of the specific catalyst;


•	income taxes receivable;


•	investments in joint ventures accounted for under the equity method;

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


•	intangible assets; and


•	goodwill.

Impairment of Assets

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

We evaluate our equity method investments for impairment when there is evidence that we may not be able to recover the carrying amount of our investments or the investee is unable to sustain an earnings capacity that justifies the carrying amount. A loss in the value of an investment that is other than a temporary decline is recognized currently in income, and is based on the difference between the estimated current fair value of the investment and its carrying amount.

Asset Retirement Obligations

We record a liability, which is referred to as an asset retirement obligation, at fair value for the estimated cost to retire a tangible long-lived asset at the time we incur that liability, which is generally when the asset is purchased, constructed, or leased. We record the liability when we have a legal obligation to incur costs to retire the asset and when a reasonable estimate of the fair value of the liability can be made. If a reasonable estimate cannot be made at the time the liability is incurred, we record the liability when sufficient information is available to estimate the liability’s fair value.

We have obligations with respect to certain of our assets related to our refining and ethanol segments to clean and/or dispose of various component parts of the assets at the time they are retired. However, these component parts can be used for extended and indeterminate periods of time as long as they are properly maintained and/or upgraded. It is our practice and current intent to maintain all our assets and continue making improvements to those assets based on technological advances. As a result, we believe that our assets related to our refining and ethanol segments have indeterminate lives for purposes of estimating asset retirement obligations because dates or ranges of dates upon which we would retire such assets cannot reasonably be estimated at this time. We will recognize a liability at such time when sufficient information exists to estimate a date or range of potential settlement dates that is needed to employ a present value technique to estimate fair value.

Environmental Matters

Liabilities for future remediation costs are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Other than for assessments, the timing and magnitude of these accruals generally are based on the completion of investigations or other studies or a commitment to a formal plan of action. Amounts recorded for environmental liabilities have not been reduced by possible recoveries from third parties and have not been measured on a discounted basis.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Legal Contingencies

We are subject to legal proceedings, claims, and liabilities that arise in the ordinary course of business. We accrue losses associated with legal claims when such losses are probable and reasonably estimable. If we determine that a loss is probable and cannot estimate a specific amount for that loss but can estimate a range of loss, the best estimate within the range is accrued. If no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. Estimates are adjusted as additional information becomes available or circumstances change. Legal defense costs associated with loss contingencies are expensed in the period incurred.

Foreign Currency Translation

Generally, our international subsidiaries use their local currency as their functional currency. Balance sheet amounts are translated into U.S. dollars using exchange rates in effect as of the balance sheet date. Income statement amounts are translated into U.S. dollars using the exchange rates in effect at the time the underlying transactions occur. Foreign currency translation adjustments are recorded as a component of accumulated other comprehensive loss.

Revenue Recognition

Our revenues are primarily generated from contracts with customers. We generate revenue from contracts with customers from the sale of products by our refining and ethanol segments. Our VLP segment generates intersegment revenues from transportation and terminaling activities provided to our refining segment that are eliminated in consolidation. Revenues are recognized when we satisfy our performance obligation to transfer products to our customers, which typically occurs at a point in time upon shipment or delivery of the products, and for an amount that reflects the transaction price that is allocated to the performance obligation.

The customer is able to direct the use of, and obtain substantially all of the benefits from, the products at the point of shipment or delivery. As a result, we consider control to have transferred upon shipment or delivery because we have a present right to payment at that time, the customer has legal title to the asset, we have transferred physical possession of the asset, and the customer has significant risks and rewards of ownership of the asset.

Our contracts with customers state the final terms of the sale, including the description, quantity, and price for goods sold. Payment is typically due in full within two to ten days of delivery. In the normal course of business, we generally do not accept product returns.

The transaction price is the consideration that we expect to be entitled to in exchange for our products. The transaction price for substantially all of our contracts is generally based on commodity market pricing (i.e., variable consideration). As such, this market pricing may be constrained (i.e., not estimable) at the inception of the contract but will be recognized based on the applicable market pricing, which will be known upon transfer of the goods to the customer. Some of our contracts also contain variable consideration in the form of sales incentives to our customers, such as discounts and rebates. For contracts that include variable consideration, we estimate the factors that determine the variable consideration in order to establish the transaction price.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

We have elected to exclude from the measurement of the transaction price all taxes assessed by governmental authorities that are both imposed on and concurrent with a specific revenue-producing transaction and collected by us from a customer (e.g., sales tax, use tax, value-added tax, etc.). We continue to include in the transaction price excise taxes that are imposed on certain inventories in our international operations. The amount of such taxes is provided in supplemental information in a footnote on the statements of income.

There are instances where we provide shipping services in relation to the goods sold to our customer. Shipping and handling costs that occur before the customer obtains control of the goods are deemed to be fulfillment activities and are included in cost of materials and other. We have elected to account for shipping and handling activities that occur after the customer has obtained control of a good as fulfillment activities rather than as a promised service and we have included these activities in cost of materials and other.

We enter into certain purchase and sale arrangements with the same counterparty that are deemed to be made in contemplation of one another. We combine these transactions and present the net effect in cost of materials and other. We also enter into refined petroleum product exchange transactions to fulfill sales contracts with our customers by accessing refined petroleum products in markets where we do not operate our own refineries. These refined petroleum product exchanges are accounted for as exchanges of nonmonetary assets, and no revenues are recorded on these transactions.

Cost Classifications

“Cost of materials and other” primarily includes the cost of materials that are a component of our products sold. These costs include (i) the direct cost of materials (such as crude oil and other refinery feedstocks, refined petroleum products and blendstocks, and ethanol feedstocks and products) that are a component of our products sold; (ii) costs related to the delivery (such as shipping and handling costs) of products sold; (iii) costs related to our environmental credit obligations to comply with various governmental and regulatory programs (such as the cost of Renewable Identification Numbers (RINs) as required by the U.S. Environmental Protection Agency’s (EPA) Renewable Fuel Standard and emission credits under various cap-and-trade systems, as defined in Note 19); (iv) gains and losses on our commodity derivative instruments; and (v) certain excise taxes.

“Operating expenses (excluding depreciation and amortization expense)” include costs to operate our refineries, ethanol plants, and logistics assets, except for depreciation and amortization expense. These costs primarily include employee-related expenses, energy and utility costs, catalysts and chemical costs, and repair and maintenance expenses.

“Depreciation and amortization expense” associated with our operations is separately presented in our statement of income as a component of cost of sales and general and administrative expenses and is disclosed by reportable segment in Note 17.

“Other operating expenses” include costs, if any, incurred by our reportable segments that are not associated with our cost of sales.

Environmental Compliance Program Costs

We purchase credits in the open market to meet our obligations under various environmental compliance programs. We purchase biofuel credits (primarily RINs in the U.S.) to comply with government regulations

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

that require us to blend a certain percentage of biofuels into the products we produce. To the degree that we are unable to blend biofuels at the required percentage, we must purchase biofuel credits to meet our obligation. We purchase greenhouse gas (GHG) emission credits to comply with government regulations concerning various GHG emission programs, including cap-and-trade systems. These programs are described in Note 20 under “Environmental Compliance Program Price Risk.”

The costs of purchased biofuel credits and GHG emission credits are charged to cost of materials and other as such credits are needed to satisfy our obligation. To the extent we have not purchased enough credits to satisfy our obligation as of the balance sheet date, we charge cost of materials and other for such deficiency based on the market price of the credits as of the balance sheet date, and we record a liability for our obligation to purchase those credits. See Note 19 for disclosure of our fair value liability.

Stock-Based Compensation

Compensation expense for our share-based compensation plans is based on the fair value of the awards granted and is recognized in income on a straight-line basis over the shorter of (i) the requisite service period of each award or (ii) the period from the grant date to the date retirement eligibility is achieved if that date is expected to occur during the vesting period established in the award.

Income Taxes

Income taxes are accounted for under the asset and liability method. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred amounts are measured using enacted tax rates expected to apply to taxable income in the year those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by unrecognized tax benefits, if such items may be available to offset the unrecognized tax benefit. Stranded income tax effects are released from accumulated other comprehensive loss to retained earnings on an individual item basis as those items are reclassified into income.

We have elected to classify any interest expense and penalties related to the underpayment of income taxes in income tax expense.

We have elected to treat the global intangible low-taxed income (GILTI) tax as a period expense.

Earnings per Common Share

Earnings per common share is computed by dividing net income attributable to Valero stockholders by the weighted-average number of common shares outstanding for the year. Participating securities are included in the computation of basic earnings per share using the two-class method. Earnings per common share – assuming dilution is computed by dividing net income attributable to Valero stockholders by the weighted-average number of common shares outstanding for the year increased by the effect of dilutive securities. Potentially dilutive securities are excluded from the computation of earnings per common share – assuming dilution when the effect of including such shares would be antidilutive.

Financial Instruments

Our financial instruments include cash and cash equivalents, receivables, payables, debt, capital lease obligations, commodity derivative contracts, and foreign currency derivative contracts. The estimated fair

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

values of these financial instruments approximate their carrying amounts, except for certain debt as discussed in Note 19.

Derivatives and Hedging

All derivative instruments, not designated as normal purchases or sales, are recorded in the balance sheet as either assets or liabilities measured at their fair values with changes in fair value recognized currently in income. To manage commodity price risk, we use economic hedges, which are derivative instruments not designated as fair value or cash flow hedges, and we also use fair value and cash flow hedges from time to time. The cash flow effects of all of our derivative instruments are reflected in operating activities in the statements of cash flows.

Accounting Pronouncements Adopted During 2018

Topic 606

On January 1, 2018, we adopted the provisions of Accounting Standards Codification (ASC) Topic 606, “Revenue from Contracts with Customers,” (Topic 606). This standard clarifies the principles for recognizing revenue and supersedes previous revenue recognition requirements under “Revenue Recognition (Topic 605).” We adopted the provisions of Topic 606 using the modified retrospective method of adoption as permitted by the standard. Under this method, the cumulative effect of initially applying the standard is recognized as an adjustment to the opening balance of retained earnings, and revenues reported in the periods prior to the date of adoption are not changed. We elected to apply the transition guidance for Topic 606 only to contracts that were not completed as of the date of adoption. There was no material impact to our financial position as a result of adopting Topic 606; therefore, there was no cumulative-effect adjustment to retained earnings as of January 1, 2018, and there was no material impact to our financial statements as of and for the year ended December 31, 2018. Our revenue recognition accounting policy described above has been updated in conjunction with our adoption of Topic 606, but our previous policy has been omitted because the adoption of Topic 606 had no material impact to us as previously described.

ASU No. 2016-01

On January 1, 2018, we adopted the provisions of ASU No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” This ASU enhances the reporting model for financial instruments regarding certain aspects of recognition, measurement, presentation, and disclosure. We adopted the provisions of this ASU using the cumulative-effect method of adoption as required by the ASU. The adoption of this ASU did not affect our financial position or our results of operations as of or for the year ended December 31, 2018, but resulted in reduced disclosures as it eliminated the requirement to disclose the methods and significant assumptions used to estimate the fair value of financial instruments.

ASU No. 2017-04

Effective October 1, 2018, we early adopted the provisions of ASU No. 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” This ASU simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under the provisions of this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, including goodwill, and should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value. However, the impairment charge should not exceed the carrying amount of goodwill allocated to that reporting unit. An

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The adoption of this ASU did not affect our financial position or results of operations and did not result in additional disclosures because it is applied prospectively to impairment tests performed after the date of adoption.

ASU No. 2017-09

On January 1, 2018, we adopted the provisions of ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.” This ASU reduces diversity in practice, as well as reduces cost and complexity regarding a change to the terms or conditions of a share-based payment award. The adoption of this ASU did not have an immediate effect on our financial position or results of operations as it is applied prospectively to an award modified on or after adoption.

ASU No. 2018-02

On January 1, 2018, we adopted the provisions of ASU No. 2018-02, “Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income,” (ASU No. 2018-02). This ASU allows for the stranded tax effects resulting from the Tax Cuts and Jobs Act of 2017 (Tax Reform) to be reclassified from accumulated other comprehensive income to retained earnings. We elected to reclassify the stranded income tax effects resulting from Tax Reform from accumulated other comprehensive income to retained earnings as of the beginning of the interim period of adoption. The adoption of this ASU did not affect our financial position or results of operations but resulted in the reclassification of $91 million of income tax benefits related to Tax Reform from accumulated other comprehensive loss to retained earnings as of January 1, 2018 as presented in our statement of equity and in Note 11 under “Accumulated Other Comprehensive Loss.”

ASU No. 2018-05

In March 2018, the Financial Accounting Standards Board (FASB) issued ASU No. 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118,” (ASU No. 2018-05) to amend certain SEC material in Topic 740 for the income tax accounting implications of the recently issued Tax Reform. This guidance clarifies the application of Topic 740 in situations where a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting under Topic 740 for certain income tax effects of Tax Reform for the reporting period in which Tax Reform was enacted. See Note 15 for a discussion of the impact of this ASU.

ASU No. 2018-13

Effective October 1, 2018, we adopted all of the provisions of ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.” This ASU improves the effectiveness of disclosures in the notes to financial statements by removing, modifying, and adding certain disclosure requirements for fair value measurements. We are no longer required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, but are required to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. Certain provisions of this ASU, primarily related to disclosures, require the prospective method of adoption, with the remaining provisions applied retrospectively. The early adoption of this ASU did not affect our financial position or results of operations, but resulted in revised disclosures as discussed above.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

ASU No. 2018-14

Effective December 31, 2018, we adopted the provisions of ASU No. 2018-14, “Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans.” This ASU improves the effectiveness of disclosures in the notes to financial statements by removing, modifying, and adding certain disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. We are no longer required to disclose the amounts in accumulated other comprehensive income expected to be recognized as components of net periodic benefit cost over the next fiscal year, but we are required to (i) disclose the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and (ii) provide an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The early adoption of this ASU did not affect our financial position or results of operations, but resulted in revised disclosures as discussed above.

Accounting Pronouncements Adopted on January 1, 2019

Topic 842

In February 2016, the FASB issued ASC Topic 842, “Leases,” (Topic 842) to increase the transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. This new standard is effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual reporting periods, with early adoption permitted. We adopted this new standard on January 1, 2019 using the optional transition method; however, we did not have a cumulative-effect adjustment to the opening balance of retained earnings at the date of adoption as noted below, but we will apply the new disclosure requirements beginning in 2019.

The new standard provides a number of optional practical expedients and we elected the following:


•	Transition Elections. We elected the package of practical expedients that permits us to not reassess our prior conclusions about lease identification, lease classification, and initial direct costs under the new standard, as well as the practical expedient that permits us to not assess existing land easements under the new standard.


•	Lessee Accounting Policy Elections. We elected the short-term lease recognition exemption whereby right-of-use (ROU) assets and lease liabilities are not recognized for leasing arrangements with terms less than one year, and the practical expedient to not separate lease and non-lease components for all classes of underlying assets other than the marine transportation asset class.

In preparation for the adoption of Topic 842, we enhanced our contracting and lease evaluation systems and related processes, and we developed a new lease accounting system to capture our leases and support the required disclosures. We have integrated our lease accounting system with our general ledger and modified our related procurement and payment processes.

Adoption of this standard resulted in (i) the recognition of ROU assets and lease liabilities for our operating leases of approximately $1.3 billion, (ii) the derecognition of existing assets under construction of approximately $539 million related to a build-to-suit lease arrangement (see Note 10 under “Other Commitments—MVP Terminal”), and (iii) the presentation of new disclosures about our leasing activities

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

beginning in the first quarter of 2019. Adoption of this standard did not impact our results of operations or liquidity and our accounting for finance leases is substantially unchanged.

ASU No. 2017-12

In August 2017, the FASB issued ASU No. 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities,” (ASU No. 2017-12) to improve and simplify accounting guidance for hedge accounting. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within those annual reporting periods, with early adoption permitted. Certain provisions of this ASU, primarily related to disclosures, require the prospective method of adoption, with the remaining provisions applied through a cumulative-effect adjustment to retained earnings as of the adoption date. The adoption of ASU No. 2017-12 effective January 1, 2019 did not affect our financial position or results of operations.

Accounting Pronouncements Not Yet Adopted

ASU No. 2016-13

In June 2016, the FASB issued “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” (ASU No. 2016-13) to improve financial reporting by requiring the immediate recognition of credit losses on financial instruments held by a reporting entity. This ASU requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. It also requires enhanced disclosures, including qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. In November 2018, the FASB issued “Codification Improvements to Topic 326, Financial Instruments—Credit Losses,” (ASU 2018-19), which clarified that this guidance does not apply to receivables arising from operating leases. The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2019, and interim periods within those annual reporting periods, with early adoption permitted for annual periods beginning after December 15, 2018. The provisions of this ASU should be applied through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which this ASU is effective (i.e., the modified-retrospective approach). We expect to adopt ASU No. 2016-13 effective January 1, 2020, and we do not expect such adoption to materially affect our financial position or our results of operations.

ASU No. 2018-17

In October 2018, the FASB issued ASU No. 2018-17, “Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities,” (ASU No. 2018-17) to reduce the cost and complexity of financial reporting associated with consolidation of VIEs. One of the provisions of this ASU amends how a decision maker or service provider determines whether its fee is a variable interest. This guidance requires reporting entities to consider indirect interests held through related parties under common control on a proportional basis rather than as the equivalent of a direct interest in its entirety (as currently required by U.S. GAAP). The provisions of this ASU are effective for annual reporting periods beginning after December 15, 2019, and interim reporting periods within those annual reporting periods, with early adoption permitted. The provisions of this ASU should be applied on a retrospective basis with a cumulative-effect adjustment to retained earnings as of the beginning of the earliest period presented. We expect to adopt ASU No. 2018-17 effective January 1, 2020, and we do not expect such adoption to materially affect our financial position or our results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


2.	ACQUISITIONS AND MERGER

Peru Acquisition

On May 14, 2018, we acquired 100 percent of the issued and outstanding equity interests in Pure Biofuels del Peru S.A.C. (Pure Biofuels) from Pegasus Capital Advisors L.P. and various minority equity holders. Pure Biofuels markets refined petroleum products through its logistics assets in Peru. Pure Biofuels owns a terminal at the Port of Callao, near Lima, with approximately 1 million barrels of storage capacity for refined petroleum and renewable products. Through one of its subsidiaries, Pure Biofuels also owns a 180,000 -barrel storage terminal in Paita, in northern Peru, which is scheduled to commence operations in the second half of 2019, pending regulatory approvals. We paid $468 million from available cash on hand, of which $132 million was for working capital. This acquisition, which is referred to as the Peru Acquisition, is consistent with our general business strategy and broadens the geographic diversity of our refining segment. This acquisition was accounted for as a business acquisition.

The following table summarizes the fair values of the assets acquired and liabilities assumed at the acquisition date, based on an independent appraisal that was completed in the fourth quarter of 2018 (in millions). During the third and fourth quarters of 2018, we recognized immaterial adjustments to the preliminary amounts recorded for the Peru Acquisition with a corresponding adjustment to goodwill due to the completion of the independent appraisal. These adjustments did not have a material effect on our results of operations for the year ended December 31, 2018.



Current assets, net of cash acquired	$	158
Property, plant, and equipment	102
Deferred charges and other assets	466
Current liabilities, excluding current portion of debt	(26		)
Debt assumed, including current portion	(137		)
Deferred income tax liabilities	(62		)
Other long-term liabilities	(27		)
Noncontrolling interest	(6		)
Total consideration, net of cash acquired	$	468

Deferred charges and other assets primarily include identifiable intangible assets of $200 million and goodwill of $260 million. Identifiable intangible assets, which consist of customer contracts and relationships, are amortized on a straight-line basis over ten years. Goodwill is calculated as the excess of the consideration transferred over the estimated fair values of the underlying tangible and identifiable intangible assets acquired and liabilities assumed. Goodwill represents the future economic benefits expected to be recognized from our expansion into the Latin American refined petroleum products markets arising from other assets acquired that were not individually identified and separately recognized. We determined that the entire balance of goodwill is related to the refining segment. None of the goodwill is deductible for tax purposes.

Our statements of income include the results of operations of Pure Biofuels since the date of acquisition, and such results are reflected in the refining segment. Results of operations since the date of acquisition, supplemental pro forma financial information, and acquisition-related costs have not been presented for the Peru Acquisition as such information is not material to our results of operations.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Acquisition of Ethanol Plants

On November 15, 2018, we acquired three ethanol plants from two subsidiaries of Green Plains Inc. for total cash consideration of $320 million including working capital of $20 million. The ethanol plants are located in Bluffton, Indiana; Lakota, Iowa; and Riga, Michigan with a combined ethanol production capacity of 280 million gallons per year. This acquisition was accounted for as an asset acquisition.

Merger with VLP

On January 10, 2019, we completed our acquisition of all of the outstanding publicly held common units of VLP pursuant to a definitive Agreement and Plan of Merger (Merger Agreement, and together with the transactions contemplated thereby, the Merger Transaction) with VLP. Upon completion of the Merger Transaction, each outstanding publicly held common unit was converted into the right to receive $42.25 per common unit in cash without any interest thereon, and all such publicly traded common units were automatically canceled and ceased to exist. Upon completion of the Merger Transaction, we paid aggregate merger consideration of $950 million, which was funded with available cash on hand.

We consolidate the financial statements of VLP (see Note 12) and we reflect noncontrolling interests on our balance sheet for the portion of VLP’s partners’ capital held by VLP’s public common unitholders. However, upon completion of the Merger Transaction, VLP became our indirect wholly owned subsidiary and, as a result, we will no longer reflect noncontrolling interests on our balance sheet with respect to VLP. In addition, we will no longer attribute a portion of VLP’s net income to noncontrolling interests. Because we had a controlling financial interest in VLP before the merger and retained our controlling financial interest in VLP after the merger, the change in our ownership interest in VLP as a result of the merger was accounted for as an equity transaction. Accordingly, we did not recognize a gain or loss on the merger.


3.	ARUBA DISPOSITION

Effective October 1, 2016, we (i) transferred ownership of all of our assets in Aruba, other than certain hydrocarbon inventories and working capital, to Refineria di Aruba N.V., an entity wholly-owned by the Government of Aruba (GOA), (ii) settled our obligations under various agreements with the GOA, including agreements that required us to dismantle our leasehold improvements under certain conditions, and (iii) sold the working capital of our Aruba operations, including hydrocarbon inventories, to the GOA and CITGO (defined below). We refer to this transaction as the “Aruba Disposition.” The agreements associated with the Aruba Disposition were finalized in September 2016, including approval of such agreements by the Aruba Parliament. We no longer own any assets or have any operations in Aruba.

In September 2016 and in connection with the Aruba Disposition, our U.S. subsidiaries were unable to collect outstanding debt obligations owed to them by our Aruba subsidiaries, which resulted in the recognition by us of an income tax benefit in the U.S. of $42 million during the year ended December 31, 2016. We had no income tax effect in Aruba from the cancellation of debt or other effects of the Aruba Disposition because of net operating loss carryforwards associated with our operations in Aruba against which we had previously recorded a full valuation allowance.

Prior to the Aruba Disposition, we recognized an asset impairment loss of $56 million in June 2016 representing all of the remaining carrying value of our long-lived assets in Aruba. These assets were primarily related to our crude oil and refined petroleum products terminal and transshipment facility in Aruba (collectively, the Aruba Terminal), which were included in our refining segment. We recognized the

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

impairment loss at that time because we concluded that it was more likely than not that we would ultimately transfer ownership of these assets to the GOA as a result of agreements entered into in June 2016 between the GOA, CITGO Aruba Refining N.V. (CAR), and CITGO Petroleum Corporation (together with CAR and certain other affiliates, collectively, CITGO) providing for, among other things, the GOA’s lease of those assets to CITGO. (See Note 19 for disclosure related to the method to determine fair value.)


4.	RECEIVABLES

Receivables consisted of the following (in millions):



	December 31,
	2018			2017
Receivables from contracts with customers	$	4,673		$	5,686
Receivables from certain purchase and sale arrangements	2,311			1,098
Commodity derivative and foreign currency contract receivables	229			102
Other receivables	166			69
Total receivables	7,379			6,955
Allowance for doubtful accounts	(34		)	(33		)
Receivables, net	$	7,345		$	6,922

There were no significant changes in our allowance for doubtful accounts during the years ended December 31, 2018, 2017, and 2016.


5.	INVENTORIES

Inventories consisted of the following (in millions):



	December 31,
	2018		2017
Refinery feedstocks	$	2,292	$	2,427
Refined petroleum products and blendstocks	3,678		3,459
Ethanol feedstocks and products	298		242
Materials and supplies	264		256
Inventories	$	6,532	$	6,384

As of December 31, 2018 and 2017, the replacement cost (market value) of LIFO inventories exceeded their LIFO carrying amounts by $1.5 billion and $3.0 billion, respectively, and our non-LIFO inventories accounted for $1.1 billion and $1.0 billion, respectively, of our total inventories.

During the year ended December 31, 2016, we recorded a change in our lower of cost or market inventory valuation reserve that resulted in a net benefit to our results of operations of $747 million.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


6.	PROPERTY, PLANT, AND EQUIPMENT

Major classes of property, plant, and equipment, including assets held under capital leases, consisted of the following (in millions):



	December 31,
	2018			2017
Land	$	416		$	411
Crude oil processing facilities	30,721			30,109
Transportation and terminaling facilities	4,935			4,335
Grain processing equipment	1,212			903
Administrative buildings	953			910
Other	2,276			2,068
Construction in progress	1,960			1,274
Property, plant, and equipment, at cost	42,473			40,010
Accumulated depreciation	(13,625		)	(12,530		)
Property, plant, and equipment, net	$	28,848		$	27,480

Our assets under capital leases are presented in the table above within “Other” and consist of various types of assets that primarily support our refining operations and totaled $711 million and $635 million as of December 31, 2018 and 2017, respectively. Accumulated amortization on assets under capital leases was $106 million and $72 million as of December 31, 2018 and 2017, respectively.

Depreciation expense for the years ended December 31, 2018, 2017, and 2016 was $1.4 billion, $1.3 billion, and $1.3 billion, respectively.

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


7.	DEFERRED CHARGES AND OTHER ASSETS

“Deferred charges and other assets, net” consisted of the following (in millions):



	December 31,
	2018		2017
Deferred turnaround and catalyst costs, net	$	1,749	$	1,520
Income taxes receivable	343		673
Investments in joint ventures	542		530
Intangible assets, net	307		142
Goodwill	260		—
Other	431		501
Deferred charges and other assets, net	$	3,632	$	3,366

Amortization expense for the deferred charges and other assets shown above was $668 million, $650 million, and $575 million for the years ended December 31, 2018, 2017, and 2016, respectively.

The increase in intangible assets, net and goodwill resulted primarily from the Peru Acquisition as described in Note 2.


8.	ACCRUED EXPENSES AND OTHER LONG-TERM LIABILITIES

Accrued expenses and other long-term liabilities consisted of the following (in millions):



	Accrued Expenses				Other Long-Term Liabilities
	December 31,				December 31,
	2018		2017		2018		2017
Defined benefit plan liabilities (see Note 13)	$	43	$	33	$	654	$	776
Wage and other employee-related liabilities	302		278		109		111
Uncertain income tax position liabilities (see Note 15)	—		—		721		723
Repatriation tax liability (see Note 15) (a)	—		—		603		597
Environmental liabilities (see Note 10)	29		30		327		232
Environmental credit obligations (see Note 19)	34		152		—		—
Accrued interest expense	93		105		—		—
Other accrued liabilities	129		114		453		290
Accrued expenses and other long-term liabilities	$	630	$	712	$	2,867	$	2,729


(a)	The current portion of repatriation tax liability is included in income taxes payable. There was no current portion of repatriation tax liability as of December 31, 2018 and $114 million as of December 31, 2017.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


9.	DEBT AND CAPITAL LEASE OBLIGATIONS

Debt, at stated values, and capital lease obligations consisted of the following (in millions):



	Final Maturity		December 31,
		2018				2017
Credit facilities:
Valero Revolver	2020		$	—			$	—
VLP Revolver	2020		—				410
IEnova Revolver	2028		109				—
Canadian Revolver	2019		—				—
Accounts receivable sales facility	2019		100				100
Public debt:
Valero Senior Notes
6.625%	2037		1,500				1,500
3.4%	2026		1,250				1,250
6.125%	2020		850				850
4.35 %	2028		750				—
9.375%	2019		—				750
7.5%	2032		750				750
4.9%	2045		650				650
3.65%	2025		600				600
10.5%	2039		250				250
8.75%	2030		200				200
7.45%	2097		100				100
6.75%	2037		24				24
VLP Senior Notes
4.375%	2026		500				500
4.5%	2028		500				—
Gulf Opportunity Zone Revenue Bonds, Series 2010, 4.0%	2040		300				300
Debenture, 7.65%	2026		100				100
Other debt	Various		50				49
Net unamortized debt issuance costs and other			(80		)		(73		)
Total debt			8,503				8,310
Capital lease obligations			606				562
Total debt and capital lease obligations			9,109				8,872
Less current portion			238				122
Debt and capital lease obligations, less current portion			$	8,871			$	8,750

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Credit Facilities

Valero Revolver

We have a $3 billion revolving credit facility (the Valero Revolver) with a group of financial institution lenders that matures in November 2020. The Valero Revolver also provides for the issuance of letters of credit of up to $2.0 billion.

Outstanding borrowings under the Valero Revolver bear interest, at our option, at either (i) the adjusted LIBO rate (as defined in the Valero Revolver) for the applicable interest period in effect from time to time plus the applicable margin or (ii) the alternate base rate (as defined in the Valero Revolver) plus the applicable margin. The Valero Revolver also requires payments for customary fees, including facility fees, letter of credit participation fees, and administrative agent fees. The interest rate and facility fees under the Valero Revolver are subject to adjustment based upon the credit ratings assigned to our senior unsecured debt.

We had no borrowings or repayments under the Valero Revolver during the years ended December 31, 2018, 2017, and 2016.

VLP Revolver

As of December 31, 2018 and 2017, VLP had a $750 million senior unsecured revolving credit facility (the VLP Revolver) with a group of lenders that was scheduled to mature in November 2020. However, on January 10, 2019, in connection with the completion of the Merger Transaction as described in Note 2, the VLP Revolver was terminated.

Outstanding borrowings under the VLP Revolver bore interest, at VLP’s option, at either (i) the adjusted LIBO rate (as defined in the VLP Revolver) for the applicable interest period in effect from time to time plus the applicable margin or (ii) the alternate base rate (as defined in the VLP Revolver) plus the applicable margin. As of December 31, 2017, the variable rate was 2.875 percent. The VLP Revolver required payments for customary fees, including commitment fees, letter of credit participation fees, and administrative agent fees.

During the year ended December 31, 2018, VLP repaid the outstanding balance of $410 million on the VLP Revolver using proceeds from its public offering of $500 million 4.5 percent Senior Notes as described in “Public Debt” below. During the year ended December 31, 2017, VLP borrowed $380 million under the revolver and made no repayments. During the year ended December 31, 2016, VLP borrowed $349 million under the revolver and repaid $494 million.

IEnova Revolver

In February 2018, Central Mexico Terminals (as described in Note 12) entered into a combined $340 million unsecured revolving credit facility (IEnova Revolver) with IEnova (defined in Note 12) that matures in February 2028. IEnova may terminate this revolver at any time and demand repayment of all outstanding amounts; therefore, all outstanding borrowings are reflected in current portion of debt. The IEnova Revolver is available only to the operations of Central Mexico Terminals, and the creditors of Central Mexico Terminals do not have recourse against us.

Outstanding borrowings under this revolver bear interest at the three-month LIBO rate for the applicable interest period in effect from time to time plus the applicable margin. The interest rate under this revolver

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

is subject to adjustment, with agreement by both parties, based upon changes in market conditions. As of December 31, 2018, the variable rate was 6.046 percent.

During the year ended December 31, 2018, Central Mexico Terminals borrowed $109 million and had no repayments under this revolver.

Canadian Revolver

In November 2018, one of our Canadian subsidiaries amended its committed revolving credit facility (the Canadian Revolver) to increase the borrowing capacity from C$75 million to C$150 million under which it may borrow and obtain letters of credit and to extend the maturity date from November 2018 to November 2019.

We had no borrowings or repayments under this revolver during the years ended December 31, 2018, 2017, and 2016.

Accounts Receivable Sales Facility

We have an accounts receivable sales facility with a group of third-party entities and financial institutions to sell up to $1.3 billion of eligible trade receivables on a revolving basis. In July 2018, we amended our agreement to extend the maturity date to July 2019. Under this program, one of our marketing subsidiaries (Valero Marketing) sells eligible receivables, without recourse, to another of our subsidiaries (Valero Capital), whereupon the receivables are no longer owned by Valero Marketing. Valero Capital, in turn, sells an undivided percentage ownership interest in the eligible receivables, without recourse, to the third-party entities and financial institutions. To the extent that Valero Capital retains an ownership interest in the receivables it has purchased from Valero Marketing, such interest is included in our financial statements solely as a result of the consolidation of the financial statements of Valero Capital with those of Valero Energy Corporation; the receivables are not available to satisfy the claims of the creditors of Valero Marketing or Valero Energy Corporation.

As of December 31, 2018 and 2017, $1.8 billion and $2.3 billion, respectively, of our accounts receivable composed the designated pool of accounts receivable included in the program. All amounts outstanding under the accounts receivable sales facility are reflected as debt on our balance sheets and proceeds and repayments are reflected as cash flows from financing activities on the statements of cash flows. As of December 31, 2018 and 2017, the variable interest rate on the accounts receivable sales facility was 3.0618 percent and 2.0387 percent, respectively. During the years ended December 31, 2018, 2017, and 2016, we had no proceeds from or repayments under the accounts receivable sales facility.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Summary of Credit Facilities

We had outstanding borrowings, letters of credit issued, and availability under our credit facilities as follows (amounts in millions and currency in U.S. dollars, except as noted):



				December 31, 2018
	Facility Amount		Maturity Date	Outstanding Borrowings		Letters of Credit Issued		Availability

Committed facilities:
Valero Revolver	$	3,000	November 2020	$	—	$	57	$	2,943
Canadian Revolver	C$	150	November 2019	C$	—	C$	5	C$	145
Accounts receivable sales facility	$	1,300	July 2019	$	100	n/a		$	1,200
Letter of credit facility	$	100	November 2019	n/a		$	—	$	100
Committed facilities of VIEs (a):
VLP Revolver (b)	$	750	November 2020	$	—	$	—	$	750
IEnova Revolver	$	340	February 2028	$	109	n/a		$	231
Uncommitted facilities:
Letter of credit facilities	n/a		n/a	n/a		$	229	n/a


(a)	Creditors of our VIEs do not have recourse against us.


(b)	The VLP Revolver was terminated on January 10, 2019. See “VLP Revolver” above.

In November 2018, our committed letter of credit facility was amended to extend the maturity date from November 2018 to November 2019.

Letters of credit issued as of December 31, 2018 expire at various times in 2019 through 2020.

We are charged letter of credit issuance fees under our various uncommitted short-term bank credit facilities. These uncommitted credit facilities have no commitment fees or compensating balance requirements.

Public Debt

During the year ended December 31, 2018, the following activity occurred:


•	We issued $750 million of 4.35 percent Senior Notes due June 1, 2028. Proceeds from this debt issuance totaled $749 million before deducting the underwriting discount and other debt issuance costs. The proceeds were used to redeem our 9.375 percent Senior Notes due March 15, 2019 for $787 million, or 104.9 percent of stated value, which includes an early redemption fee of $37 million that is reflected in other income, net.

•

We issued $750 million of 4.35 percent Senior Notes due June 1, 2028. Proceeds from this debt issuance totaled $749 million before deducting the underwriting discount and other debt issuance costs. The proceeds were used to redeem our 9.375 percent Senior Notes due March 15, 2019 for $787 million, or 104.9 percent of stated value, which includes an early redemption fee of $37 million that is reflected in other income, net.


•	VLP issued $500 million of 4.5 percent Senior Notes due March 15, 2028. Proceeds from this debt issuance totaled $498 million before deducting the underwriting discount and other debt issuance costs. The proceeds were available only to the operations of VLP and were used to repay the outstanding balance of $410 million on the VLP Revolver and $85 million on its notes payable to

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

us, which is eliminated in consolidation. On January 10, 2019, in connection with the completion of the Merger Transaction as described in Note 2, Valero entered into a guarantee agreement to fully and unconditionally guarantee the prompt payment, when due, of any amount owed to the holders of these notes.

During the year ended December 31, 2017, there was no issuance or redemption activity related to our public debt.

During the year ended December 31, 2016, the following activity occurred:


•	We issued $1.25 billion of 3.4 percent Senior Notes due September 15, 2026. Proceeds from this debt issuance totaled $1.246 billion before deducting the underwriting discount and other debt issuance costs.


•	We redeemed our 6.125 percent Senior Notes due June 15, 2017 for $778 million, or 103.70 percent of stated value.


•	We redeemed our 7.2 percent Senior Notes due October 15, 2017 for $213 million, or 106.27 percent of stated value.


•	VLP issued $500 million of 4.375 percent Senior Notes due December 15, 2026. Proceeds from this debt issuance totaled $500 million before deducting the underwriting discount and other debt issuance costs. The proceeds were available only to the operations of VLP and were used to repay $494 million on the VLP Revolver. On January 10, 2019, in connection with the completion of the Merger Transaction as described in Note 2, Valero entered into a guarantee agreement to fully and unconditionally guarantee the prompt payment, when due, of any amount owed to the holders of these notes.

•

VLP issued $500 million of 4.375 percent Senior Notes due December 15, 2026. Proceeds from this debt issuance totaled $500 million before deducting the underwriting discount and other debt issuance costs. The proceeds were available only to the operations of VLP and were used to repay $494 million on the VLP Revolver. On January 10, 2019, in connection with the completion of the Merger Transaction as described in Note 2, Valero entered into a guarantee agreement to fully and unconditionally guarantee the prompt payment, when due, of any amount owed to the holders of these notes.

Other Debt

During the year ended December 31, 2018, we retired $137 million of debt assumed in connection with the Peru Acquisition with available cash on hand.

Capital Lease Obligations

We have capital lease obligations that mature at various dates through 2046 for storage tanks, terminal facilities, and other assets that are used in our refining operations. During the years ended December 31, 2018 and 2017, we recognized capital lease assets and related obligations totaling $63 million and $502 million, respectively. These capital lease agreements were primarily for the lease of storage tanks.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Other Disclosures

Interest and debt expense, net of capitalized interest is comprised as follows (in millions):



	Year Ended December 31,
	2018		2017		2016
Interest and debt expense	$	557	$	539	$	511
Less capitalized interest	87		71		65
Interest and debt expense, net of capitalized interest	$	470	$	468	$	446

Our credit facilities and other debt arrangements contain various customary restrictive covenants, including cross-default and cross-acceleration clauses.

Principal maturities for our debt obligations and future minimum rentals on capital lease obligations as of December 31, 2018 were as follows (in millions):



	Debt			Capital Lease Obligations
2019	$	214		$	69
2020	855			65
2021	15			62
2022	5			64
2023	20			65
Thereafter	7,474			957
Net unamortized debt issuance costs and other	(80		)	n/a
Total minimum lease payments	n/a			1,282
Less amount representing interest	n/a			676
Total	$	8,503		$	606


10.	COMMITMENTS AND CONTINGENCIES

Operating Leases

We have long-term operating lease commitments for land and office facilities; time charters for ocean-going tankers and coastal vessels (i.e., marine transportation assets); railcars; facilities and equipment related to industrial gases and power used in our operations; machinery and equipment used in our refining and ethanol operations; and various facilities and equipment used in the storage, transportation, production, and sale of refinery feedstock, refined petroleum product and corn inventories.

In addition to minimum lease payments, some arrangements contain provisions for contingent lease payments. Certain leases for the storage and transportation of feedstock and refined petroleum products provide for contingent lease payments based on throughput volumes in excess of a base amount, while other leases for time charters of ocean-going tankers and coastal vessels contain payment provisions that are

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

contingent on usage. Additionally, rental increases that are not scheduled in the lease are considered contingent lease payments. In most cases, we expect that in the normal course of business, our leases will be renewed or replaced by other leases.

As of December 31, 2018, our future minimum rentals for leases having initial or remaining noncancelable lease terms in excess of one year were as follows (in millions):



2019	$	359
2020	245
2021	178
2022	146
2023	123
Thereafter	514
Total minimum rental payments	$	1,565

Rental expense, net of sublease rental income was as follows (in millions):



	Year Ended December 31,
	2018		2017		2016
Minimum rental expense	$	515	$	691	$	739
Contingent rental expense	19		21		70
Total rental expense	534		712		809
Less sublease rental income	31		54		31
Rental expense, net of sublease rental income	$	503	$	658	$	778

Purchase Obligations

We have various purchase obligations under certain crude oil and other feedstock supply arrangements, industrial gas supply arrangements (such as hydrogen supply arrangements), natural gas supply arrangements, and various throughput, transportation and terminaling agreements. We enter into these contracts to ensure an adequate supply of feedstock and utilities and adequate storage capacity to operate our refineries and ethanol plants. Substantially all of our purchase obligations are based on market prices or adjustments based on market indices. Certain of these purchase obligations include fixed or minimum volume requirements, while others are based on our usage requirements. None of these obligations is associated with suppliers’ financing arrangements. These purchase obligations are not reflected as liabilities.

Other Commitments

MVP Terminal

We have a 50 percent membership interest in MVP Terminalling, LLC (MVP), a Delaware limited liability company formed in September 2017 with a subsidiary of Magellan Midstream Partners LP (Magellan), to construct, own, and operate the Magellan Valero Pasadena marine terminal (MVP Terminal) located adjacent to the Houston Ship Channel in Pasadena, Texas. The MVP Terminal will contain (i) approximately 5 million barrels of storage capacity, (ii) a dock with two ship berths, and (iii) a three-bay truck rack facility. In

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

connection with our terminaling agreement with MVP, described below, we will have dedicated use of (i) approximately 4 million barrels of storage, (ii) one ship berth, and (iii) the three-bay truck rack facility. Construction of phases one and two of the project began in 2017 with a total estimated cost of approximately $840 million, of which we have committed to contribute 50 percent (approximately $420 million). The project could expand up to four phases with a total project cost of approximately $1.4 billion if warranted by additional demand and agreed to by Magellan and us. Since inception, we have contributed $247 million to MVP, of which $166 million was contributed during the year ended December 31, 2018.

Concurrent with the formation of MVP, we entered into a terminaling agreement with MVP to utilize the MVP Terminal upon completion of phase two, which is expected to occur in early 2020. The terminaling agreement has an initial term of 12 years with two five-year automatic renewals, and year-to-year renewals thereafter.

Due to our membership interest in MVP and because we determined that the terminaling agreement was a capital lease, we are the accounting owner of the MVP Terminal during the construction period. Accordingly, as of December 31, 2018, we recorded an asset of $539 million in property, plant, and equipment representing 100 percent of the construction costs incurred by MVP, as well as capitalized interest incurred by us, and a long-term liability of $292 million payable to Magellan. The amounts recorded for the portion of the construction costs associated with the payable to Magellan are noncash investing and financing items, respectively.

On January 1, 2019, as a result of our adoption of Topic 842 as described in Note 1, we derecognized the asset and liability related to MVP discussed above and recorded our equity investment in MVP of $247 million, which will be included in deferred charges and other assets. We will recognize a finance lease asset and liability upon commencement of our terminaling arrangement with MVP as described above.

Central Texas Pipeline

We have committed to a 40 percent undivided interest in a project with a subsidiary of Magellan to jointly build an estimated 130-mile, 20-inch refined petroleum products pipeline with a capacity of up to 150,000 barrels per day from Houston to Hearne, Texas. The pipeline is expected to be completed in mid-2019. The estimated cost of our 40 percent undivided interest in this pipeline is $170 million. Since inception, expenditures have totaled $80 million, of which $73 million was spent during the year ended December 31, 2018.

Sunrise Pipeline System

Effective January 31, 2018, we entered into a joint ownership agreement with Sunrise Pipeline LLC, a subsidiary of Plains All American Pipeline, L.P. (Plains), that provides us a 20 percent undivided interest in the Sunrise Pipeline System expansion to be constructed by Plains. The Sunrise Pipeline System contains (i) a 262-mile, 24-inch crude oil pipeline (the Sunrise Pipeline) that originates at Plains’ terminal in Midland, Texas and terminates at Plains’ station in Wichita Falls, Texas with throughput capacity of approximately 500,000 barrels per day, and (ii) two 270,000 shell barrel capacity tanks located at the Colorado City, Texas station. The Sunrise Pipeline System expansion was placed in service in the fourth quarter of 2018. Expenditures totaled $139 million for the year ended December 31, 2018.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Environmental Matters

We are involved, together with several other companies, in an environmental cleanup in the Village of Hartford, Illinois (the Village) and during 2015, one of these companies assumed the ongoing environmental cleanup in the Village pursuant to a federal court order. We had previously conducted an initial response in the Village, along with other companies, pursuant to an administrative order issued by the U.S. EPA. The parties involved in the initial response may have further claims among themselves for costs already incurred.

We also continue to be engaged in site assessment and interim measures at the shutdown refinery site, which is adjacent to the Village. In 2018, we entered into a consent order with the Illinois EPA that was approved by the Illinois state court on July 26, 2018. In the consent order, we assumed the underlying liability for full cleanup of the shutdown refinery site, and we recorded an adjustment to our existing environmental liability related to this matter, which did not materially affect our financial position or results of operations as of or for the year ended December 31, 2018. We continue to seek contribution under Illinois law in state court and are pursuing claims under the Comprehensive Environmental Response, Compensation and Liability Act in federal court from other potentially responsible parties. Factors underlying the expected cost of the cleanup are subject to change from time to time, and actual results may vary significantly from the current estimate.

Self-Insurance

We are self-insured for certain medical and dental, workers’ compensation, automobile liability, general liability, and property liability claims up to applicable retention limits. Liabilities are accrued for self-insured claims, or when estimated losses exceed coverage limits, and when sufficient information is available to reasonably estimate the amount of the loss. These liabilities are included in accrued expenses and other long-term liabilities.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


11.	EQUITY

Share Activity

Activity in the number of shares of common stock and treasury stock was as follows (in millions):



	Common Stock	Treasury Stock
Balance as of December 31, 2015	673	(200	)
Transactions in connection with stock-based compensation plans	—	1
Stock purchases under purchase program	—	(23	)
Balance as of December 31, 2016	673	(222	)
Transactions in connection with stock-based compensation plans	—	1
Stock purchases under purchase programs	—	(19	)
Balance as of December 31, 2017	673	(240	)
Stock purchases under purchase programs	—	(16	)
Balance as of December 31, 2018	673	(256	)

Preferred Stock

We have 20 million shares of preferred stock authorized with a par value of $0.01 per share. No shares of preferred stock were outstanding as of December 31, 2018 or 2017.

Treasury Stock

We purchase shares of our common stock as authorized under our common stock purchase program (described below) and to meet our obligations under employee stock-based compensation plans.

On July 13, 2015, our board of directors authorized us to purchase $2.5 billion of our outstanding common stock with no expiration date, and we completed that program during 2017. On September 21, 2016, our board of directors authorized our purchase of up to an additional $2.5 billion with no expiration date, and we completed that program during 2018. On January 23, 2018, our board of directors authorized our purchase of up to an additional $2.5 billion (the 2018 Program) with no expiration date. During the years ended December 31, 2018, 2017, and 2016, we purchased $1.5 billion, $1.3 billion, and $1.3 billion, respectively, of our common stock under our programs. As of December 31, 2018, we have approval under the 2018 Program to purchase approximately $2.2 billion of our common stock.

Common Stock Dividends

On January 24, 2019, our board of directors declared a quarterly cash dividend of $0.90 per common share payable on March 5, 2019 to holders of record at the close of business on February 13, 2019.

Valero Energy Partners LP Units

On September 16, 2016, VLP entered into an equity distribution agreement pursuant to which VLP offered and sold from time to time their common units having an aggregate offering price of up to $350 million based on amounts, at prices, and on terms determined by market conditions and other factors at the time of

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

the offerings (such continuous offering program, or at-the-market program, referred to as the “ATM Program”). There were no issuances of common units under the ATM Program during the year ended December 31, 2018. VLP issued 742,897 and 223,083 common units under the ATM Program and received net proceeds of $35 million and $9 million after deducting offering costs during the years ended December 31, 2017 and 2016, respectively. Simultaneous with the Merger Transaction as described in Note 2, the ATM Program was terminated.

Income Tax Effects Related to Components of Other Comprehensive Income (Loss)

The tax effects allocated to each component of other comprehensive income (loss) were as follows (in millions):



	Before-Tax Amount			Tax Expense (Benefit)			Net Amount
Year Ended December 31, 2018:
Foreign currency translation adjustment	$	(517	)	$	—		$	(517	)
Pension and other postretirement benefits:
Gain arising during the year related to:
Net actuarial gain	1			—			1
Prior service credit	7			1			6
Amounts reclassified into income related to:
Net actuarial loss	63			14			49
Prior service credit	(29		)	(7		)	(22		)
Curtailment and settlement loss	7			2			5
Net gain on pension and other postretirement benefits	49			10			39
Other comprehensive loss	$	(468	)	$	10		$	(478	)

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	Before-Tax Amount			Tax Expense (Benefit)			Net Amount
Year Ended December 31, 2017:
Foreign currency translation adjustment	$	514		$	—		$	514
Pension and other postretirement benefits:
Loss arising during the year related to:
Net actuarial loss	(79		)	(29		)	(50		)
Prior service cost	(4		)	(1		)	(3		)
Miscellaneous loss	—			3			(3		)
Amounts reclassified into income related to:
Net actuarial loss	50			18			32
Prior service credit	(36		)	(13		)	(23		)
Curtailment and settlement loss	4			1			3
Net loss on pension and other postretirement benefits	(65		)	(21		)	(44		)
Other comprehensive income	$	449		$	(21	)	$	470



Year Ended December 31, 2016:
Foreign currency translation adjustment	$	(415	)	$	—		$	(415	)
Pension and other postretirement benefits:
Loss arising during the year related to:
Net actuarial loss	(110		)	(34		)	(76		)
Miscellaneous gain	—			(8		)	8
Amounts reclassified into income related to:
Net actuarial loss	48			18			30
Prior service credit	(36		)	(13		)	(23		)
Net loss on pension and other postretirement benefits	(98		)	(37		)	(61		)
Other comprehensive loss	$	(513	)	$	(37	)	$	(476	)

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Accumulated Other Comprehensive Loss

Changes in accumulated other comprehensive loss by component, net of tax, were as follows (in millions):



	Foreign Currency Translation Adjustment			Defined Benefit Plan Items			Total
Balance as of December 31, 2015	$	(605	)	$	(328	)	$	(933	)
Other comprehensive loss before reclassifications	(416		)	(68		)	(484		)
Amounts reclassified from accumulated other comprehensive loss	—			7			7
Other comprehensive loss	(416		)	(61		)	(477		)
Balance as of December 31, 2016	(1,021		)	(389		)	(1,410		)
Other comprehensive income (loss) before reclassifications	514			(56		)	458
Amounts reclassified from accumulated other comprehensive loss	—			12			12
Other comprehensive income (loss)	514			(44		)	470
Balance as of December 31, 2017	(507		)	(433		)	(940		)
Other comprehensive income (loss) before reclassifications	(515		)	7			(508		)
Amounts reclassified from accumulated other comprehensive loss	—			32			32
Other comprehensive income (loss)	(515		)	39			(476		)
Reclassification of stranded income tax effects of Tax Reform to retained earnings per ASU 2018-02 (see Note 1)	—			(91		)	(91		)
Balance as of December 31, 2018	$	(1,022	)	$	(485	)	$	(1,507	)

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Gains (losses) reclassified out of accumulated other comprehensive loss and into net income were as follows (in millions):



Details about Accumulated Other Comprehensive Loss Components													Affected Line Item in the Statement of Income
	Year Ended December 31,
	2018				2017				2016
Amortization of items related to defined benefit pension plans:
Net actuarial loss		$	(63	)		$	(50	)		$	(48	)	(a) Other income, net
Prior service credit		29				36				36			(a) Other income, net
Curtailment and settlement		(7		)		(4		)		—			(a) Other income, net
		(41		)		(18		)		(12		)	Total before tax
		9				6				5			Tax benefit
Total reclassifications for the year		$	(32	)		$	(12	)		$	(7	)	Net of tax


(a)	These accumulated other comprehensive loss components are included in the computation of net periodic benefit cost (credit), as discussed in Note 13.


12.	VARIABLE INTEREST ENTITIES

Consolidated VIEs

In the normal course of business, we have financial interests in certain entities that have been determined to be VIEs. We consolidate a VIE when we have a variable interest in an entity for which we are the primary beneficiary such that we have (i) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb losses of or the right to receive benefits from the VIE that could potentially be significant to the VIE. In order to make this determination, we evaluated our contractual arrangements with the VIEs, including arrangements for the use of assets, purchases of products and services, debt, equity, or management of operating activities.

The following discussion summarizes our involvement with our VIEs:

•

Prior to the completion of the Merger Transaction with VLP on January 10, 2019 as discussed in Note 2, VLP was a publicly traded master limited partnership whose common limited partner units were traded on the New York Stock Exchange under the trading symbol “VLP.” VLP was formed by us to own, operate, develop, and acquire crude oil and refined petroleum products pipelines, terminals, and other transportation and logistics assets. VLP’s assets include crude oil and refined petroleum products pipeline and terminal systems in the U.S. Gulf Coast and U.S. Mid-Continent regions that are integral to the operations of ten of our refineries. As of December 31, 2018, we owned a 66.2 percent limited partner interest and a 2.0 percent general partner interest in VLP, and public unitholders owned a 31.8 percent limited partner interest.

We determined VLP was a VIE because the public limited partners of VLP (i.e., parties other than entities under common control with the general partner) lacked the power to direct the activities of VLP that most significantly impacted its economic performance because they did not have

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

substantive kick-out rights over the general partner or substantive participating rights in VLP. Furthermore, we determined that we were the primary beneficiary of VLP because (i) we were the single decision maker and our general partner interest provides us with the sole power to direct the activities that most significantly impact VLP’s economic performance and (ii) our 66.2 percent limited partner interest and 2.0 percent general partner interest provides us with significant economic rights and obligations. Substantially all of VLP’s revenues were derived from us; therefore, there was limited risk to us associated with VLP’s operations.

•

Diamond Green Diesel Holdings LLC (DGD) is a joint venture with Darling Green Energy LLC, a subsidiary of Darling Ingredients Inc., that was formed to construct and operate a biodiesel plant that processes animal fats, used cooking oils, and other vegetable oils into renewable green diesel. The plant is located next to our St. Charles Refinery and began operations in June 2013. Our significant agreements with DGD include an operations agreement that outlines our responsibilities as operator of the plant, a debt agreement whereby we financed approximately 60 percent of the construction costs of the plant, and a marketing agreement.

As operator, we operate the plant and perform certain day-to-day operating and management functions for DGD as an independent contractor. The operations agreement provides us (as operator) with certain power to direct the activities that most significantly impact DGD’s economic performance. Because this agreement conveys such power to us and is separate from our ownership rights, we determined that DGD was a VIE. For this reason and because we hold a 50 percent ownership interest that provides us with significant economic rights and obligations, we determined that we are the primary beneficiary of DGD. DGD has risk associated with its operations because it generates revenues from third-party customers.

•

We have terminaling agreements with three subsidiaries of Infraestructura Energetica Nova, S.A.B. de C.V. (IEnova), a Mexican company and subsidiary of Sempra Energy, a U.S. public company. The three subsidiaries are collectively referred to as Central Mexico Terminals and were previously referred to by us as VPM Terminals. The terminaling agreements represent variable interests because we have determined them to be capital leases due to our exclusive use of the terminals. Although we do not have an ownership interest in the entities that own each of the three terminals, the capital leases convey to us (i) the power to direct the activities that most significantly impact the economic performance of all three terminals and (ii) the ability to influence the benefits received or the losses incurred by the terminals because of our use of the terminals. As a result, we determined each of the entities was a VIE and that we are the primary beneficiary of each. Substantially all of Central Mexico Terminals’ revenues will be derived from us; therefore, there is limited risk to us associated with Central Mexico Terminals’ operations.

•

We also have financial interests in other entities that have been determined to be VIEs because the entities’ contractual arrangements transfer the power to us to direct the activities that most significantly impact their economic performance or reduce the exposure to operational variability and risk of loss created by the entity that otherwise would be held exclusively by the equity owners. Furthermore, we determined that we are the primary beneficiary of these VIEs because (i) certain contractual arrangements (exclusive of our ownership rights) provide us with the power to direct the activities that most significantly impact the economic performance of these entities and/or (ii) our

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

50 percent ownership interests provide us with significant economic rights and obligations. The financial position, results of operations, and cash flows of these VIEs are not material to us.

The VIEs’ assets can only be used to settle their own obligations and the VIEs’ creditors have no recourse to our assets. We do not provide financial guarantees to our VIEs. Although we have provided credit facilities to some of our VIEs in support of their construction or acquisition activities, these transactions are eliminated in consolidation. Our financial position, results of operations, and cash flows are impacted by our consolidated VIEs’ performance, net of intercompany eliminations, to the extent of our ownership interest in each VIE.

The following tables present summarized balance sheet information for the significant assets and liabilities of our VIEs, which are included in our balance sheets (in millions).



	December 31, 2018
	VLP		DGD		Central Mexico Terminals		Other		Total
Assets
Cash and cash equivalents	$	152	$	65	$	—	$	18	$	235
Other current assets	2		112		20		64		198
Property, plant, and equipment, net	1,409		576		156		113		2,254
Liabilities
Current liabilities, including current portion of debt and capital lease obligations	$	27	$	28	$	118	$	9	$	182
Debt and capital lease obligations, less current portion	990		—		—		34		1,024



	December 31, 2017
	VLP		DGD		Central Mexico Terminals		Other		Total
Assets
Cash and cash equivalents	$	42	$	123	$	1	$	13	$	179
Other current assets	2		66		4		—		72
Property, plant, and equipment, net	1,416		435		51		127		2,029
Liabilities
Current liabilities, including current portion of debt and capital lease obligations	$	27	$	33	$	26	$	9	$	95
Debt and capital lease obligations, less current portion	905		—		—		43		948

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Non-Consolidated VIEs

We hold variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary. These non-consolidated VIEs are not material to our financial position or results of operations and are primarily accounted for as equity investments.

One of our non-consolidated VIEs is MVP, which is described in Note 10. We have a 50 percent membership interest in MVP, which was formed to construct, own, and operate the MVP Terminal. We determined MVP is a VIE because the power to direct the activities that most significantly impact its economic performance is not required to be held by its two members, but is held by Magellan, as operator under a construction, operating, and management agreement with MVP. For this reason and because Magellan holds a 50 percent interest in MVP that provides it with significant economic rights and obligations, we determined that we are not the primary beneficiary. As of December 31, 2018, our maximum exposure to loss was $247 million, which represents our equity investment in MVP. We have not provided any financial support to MVP other than amounts previously required by our membership interest.


13.	EMPLOYEE BENEFIT PLANS

Defined Benefit Plans

We have defined benefit pension plans, some of which are subject to collective bargaining agreements, that cover most of our employees. These plans provide eligible employees with retirement income based primarily on years of service and compensation during specific periods under final average pay and cash balance formulas. We fund our pension plans as required by local regulations. In the U.S., all qualified pension plans are subject to the Employee Retirement Income Security Act minimum funding standard. We typically do not fund or fully fund U.S. nonqualified and certain international pension plans that are not subject to funding requirements because contributions to these pension plans may be less economic and investment returns may be less attractive than our other investment alternatives.

We also provide health care and life insurance benefits for certain retired employees through our postretirement benefit plans. Most of our employees become eligible for these benefits if, while still working for us, they reach normal retirement age or take early retirement. These plans are unfunded, and retired employees share the cost with us. Individuals who became our employees as a result of an acquisition became eligible for postretirement benefits under our plans as determined by the terms of the relevant acquisition agreement.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The changes in benefit obligation related to all of our defined benefit plans, the changes in fair value of plan assets(a), and the funded status of our defined benefit plans as of and for the years ended were as follows (in millions):



	Pension Plans						Other Postretirement Benefit Plans
	December 31,						December 31,
	2018			2017			2018			2017
Changes in benefit obligation:
Benefit obligation as of beginning of year	$	2,926		$	2,567		$	306		$	302
Service cost	133			123			6			6
Interest cost	91			86			10			10
Participant contributions	—			—			10			9
Benefits paid	(207		)	(158		)	(28		)	(28		)
Actuarial (gain) loss	(285		)	286			(9		)	6
Other	(19		)	22			(3		)	1
Benefit obligation as of end of year	$	2,639		$	2,926		$	292		$	306

Changes in plan assets (a):
Fair value of plan assets as of beginning of year	$	2,428		$	2,097		$	—		$	—
Actual return on plan assets	(130		)	363			—			—
Valero contributions	156			110			18			19
Participant contributions	—			—			10			9
Benefits paid	(207		)	(158		)	(28		)	(28		)
Other	(11		)	16			—			—
Fair value of plan assets as of end of year	$	2,236		$	2,428		$	—		$	—

Reconciliation of funded status (a):
Fair value of plan assets as of end of year	$	2,236		$	2,428		$	—		$	—
Less benefit obligation as of end of year	2,639			2,926			292			306
Funded status as of end of year	$	(403	)	$	(498	)	$	(292	)	$	(306	)

Accumulated benefit obligation	$	2,492		$	2,746		n/a			n/a

(a)

Plan assets include only the assets associated with pension plans subject to legal minimum funding standards. Plan assets associated with U.S. nonqualified pension plans are not included here because they are not protected from our creditors and therefore cannot be reflected as a reduction from our obligations under the pension plans. As a result, the reconciliation of funded status does not reflect the effect of plan assets that exist for all of our defined benefit plans. See Note 19 for the assets associated with certain U.S. nonqualified pension plans.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The actuarial gain for the year ended December 31, 2018 primarily resulted from an increase in the discount rates used to determine our benefit obligations for our pension plans from 3.58 percent in 2017 to 4.25 percent in 2018. The actuarial loss for the year ended December 31, 2017 primarily resulted from a decrease in the discount rates used to determine the benefit obligations for our pension plans from 4.08 percent in 2016 to 3.58 percent in 2017.

The fair value of our plan assets as of December 31, 2018 was unfavorably impacted by the negative return on plan assets resulting primarily from a significant decline in equity market prices for the year. The fair value of our plan assets as of December 31, 2017 was favorably impacted by the return on plan assets resulting primarily from a favorable increase in equity market prices for the year.

Amounts recognized in our balance sheet for our pension and other postretirement benefits plans include (in millions):



	Pension Plans						Other Postretirement Benefit Plans
	December 31,						December 31,
	2018			2017			2018			2017
Deferred charges and other assets, net	$	2		$	5		$	—		$	—
Accrued expenses	(22		)	(14		)	(21		)	(19		)
Other long-term liabilities	(383		)	(489		)	(271		)	(287		)
	$	(403	)	$	(498	)	$	(292	)	$	(306	)

The following table presents information for our pension plans with projected benefit obligations in excess of plan assets (in millions).



	December 31,
	2018		2017
Projected benefit obligation	$	2,564	$	2,872
Fair value of plan assets	2,160		2,369

The following table presents information for our pension plans with accumulated benefit obligations in excess of plan assets (in millions).



	December 31,
	2018		2017
Accumulated benefit obligation	$	2,253	$	2,526
Fair value of plan assets	1,974		2,180

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Benefit payments that we expect to pay, including amounts related to expected future services that we expect to receive, are as follows for the years ending December 31 (in millions):



	Pension Benefits		Other Postretirement Benefits
2019	$	169	$	21
2020	193		21
2021	175		21
2022	180		20
2023	194		20
2024-2028	1,043		95

We plan to contribute approximately $35 million to our pension plans and $21 million to our other postretirement benefit plans during 2019.

The components of net periodic benefit cost (credit) related to our defined benefit plans were as follows (in millions):



	Pension Plans									Other Postretirement Benefit Plans
	Year Ended December 31,									Year Ended December 31,
	2018			2017			2016			2018			2017			2016
Service cost	$	133		$	123		$	111		$	6		$	6		$	7
Interest cost	91			86			84			10			10			12
Expected return on plan assets	(163		)	(150		)	(139		)	—			—			—
Amortization of:
Net actuarial (gain) loss	65			53			49			(2		)	(3		)	(1		)
Prior service credit	(18		)	(20		)	(20		)	(11		)	(16		)	(16		)
Special charges (credits)	7			4			(7		)	—			—			—
Net periodic benefit cost (credit)	$	115		$	96		$	78		$	3		$	(3	)	$	2

The components of net periodic benefit cost (credit) other than the service cost component (i.e., the non-service cost components) are included in other income, net in the statements of income.

Amortization of prior service credit shown in the preceding table was based on a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under each respective plan. Amortization of the net actuarial (gain) loss shown in the preceding table was based on the straight-line amortization of the excess of the unrecognized (gain) loss over 10 percent of the greater of the projected benefit obligation or market-related value of plan assets (smoothed asset value) over the average remaining service period of active employees expected to receive benefits under each respective plan.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Pre-tax amounts recognized in other comprehensive income (loss) were as follows (in millions):



	Pension Plans									Other Postretirement Benefit Plans
	Year Ended December 31,									Year Ended December 31,
	2018			2017			2016			2018			2017			2016
Net gain (loss) arising during the year:
Net actuarial gain (loss)	$	(8	)	$	(73	)	$	(145	)	$	9		$	(6	)	$	35
Prior service (cost) credit	7			(4		)	—			—			—			—
Net (gain) loss reclassified into income:
Net actuarial (gain) loss	65			53			49			(2		)	(3		)	(1		)
Prior service credit	(18		)	(20		)	(20		)	(11		)	(16		)	(16		)
Curtailment and settlement loss	7			4			—			—			—			—
Total changes in other comprehensive income (loss)	$	53		$	(40	)	$	(116	)	$	(4	)	$	(25	)	$	18

The pre-tax amounts in accumulated other comprehensive loss that have not yet been recognized as components of net periodic benefit cost (credit) were as follows (in millions):



	Pension Plans						Other Postretirement Benefit Plans
	December 31,						December 31,
	2018			2017			2018			2017
Net actuarial (gain) loss	$	828		$	894		$	(64	)	$	(57	)
Prior service credit	(108		)	(121		)	(31		)	(42		)
Total	$	720		$	773		$	(95	)	$	(99	)

The weighted-average assumptions used to determine the benefit obligations were as follows:



	Pension Plans				Other Postretirement Benefit Plans
	December 31,				December 31,
	2018		2017		2018		2017
Discount rate	4.25	%	3.58	%	4.40	%	3.72	%
Rate of compensation increase	3.78	%	3.86	%	n/a		n/a
Interest crediting rate for cash balance plans	3.04	%	3.04	%	n/a		n/a

The discount rate assumption used to determine the benefit obligations as of December 31, 2018 and 2017 for the majority of our pension plans and other postretirement benefit plans was based on the Aon AA Only Above Median yield curve and considered the timing of the projected cash outflows under our plans. This curve was designed by Aon to provide a means for plan sponsors to value the liabilities of their pension plans

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

or postretirement benefit plans. It is a hypothetical double-A yield curve represented by a series of annualized individual discount rates with maturities from one-half year to 99 years. Each bond issue underlying the curve is required to have an average rating of double-A when averaging all available ratings by Moody’s Investors Service, Standard & Poor’s Ratings Services, and Fitch Ratings. Only the bonds representing the 50 percent highest yielding issuances among those with average ratings of double-A are included in this yield curve.

We based our discount rate assumption on the Aon AA Only Above Median yield curve because we believe it is representative of the types of bonds we would use to settle our pension and other postretirement benefit plan liabilities as of those dates. We believe that the yields associated with the bonds used to develop this yield curve reflect the current level of interest rates.

The weighted-average assumptions used to determine the net periodic benefit cost were as follows:



	Pension Plans						Other Postretirement Benefit Plans
	Year Ended December 31,						Year Ended December 31,
	2018		2017		2016		2018		2017		2016
Discount rate	3.59	%	4.08	%	4.45	%	3.72	%	4.26	%	4.53	%
Expected long-term rate of return on plan assets	7.24	%	7.29	%	7.28	%	n/a		n/a		n/a
Rate of compensation increase	3.86	%	3.81	%	3.79	%	n/a		n/a		n/a
Interest crediting rate for cash balance plans	3.04	%	3.04	%	3.10	%	n/a		n/a		n/a

The assumed health care cost trend rates were as follows:



	December 31,
	2018		2017
Health care cost trend rate assumed for the next year	7.29	%	7.30	%
Rate to which the cost trend rate was assumed to decline (the ultimate trend rate)	5.00	%	5.00	%
Year that the rate reaches the ultimate trend rate	2026		2026

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following tables present the fair values of the assets of our pension plans (in millions) as of December 31, 2018 and 2017 by level of the fair value hierarchy. Assets categorized in Level 1 of the hierarchy are measured at fair value using a market approach based on unadjusted quoted prices from national securities exchanges. Assets categorized in Level 2 of the hierarchy are measured at net asset value in a market that is not active. As previously noted, we do not fund or fully fund U.S. nonqualified and certain international pension plans that are not subject to funding requirements, and we do not fund our other postretirement benefit plans.



	Fair Value Hierarchy							Total as of December 31, 2018
	Level 1			Level 2		Level 3
Equity securities:
U.S. companies (a)	$	497		$	—	$	—	$	497
International companies	159			1		—		160
Preferred stock	4			—		—		4
Mutual funds:
International growth	97			—		—		97
Index funds (b)	76			—		—		76
Corporate debt instruments	—			284		—		284
Government securities:
U.S. Treasury securities	45			—		—		45
Other government securities	—			138		—		138
Common collective trusts (c)	—			609		—		609
Pooled separate accounts (d)	—			190		—		190
Private funds	—			87		—		87
Insurance contract	—			18		—		18
Interest and dividends receivable	5			—		—		5
Cash and cash equivalents	40			—		—		40
Securities transactions payable, net	(14		)	—		—		(14		)
Total pension plan assets	$	909		$	1,327	$	—	$	2,236

See notes on page 110.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	Fair Value Hierarchy							Total as of December 31, 2017
	Level 1			Level 2		Level 3
Equity securities:
U.S. companies (a)	$	571		$	—	$	—	$	571
International companies	187			1		—		188
Preferred stock	4			—		—		4
Mutual funds:
International growth	118			—		—		118
Index funds (b)	85			—		—		85
Corporate debt instruments	—			272		—		272
Government securities:
U.S. Treasury securities	45			—		—		45
Other government securities	—			144		—		144
Common collective trusts (c)	—			621		—		621
Pooled separate accounts (d)	—			192		—		192
Private funds	—			101		—		101
Insurance contract	—			18		—		18
Interest and dividends receivable	5			—		—		5
Cash and cash equivalents	85			1		—		86
Securities transactions payable, net	(22		)	—		—		(22		)
Total pension plan assets	$	1,078		$	1,350	$	—	$	2,428


(a)	Equity securities are held in a wide range of industrial sectors, including consumer goods, information technology, healthcare, industrials, and financial services.


(b)	This class includes primarily investments in approximately 60 percent equities and 40 percent bonds as of December 31, 2018. As of December 31, 2017, this class included primarily investments in approximately 70 percent equities and 30 percent bonds.


(c)	This class includes primarily investments in approximately 70 percent equities and 30 percent bonds as of December 31, 2018. As of December 31, 2017, this class included primarily investments in approximately 80 percent equities and 20 percent bonds.


(d)	This class includes primarily investments in approximately 50 percent equities and 50 percent bonds as of December 31, 2018 and 2017.

The investment policies and strategies for the assets of our pension plans incorporate a well-diversified approach that is expected to earn long-term returns from capital appreciation and a growing stream of current income. This approach recognizes that assets are exposed to risk and the market value of the pension plans’ assets may fluctuate from year to year. Risk tolerance is determined based on our financial ability to withstand risk within the investment program and the willingness to accept return volatility. In line with the investment return objective and risk parameters, the pension plans’ mix of assets includes a diversified portfolio of equity and fixed-income investments. Equity securities include international stocks and a blend of U.S. growth and value stocks of various sizes of capitalization. Fixed income securities include bonds and notes issued by

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

the U.S. government and its agencies, corporate bonds, and mortgage-backed securities. The aggregate asset allocation is reviewed on an annual basis. As of December 31, 2018, the target allocations for plan assets under our primary pension plan are 70 percent equity securities and 30 percent fixed income investments.

The expected long-term rate of return on plan assets is based on a forward-looking expected asset return model. This model derives an expected rate of return based on the target asset allocation of a plan’s assets. The underlying assumptions regarding expected rates of return for each asset class reflect Aon’s best expectations for these asset classes. The model reflects the positive effect of periodic rebalancing among diversified asset classes. We select an expected asset return that is supported by this model.

Defined Contribution Plans

We have defined contribution plans that cover most of our employees. Our contributions to these plans are based on employees’ compensation and/or a partial match of employee contributions to the plans. Our contributions to these defined contribution plans were $74 million, $70 million, and $67 million for the years ended December 31, 2018, 2017, and 2016, respectively.


14.	STOCK-BASED COMPENSATION

Overview

Under our 2011 Omnibus Stock Incentive Plan (the OSIP), various stock and stock-based awards may be granted to employees and non-employee directors. Awards available under the OSIP include, but are not limited to, (i) restricted stock that vests over a period determined by our compensation committee, (ii) performance awards that vest upon the achievement of an objective performance goal, (iii) options to purchase shares of common stock, (iv) dividend equivalent rights, and (v) stock appreciation rights. The OSIP was approved by our stockholders on April 28, 2011 and re-approved by our stockholders on May 12, 2016. As of December 31, 2018, 8,532,542 shares of our common stock remained available to be awarded under the OSIP.

We also maintain other stock-based compensation plans under which previously granted equity awards remain outstanding. No additional grants may be awarded under these plans.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table reflects activity related to our stock-based compensation arrangements (in millions):



	Year Ended December 31,
	2018		2017		2016
Stock-based compensation expense:
Restricted stock	$	63	$	58	$	52
Performance awards	22		19		15
Stock options and other awards	1		—		1
Total stock-based compensation expense	$	86	$	77	$	68
Tax benefit recognized on stock-based compensation expense	$	18	$	27	$	24
Tax benefit realized for tax deductions resulting from exercises and vestings	32		44		33
Effect of tax deductions in excess of recognized stock-based compensation expense	20		24		22

The following is a discussion of our significant stock-based compensation arrangement.

Restricted Stock

Restricted stock is granted to employees and non-employee directors. Restricted stock granted to employees vests in accordance with individual written agreements between the participants and us, usually in equal annual installments over a period of three years beginning one year after the date of grant. Restricted stock granted to our non-employee directors vests in equal annual installments over a period of three years beginning one year after the date of grant. The fair value of each restricted stock per share is equal to the market price of our common stock. A summary of the status of our restricted stock awards is presented in the following table.



	Number of Shares		Weighted- Average Grant-Date Fair Value Per Share
Nonvested shares as of January 1, 2018	1,401,040		$	69.82
Granted	628,908		92.12
Vested	(843,709	)	71.26
Forfeited	(9,661	)	69.97
Nonvested shares as of December 31, 2018	1,176,578		80.70

As of December 31, 2018, there was $56 million of unrecognized compensation cost related to outstanding unvested restricted stock awards, which is expected to be recognized over a weighted-average period of approximately two years.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table reflects activity related to our restricted stock:



	Year Ended December 31,
	2018		2017		2016
Weighted-average grant-date fair value per share of restricted stock granted	$	92.12	$	79.32	$	59.00
Fair value of restricted stock vested (in millions)	80		71		46


15.	INCOME TAXES

Tax Reform

On December 22, 2017, Tax Reform was enacted, which resulted in significant changes to the U.S. Internal Revenue Code of 1986, as amended (the Code) and was effective beginning on January 1, 2018. The most significant changes affecting us are as follows:


•	reduction in the statutory income tax rate from 35 percent to 21 percent;


•	repeal of the manufacturing deduction;


•	deduction for all of the costs to acquire or construct certain business assets in the year they are placed in service through 2022;


•	shift from a worldwide system of taxation to a territorial system of taxation, resulting in a minimum tax on the income of international subsidiaries (the GILTI tax) rather than a tax deferral on such earnings in certain circumstances; and


•	assessment of a one-time transition tax on deemed repatriated earnings and profits from our international subsidiaries.

The following narrative describes the activity that occurred with respect to Tax Reform for the years ended December 31, 2017 and 2018.

We reflected an overall income tax benefit of $1.9 billion for the year ended December 31, 2017 with respect to Tax Reform as a result of the following:


•	We remeasured our U.S. deferred tax assets and liabilities using the 21 percent rate, which resulted in a tax benefit and a reduction to our net deferred tax liabilities of $2.6 billion.

•

We recognized a one-time transition tax of $734 million on the deemed repatriation of previously undistributed accumulated earnings and profits of our international subsidiaries based on approximately $4.7 billion of the combined earnings and profits of our international subsidiaries that had not been distributed to us. This transition tax will be remitted to the Internal Revenue Service (IRS) over the eight-year period provided in the Code, with the first annual remittance being paid in 2018.


•	We accrued withholding tax of $47 million on a portion of the cash held by one of our international subsidiaries that we have deemed to not be permanently reinvested in our operations in that country.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Because of the significant and complex changes to the Code from Tax Reform, including the need for regulatory guidance from the IRS to properly account for many of the provisions, the SEC issued Staff Accounting Bulletin No. 118, “Income Tax Accounting Implications of the Tax Cuts and Jobs Act,” that was codified through the issuance of ASU No. 2018-05 as described in Note 1. Specifically, ASU No. 2018-05 required that the effects of Tax Reform be recorded for items where the accounting was complete, as well as for items where a reasonable estimate could be made (referred to as provisional amounts). For items where reasonable estimates could not be made, provisional amounts were not recorded and those items continued to be accounted for under the Code prior to changes from Tax Reform until a reasonable estimate could be made. During the fourth quarter of 2018, we completed our accounting for the income tax effects of Tax Reform, and we reflected an overall income tax benefit of $12 million for the year ended December 31, 2018 with respect to Tax Reform.

The following table summarizes the components of our adjustment (in millions) to reflect the effects of Tax Reform for the years ended December 31, 2018 and 2017, including whether such amounts were complete, provisional, or incomplete. The amounts presented for 2018 were completed during the fourth quarter of 2018.



	Year Ended December 31,								Cumulative Tax Reform Adjustment
	2017				2018
	Accounting Status	Amount			Accounting Status	Amount
Income tax benefit from the remeasurement of U.S. deferred income tax assets and liabilities	Complete	$	(2,643	)	Complete	$	—		$	(2,643	)
Tax on the deemed repatriation of the accumulated earnings and profits of our international subsidiaries	Provisional	734			Complete	6			740
Recognition of foreign withholding tax, net of U.S. federal tax benefit	Complete	47			Complete	—			47
Deductibility of certain executive compensation expense	Incomplete	—			Complete	5			5
Income tax expense associated with the statutory income tax rate differential on accrual to return adjustments that were identified upon completion of our U.S. federal income tax return in 2018	Incomplete	—			Complete	9			9
Foreign tax credit available to offset the tax on deemed repatriation of the accumulated earnings and profits of our international subsidiaries	Incomplete	—			Complete	(32		)	(32		)
Tax Reform benefit		$	(1,862	)		$	(12	)	$	(1,874	)

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Income Statement Components

Income before income tax expense (benefit) was as follows (in millions):



	Year Ended December 31,
	2018		2017		2016
U.S. operations	$	3,168	$	2,283	$	1,733
International operations	1,064		924		1,449
Income before income tax expense (benefit)	$	4,232	$	3,207	$	3,182

Statutory income tax rates applicable to the countries in which we operate were as follows:



	Year Ended December 31,
	2018		2017		2016
U.S.	21	%	35	%	35	%
Canada	15	%	15	%	15	%
U.K.	19	%	19	%	20	%
Ireland	13	%	13	%	13	%
Peru	30	%	n/a		n/a
Mexico	30	%	n/a		n/a
Aruba	n/a		n/a		7	%

The following is a reconciliation of income tax expense (benefit) computed by applying statutory income tax rates as reflected in the preceding table to actual income tax expense (benefit) related to our operations (in millions):



	Year Ended December 31, 2018
	U.S.					International				Total
	Amount			Percent		Amount		Percent		Amount			Percent
Income tax expense at statutory rates	$	665		21.0	%	$	163	15.3	%	$	828		19.6	%
U.S. state and Canadian provincial tax expense, net of federal income tax effect	44			1.4	%	80		7.5	%	124			2.9	%
Permanent differences	(9		)	(0.3	)%	—		—		(9		)	(0.2	)%
GILTI tax	67			2.1	%	—		—		67			1.6	%
Foreign tax credits	(50		)	(1.6	)%	—		—		(50		)	(1.2	)%
Effects of Tax Reform	(12		)	(0.4	)%	—		—		(12		)	(0.3	)%
Tax effects of income associated with noncontrolling interests	(49		)	(1.5	)%	—		—		(49		)	(1.2	)%
Other, net	(23		)	(0.7	)%	3		0.3	%	(20		)	(0.5	)%
Income tax expense	$	633		20.0	%	$	246	23.1	%	$	879		20.7	%

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	Year Ended December 31, 2017
	U.S.					International				Total
	Amount			Percent		Amount		Percent		Amount			Percent
Income tax expense at statutory rates	$	799		35.0	%	$	158	17.1	%	$	957		29.8	%
U.S. state and Canadian provincial tax expense, net of federal income tax effect	37			1.6	%	46		5.0	%	83			2.6	%
Permanent differences:
Manufacturing deduction	(42		)	(1.8	)%	—		—		(42		)	(1.3	)%
Other	(9		)	(0.4	)%	—		—		(9		)	(0.3	)%
Change in tax law	(1,862		)	(81.6	)%	—		—		(1,862		)	(58.1	)%
Tax effects of income associated with noncontrolling interests	(31		)	(1.4	)%	—		—		(31		)	(1.0	)%
Other, net	(52		)	(2.3	)%	7		0.8	%	(45		)	(1.4	)%
Income tax expense (benefit)	$	(1,160	)	(50.9	)%	$	211	22.9	%	$	(949	)	(29.7	)%



	Year Ended December 31, 2016
	U.S.					International					Total
	Amount			Percent		Amount			Percent		Amount			Percent
Income tax expense at statutory rates	$	606		35.0	%	$	256		17.7	%	$	862		27.1	%
U.S. state and Canadian provincial tax expense, net of federal income tax effect	5			0.3	%	31			2.1	%	36			1.1	%
Permanent differences:
Manufacturing deduction	(22		)	(1.3	)%	—			—		(22		)	(0.7	)%
Other	(3		)	(0.2	)%	(10		)	(0.7	)%	(13		)	(0.4	)%
Change in tax law	—			—		(7		)	(0.5	)%	(7		)	(0.2	)%
Tax effects of income associated with noncontrolling interests	(44		)	(2.5	)%	—			—		(44		)	(1.4	)%
Other, net	(37		)	(2.1	)%	(10		)	(0.7	)%	(47		)	(1.5	)%
Income tax expense	$	505		29.2	%	$	260		17.9	%	$	765		24.0	%

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Components of income tax expense (benefit) related to our operations were as follows (in millions):



	Year Ended December 31, 2018
	U.S.			International		Total
Current:
Country	$	432		$	141	$	573
U.S. state / Canadian provincial	37			66		103
Total current	469		(a)	207		676
Deferred:
Country	145			25		170
U.S. state / Canadian provincial	19			14		33
Total deferred	164		(b)	39		203
Income tax expense	$	633		$	246	$	879



	Year Ended December 31, 2017
	U.S.				International			Total
Current:
Country	$	1,305			$	194		$	1,499
U.S. state / Canadian provincial	34				61			95
Total current	1,339			(a)	255			1,594
Deferred:
Country	(2,522		)		(29		)	(2,551		)
U.S. state / Canadian provincial	23				(15		)	8
Total deferred	(2,499		)	(b)	(44		)	(2,543		)
Income tax expense (benefit)	$	(1,160	)		$	211		$	(949	)


(a)	Current income tax expense includes a $21 million benefit and a $781 million expense related to our Tax Reform adjustment for the years ended December 31, 2018 and 2017, respectively, as described in “Tax Reform” above.


(b)	Deferred income tax expense (benefit) includes a $9 million expense and a $2.6 billion benefit related to our Tax Reform adjustment for the years ended December 31, 2018 and 2017, respectively, as described in “Tax Reform” above.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	Year Ended December 31, 2016
	U.S.			International			Total
Current:
Country	$	294		$	194		$	488
U.S. state / Canadian provincial	12			35			47
Total current	306			229			535
Deferred:
Country	203			35			238
U.S. state / Canadian provincial	(4		)	(4		)	(8		)
Total deferred	199			31			230
Income tax expense	$	505		$	260		$	765

Income Taxes Paid

Income taxes paid to U.S. and international taxing authorities were as follows (in millions):



	Year Ended December 31,
	2018		2017		2016
U.S.	$	1,016	$	239	$	241
International	345		171		203
Income taxes paid, net	$	1,361	$	410	$	444

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Deferred Income Tax Assets and Liabilities

The tax effects of significant temporary differences representing deferred income tax assets and liabilities were as follows (in millions):



	December 31,
	2018			2017
Deferred income tax assets:
Tax credit carryforwards	$	644		$	69
Net operating losses (NOLs)	523			492
Inventories	101			135
Compensation and employee benefit liabilities	175			179
Environmental liabilities	71			47
Other	141			112
Total deferred income tax assets	1,655			1,034
Valuation allowance	(1,111		)	(498		)
Net deferred income tax assets	544			536

Deferred income tax liabilities:
Property, plant, and equipment	4,589			4,545
Deferred turnaround costs	316			272
Inventories	287			243
Investments	142			77
Other	172			107
Total deferred income tax liabilities	5,506			5,244
Net deferred income tax liabilities	$	4,962		$	4,708

We had the following income tax credit and loss carryforwards as of December 31, 2018 (in millions):



	Amount		Expiration
U.S. state income tax credits	$	80	2019 through 2031
U.S. state income tax credits	6		Unlimited
U.S. foreign tax credits	575		2027
U.S. state NOLs (gross amount)	10,039		2019 through 2038

We have recorded a valuation allowance as of December 31, 2018 and 2017 due to uncertainties related to our ability to utilize some of our deferred income tax assets, primarily consisting of U.S. foreign tax credits and certain U.S. state income tax credits and NOLs, before they expire. The valuation allowance is based on our estimates of taxable income in the various jurisdictions in which we operate and the period over which deferred income tax assets will be recoverable. As a part of the completion of the accounting for the income tax effects of Tax Reform as described in “Tax Reform” above, we assessed the ability of our available foreign tax credits to offset the tax on the deemed repatriation of the accumulated earnings and profits of

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

our international subsidiaries. The completion of such accounting resulted in U.S. general limitation foreign tax credit carryforwards and a correlating valuation allowance provided on the balance of the deferred income tax asset related to those carryforwards as it is not more likely than not that the deferred income tax asset will be realized. The valuation allowance increased by $613 million, primarily due to approximately $575 million of excess U.S. foreign tax credits. Foreign tax credits as of December 31, 2017 were used to offset the one-time transition tax, and excess tax credits were generated on the transition tax inclusion. Tax Reform imposes certain limits on a company’s use of foreign tax credits in the future, including any excess credits generated from the mandatory income inclusion of previously deferred foreign earnings. The realization of net deferred income tax assets related to state income tax credits and NOLs recorded as of December 31, 2018 is primarily dependent upon our ability to generate future taxable income in certain U.S. states.

As described in “Tax Reform” above, one of the most significant changes in Tax Reform was the shift from a worldwide system of taxation to a territorial system. The shift to a territorial system allows us to distribute cash via a dividend from our international subsidiaries with a full dividend received deduction. As a result, we will not recognize U.S. federal deferred taxes for the future tax consequences attributable to differences between financial statement carrying amounts of existing assets and liabilities and the respective tax bases for our international subsidiaries. As of December 31, 2017, we recognized a one-time transition tax of $734 million on approximately $4.7 billion of combined earnings and profits of our international subsidiaries. In the fourth quarter of 2018, the one-time transition tax was increased by $6 million. Also, in the fourth quarter, we recorded a foreign tax credit of $32 million related to the one-time transition tax. Because of the deemed repatriation of these accumulated earnings and profits, there are no longer any U.S. federal income tax consequences associated with the repatriation of any of the $2.4 billion of cash and cash equivalents held by our international subsidiaries as of December 31, 2018. However, certain countries in which our international subsidiaries are organized impose withholding taxes on cash distributed outside of those countries. As of December 31, 2018, the cumulative undistributed earnings of these subsidiaries were approximately $5.3 billion. We have accrued for withholding taxes on a portion of the cash held by one of our international subsidiaries that we have deemed to not be permanently reinvested in our operations in that country. The remaining cash held by that subsidiary as well as our other international subsidiaries will be permanently reinvested in our operations in those countries. It is not practicable to estimate the amount of additional tax that would be payable on those earnings, if distributed.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Unrecognized Tax Benefits

The following is a reconciliation of the change in unrecognized tax benefits, excluding related penalties and interest, (in millions):



	Year Ended December 31,
	2018			2017			2016
Balance as of beginning of year	$	941		$	936		$	964
Additions based on tax positions related to the current year	23			33			36
Additions for tax positions related to prior years	28			15			11
Reductions for tax positions related to prior years	(19		)	(42		)	(46		)
Reductions for tax positions related to the lapse of applicable statute of limitations	(1		)	(1		)	(3		)
Settlements	(2		)	—			(237		)
Reclassification of uncertain tax receivable to long-term receivable from IRS	—			—			211
Balance as of end of year	$	970		$	941		$	936

As of December 31, 2018, the balance in unrecognized tax benefits included $277 million of tax refunds that we intend to claim by amending various of our income tax returns for 2010 through 2016. We intend to propose that incentive payments received from the U.S. federal government for blending biofuels into refined petroleum products be excluded from taxable income during these periods. However, due to the complexity of this matter and uncertainties with respect to the interpretation of the Code, we concluded that the refund claims included in the following table cannot be recognized in our financial statements. As a result, these amounts are not included in our uncertain tax position liabilities as of December 31, 2018, 2017, and 2016 even though they are reflected in the preceding table.

The following is a reconciliation of unrecognized tax benefits reflected in the preceding table to our uncertain tax position liabilities that are presented in our balance sheets (in millions).



	December 31,
	2018			2017
Unrecognized tax benefits	$	970		$	941
Tax refund claim not presented in our balance sheets	(277		)	(274		)
Other	88			77
Uncertain tax position liabilities presented in our balance sheets	$	781		$	744

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Amounts recognized in our balance sheets for uncertain tax positions include (in millions):



	December 31,
	2018		2017
Income taxes payable	$	42	$	—
Other long-term liabilities	721		723
Deferred tax liabilities	18		21
Uncertain tax position liabilities presented in our balance sheets	$	781	$	744

As of December 31, 2018 and 2017, there were $807 million and $793 million, respectively, of unrecognized tax benefits that if recognized would affect our annual effective tax rate.

Penalties and interest during the years ended December 31, 2018, 2017, and 2016 were immaterial. Accrued penalties and interest totaled $88 million and $77 million as of December 31, 2018 and 2017, respectively, excluding the U.S. federal and state income tax effects related to interest.

During the next 12 months, it is reasonably possible that tax audit resolutions could reduce unrecognized tax benefits, excluding interest, either because the tax positions are sustained on audit or because we agree to their disallowance. We do not expect these reductions to have a significant impact on our financial statements because such reductions would not significantly affect our annual effective tax rate.

Tax Returns Under Audit

U.S. Federal

As of December 31, 2018, our U.S. federal tax returns for 2010 through 2015 were under audit by the IRS. The IRS has proposed adjustments to our taxable income for certain open years. We are currently contesting the proposed adjustments with the Office of Appeals of the IRS for certain open years and do not expect that the ultimate disposition of these adjustments will result in a material change to our financial position, results of operations, or liquidity. We are continuing to work with the IRS to resolve these matters and we believe that they will be resolved for amounts consistent with recorded amounts of unrecognized tax benefits associated with these matters.

We have amended our U.S federal income tax returns for 2005 through 2009 to exclude from taxable income incentive payments received from the U.S. federal government for blending alcohol fuel mixtures. These amended return claims have been disallowed by the IRS and we are currently protesting the disallowance of these adjustments. An ultimate disallowance of the exclusion from income would not result in a material change to our financial position, results of operations, or liquidity.

U.S. State

As of December 31, 2018, our California tax returns for 2004 through 2008 and 2011 through 2014 were under audit by the state of California. We do not expect the ultimate disposition of these audits will result in a material change to our financial position, results of operations, or liquidity. We believe these audits will be resolved for amounts consistent with our recorded amounts of unrecognized tax benefits associated with these audits.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

International

As of December 31, 2018, our Canadian subsidiary’s federal tax returns for 2013 and 2014 were under audit by Canada Revenue Agency (CRA) and our Quebec provincial tax returns for 2013 through 2016 were under audit by Revenue Quebec. We are protesting the proposed adjustments by CRA for 2013 and we do not expect the ultimate disposition of these adjustments will result in a material change to our financial position, results of operations, or liquidity.


16.	EARNINGS PER COMMON SHARE

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



	Year Ended December 31,
	2018		2017		2016
Earnings per common share:
Net income attributable to Valero stockholders	$	3,122	$	4,065	$	2,289
Less income allocated to participating securities	9		14		7
Net income available to common shareholders	$	3,113	$	4,051	$	2,282

Weighted-average common shares outstanding	426		442		461

Earnings per common share	$	7.30	$	9.17	$	4.94

Earnings per common share – assuming dilution:
Net income attributable to Valero stockholders	$	3,122	$	4,065	$	2,289

Weighted-average common shares outstanding	426		442		461
Effect of dilutive securities	2		2		3
Weighted-average common shares outstanding – assuming dilution	428		444		464

Earnings per common share – assuming dilution	$	7.29	$	9.16	$	4.94

Participating securities include restricted stock and performance awards granted under our 2011 Omnibus Stock Incentive Plan. Dilutive securities include participating securities as well as outstanding stock options granted under our 2011 Omnibus Stock Incentive Plan.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


17.	REVENUES AND SEGMENT INFORMATION

Revenue from Contracts with Customers

Disaggregation of Revenue

Revenue is presented in the table below under “Segment Information” disaggregated by product because this is the level of disaggregation that management has determined to be beneficial to users of our financial statements.

Receivables from Contracts with Customers

Our receivables from contracts with customers are included in receivables, net as presented in Note 4.

Remaining Performance Obligations

The majority of our contracts with customers are spot contracts and therefore have no remaining performance obligations. Our remaining contracts with customers are primarily term contracts. The transaction price for these term contracts includes an immaterial fixed amount and variable consideration (i.e., a commodity price). The variable consideration is allocated entirely to a wholly unsatisfied promise to transfer a distinct good that forms part of a single performance obligation; therefore, the variable consideration is not included in the remaining performance obligation. As of December 31, 2018, after excluding contracts with an original expected duration of one year or less, the aggregate amount of the transaction price allocated to our remaining performance obligations was not material as the transaction price for these contracts includes only an immaterial fixed amount.

Segment Information

As of December 31, 2018, we had three reportable segments – refining, ethanol, and VLP. Each segment is a strategic business unit that offers different products and services by employing unique technologies and marketing strategies and whose operations and operating performance are managed and evaluated separately. Operating performance is measured based on the operating income generated by the segment, which includes revenues and expenses that are directly attributable to the management of the respective segment. Intersegment sales are generally derived from transactions made at prevailing market rates. The following is a description of each segment’s business operations.

•

The refining segment includes the operations of our 15 petroleum refineries, the associated marketing activities, and certain logistics assets that support our refining operations that are not owned by VLP. The principal products manufactured by our refineries and sold by this segment include gasolines and blendstocks (e.g., conventional gasolines, premium gasolines, and gasoline meeting the specifications of the California Air Resources Board (CARB)), distillates (e.g., diesel, low-sulfur diesel, ultra-low-sulfur diesel, CARB diesel, jet fuel, and other distillates), and other products (e.g., asphalt, petrochemicals, lubricants, and other refined petroleum products).

•

The ethanol segment includes the operations of our 14 ethanol plants, the associated marketing activities, and logistics assets that support our ethanol operations. The principal products manufactured by our ethanol plants are ethanol and distillers grains. We sell some ethanol to our refining segment for blending into gasoline, which is sold to that segment’s customers as a finished gasoline product.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


•	The VLP segment includes the results of VLP. VLP generates revenue from transportation and terminaling activities provided to our refining segment. All of VLP’s revenues are intersegment revenues that are generated under commercial agreements with our refining segment. Revenues generated under these agreements are eliminated in consolidation.

Operations that are not included in any of the reportable segments are included in the corporate category.

The following tables reflect information about our operating income and total expenditures for long-lived assets by reportable segment (in millions):



	Refining		Ethanol		VLP		Corporate and Eliminations			Total
Year ended December 31, 2018:
Revenues:
Revenues from external customers	$	113,601	$	3,428	$	—	$	4		$	117,033
Intersegment revenues	14		210		546		(770		)	—
Total revenues	113,615		3,638		546		(766		)	117,033
Cost of sales:
Cost of materials and other	102,489		3,008		—		(765		)	104,732
Operating expenses (excluding depreciation and amortization expense reflected below)	4,099		470		125		(4		)	4,690
Depreciation and amortization expense	1,863		78		76		—			2,017
Total cost of sales	108,451		3,556		201		(769		)	111,439
Other operating expenses	45		—		—		—			45
General and administrative expenses (excluding depreciation and amortization expense reflected below)	—		—		—		925			925
Depreciation and amortization expense	—		—		—		52			52
Operating income by segment	$	5,119	$	82	$	345	$	(974	)	$	4,572
Total expenditures for long-lived assets (a)	$	2,935	$	373	$	24	$	44		$	3,376

See note on page 126.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	Refining		Ethanol		VLP		Corporate and Eliminations			Total
Year ended December 31, 2017:
Revenues:
Revenues from external customers	$	90,651	$	3,324	$	—	$	5		$	93,980
Intersegment revenues	6		176		452		(634		)	—
Total revenues	90,657		3,500		452		(629		)	93,980
Cost of sales:
Cost of materials and other	80,865		2,804		—		(632		)	83,037
Operating expenses (excluding depreciation and amortization expense reflected below)	3,959		443		104		(2		)	4,504
Depreciation and amortization expense	1,800		81		53		—			1,934
Total cost of sales	86,624		3,328		157		(634		)	89,475
Other operating expenses	58		—		3		—			61
General and administrative expenses (excluding depreciation and amortization expense reflected below)	—		—		—		829			829
Depreciation and amortization expense	—		—		—		52			52
Operating income by segment	$	3,975	$	172	$	292	$	(876	)	$	3,563
Total expenditures for long-lived assets (a)	$	1,710	$	84	$	110	$	44		$	1,948



Year Ended December 31, 2016:
Revenues:
Revenues from external customers	$	71,968		$	3,691		$	—	$	—		$	75,659
Intersegment revenues	—			210			363		(573		)	—
Total revenues	71,968			3,901			363		(573		)	75,659
Cost of sales:
Cost of materials and other	63,405			3,130			—		(573		)	65,962
Operating expenses (excluding depreciation and amortization expense reflected below)	3,740			415			96		—			4,251
Depreciation and amortization expense	1,734			66			46		—			1,846
Lower of cost or market inventory valuation adjustment	(697		)	(50		)	—		—			(747		)
Total cost of sales	68,182			3,561			142		(573		)	71,312
General and administrative expenses (excluding depreciation and amortization expense reflected below)	—			—			—		709			709
Depreciation and amortization expense	—			—			—		48			48
Asset impairment loss	56			—			—		—			56
Operating income by segment	$	3,730		$	340		$	221	$	(757	)	$	3,534
Total expenditures for long-lived assets (a)	$	1,867		$	68		$	23	$	38		$	1,996


(a)	Total expenditures for long-lived assets includes amounts related to capital expenditures, deferred turnaround and catalyst costs, and property, plant, and equipment for acquisitions.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

The following table provides a disaggregation of revenues by reportable segment (in millions). Refining and ethanol segment revenues are disaggregated for our principal products, and VLP segment revenues are disaggregated by activity type.



	Year Ended December 31,
	2018			2017			2016
Refining:
Gasolines and blendstocks	$	46,606		$	40,366		$	33,450
Distillates	55,546			42,074			32,576
Other product revenues	11,463			8,217			5,942
Total refining revenues	113,615			90,657			71,968
Ethanol:
Ethanol	2,912			2,940			3,315
Distillers grains	726			560			586
Total ethanol revenues	3,638			3,500			3,901
VLP:
Pipeline transportation	124			101			78
Terminaling	415			348			284
Storage and other	7			3			1
Total VLP revenues	546			452			363
Corporate – other revenues	4			5			—
Elimination of intersegment revenues	(770		)	(634		)	(573		)
Revenues	$	117,033		$	93,980		$	75,659

Revenues by geographic area are shown in the following table (in millions). The geographic area is based on location of customer and no customer accounted for 10 percent or more of our revenues.



	Year Ended December 31,
	2018		2017		2016
U.S.	$	82,992	$	66,614	$	51,479
Canada	9,211		7,039		6,115
U.K. and Ireland	15,208		11,556		10,797
Other countries	9,622		8,771		7,268
Revenues	$	117,033	$	93,980	$	75,659

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Long-lived assets include property, plant, and equipment and certain long-lived assets included in “deferred charges and other assets, net.” Long-lived assets by geographic area consisted of the following (in millions):



	December 31,
	2018		2017
U.S.	$	27,475	$	26,083
Canada	1,798		1,915
U.K. and Ireland	1,113		1,063
Other countries	266		—
Total long-lived assets	$	30,652	$	29,061

Total assets by reportable segment were as follows (in millions):



	December 31,
	2018		2017
Refining	$	42,673	$	40,382
Ethanol	1,691		1,344
VLP	1,620		1,517
Corporate and eliminations	4,171		6,915
Total assets	$	50,155	$	50,158

As of December 31, 2018 and 2017, our investments in joint ventures accounted for under the equity method were $542 million and $530 million, respectively, all of which related to the refining segment and are reflected in “deferred charges and other assets, net” as presented in Note 7.

Effective January 1, 2019, we revised our reportable segments to align with certain changes in how our chief operating decision maker manages and allocates resources to our business. Accordingly, we created a new reportable segment — renewable diesel — because of the growing importance of renewable fuels in the market and the growth of our investments in renewable fuels production. The renewable diesel segment includes the operations of DGD, our consolidated joint venture as discussed in Note 12. The operations of DGD have been included in the refining segment through December 31, 2018, but were transferred from that segment on January 1, 2019. Also effective January 1, 2019, we no longer have a VLP segment, and we include the operations of VLP in our refining segment. This change was made because of the Merger Transaction with VLP, as described in Note 2, and the resulting change in how we manage VLP’s operations. We no longer manage VLP as a business but as logistics assets that support the operations of our refining segment.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


18.	SUPPLEMENTAL CASH FLOW INFORMATION

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



	Year Ended December 31,
	2018			2017			2016
Decrease (increase) in current assets:
Receivables, net	$	(457	)	$	(870	)	$	(1,531	)
Inventories	(197		)	(516		)	771
Prepaid expenses and other	(77		)	151			47
Increase (decrease) in current liabilities:
Accounts payable	304			1,842			1,556
Accrued expenses	(113		)	21			117
Taxes other than income taxes payable	(73		)	172			82
Income taxes payable	(684		)	489			(66		)
Changes in current assets and current liabilities	$	(1,297	)	$	1,289		$	976

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



	Year Ended December 31,
	2018		2017		2016
Interest paid in excess of amount capitalized	$	463	$	457	$	427
Income taxes paid, net	1,361		410		444

Cash flows reflected as “other financing activities, net” for the year ended December 31, 2016 included the payment of a long-term liability of $137 million owed to a joint venture partner associated with an owner-method joint venture investment.

Noncash investing and financing activities for the year ended December 31, 2018 included the recognition of (i) capital lease assets and related obligations totaling $63 million primarily for the lease of storage tanks as described in Note 9 and (ii) terminal assets and related obligation totaling $198 million under owner accounting as described in Note 10.

Noncash investing and financing activities for the year ended December 31, 2017 included the recognition of (i) capital lease assets and related obligations totaling $502 million primarily for the lease of storage tanks as described in Note 9 and (ii) terminal assets and related obligation totaling $94 million under owner accounting as described in Note 10.

There were no significant noncash investing and financing activities for the year ended December 31, 2016.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


19.	FAIR VALUE MEASUREMENTS

General

U.S. GAAP requires or permits certain assets and liabilities to be measured at fair value on a recurring or nonrecurring basis in our balance sheets, and those assets and liabilities are presented below under “Recurring Fair Value Measurements” and “Nonrecurring Fair Value Measurements.” Assets and liabilities measured at fair value on a recurring basis, such as derivative financial instruments, are measured at fair value at the end of each reporting period. Assets and liabilities measured at fair value on a nonrecurring basis, such as the impairment of property, plant and equipment, are measured at fair value in particular circumstances.

U.S. GAAP also requires the disclosure of the fair values of financial instruments when an option to elect fair value accounting has been provided, but such election has not been made. A debt obligation is an example of such a financial instrument. The disclosure of the fair values of financial instruments not recognized at fair value in our balance sheet is presented below under “Other Financial Instruments.”

U.S. GAAP provides a framework for measuring fair value and establishes a three-level fair value hierarchy that prioritizes inputs to valuation techniques based on the degree to which objective prices in external active markets are available to measure fair value. Following is a description of each of the levels of the fair value hierarchy.


•	Level 1 - Observable inputs, such as unadjusted quoted prices in active markets for identical assets or liabilities.


•	Level 2 - Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

•

Level 3 - Unobservable inputs for the asset or liability. Unobservable inputs reflect our own assumptions about what market participants would use to price the asset or liability. The inputs are developed based on the best information available in the circumstances, which might include occasional market quotes or sales of similar instruments or our own financial data such as internally developed pricing models, discounted cash flow methodologies, as well as instruments for which the fair value determination requires significant judgment.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Recurring Fair Value Measurements

The following tables present information (in millions) about our assets and liabilities recognized at their fair values in our balance sheets categorized according to the fair value hierarchy of the inputs utilized by us to determine the fair values as of December 31, 2018 and 2017.

We have elected to offset the fair value amounts recognized for multiple similar derivative contracts executed with the same counterparty, including any related cash collateral assets or obligations as shown below; however, fair value amounts by hierarchy level are presented in the following tables on a gross basis. We have no derivative contracts that are subject to master netting arrangements that are reflected gross on the balance sheet.



	December 31, 2018
							Total Gross Fair Value		Effect of Counter- party Netting			Effect of Cash Collateral Netting			Net Carrying Value on Balance Sheet		Cash Collateral Paid or Received Not Offset
	Fair Value Hierarchy
	Level 1		Level 2		Level 3
Assets:
Commodity derivative contracts	$	2,792	$	—	$	—	$	2,792	$	(2,669	)	$	(34	)	$	89	$	—
Foreign currency contracts	4		—		—		4		n/a			n/a			4		n/a
Investments of certain benefit plans	60		—		9		69		n/a			n/a			69		n/a
Total	$	2,856	$	—	$	9	$	2,865	$	(2,669	)	$	(34	)	$	162

Liabilities:
Commodity derivative contracts	$	2,681	$	—	$	—	$	2,681	$	(2,669	)	$	(12	)	$	—	$	(136	)
Environmental credit obligations	—		13		—		13		n/a			n/a			13		n/a
Physical purchase contracts	—		5		—		5		n/a			n/a			5		n/a
Foreign currency contracts	1		—		—		1		n/a			n/a			1		n/a
Total	$	2,682	$	18	$	—	$	2,700	$	(2,669	)	$	(12	)	$	19

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)



	December 31, 2017
							Total Gross Fair Value		Effect of Counter- party Netting			Effect of Cash Collateral Netting			Net Carrying Value on Balance Sheet		Cash Collateral Paid or Received Not Offset
	Fair Value Hierarchy
	Level 1		Level 2		Level 3
Assets:
Commodity derivative contracts	$	875	$	19	$	—	$	894	$	(893	)	$	—		$	1	$	—
Investments of certain benefit plans	65		—		8		73		n/a			n/a			73		n/a
Total	$	940	$	19	$	8	$	967	$	(893	)	$	—		$	74

Liabilities:
Commodity derivative contracts	$	955	$	14	$	—	$	969	$	(893	)	$	(76	)	$	—	$	(102	)
Environmental credit obligations	—		104		—		104		n/a			n/a			104		n/a
Physical purchase contracts	—		6		—		6		n/a			n/a			6		n/a
Foreign currency contracts	7		—		—		7		n/a			n/a			7		n/a
Total	$	962	$	124	$	—	$	1,086	$	(893	)	$	(76	)	$	117

A description of our assets and liabilities recognized at fair value along with the valuation methods and inputs we used to develop their fair value measurements are as follows:

•

Commodity derivative contracts consist primarily of exchange-traded futures, which are used to reduce the impact of price volatility on our results of operations and cash flows as discussed in Note 20. These contracts are measured at fair value using the market approach. Exchange-traded futures are valued based on quoted prices from the commodity exchange and are categorized in Level 1 of the fair value hierarchy.


•	Physical purchase contracts represent the fair value of fixed-price corn purchase contracts. The fair values of these purchase contracts are measured using a market approach based on quoted prices from the commodity exchange or an independent pricing service and are categorized in Level 2 of the fair value hierarchy.

•

Investments of certain benefit plans consist of investment securities held by trusts for the purpose of satisfying a portion of our obligations under certain U.S. nonqualified benefit plans. The plan assets categorized in Level 1 of the fair value hierarchy are measured at fair value using a market approach based on quoted prices from national securities exchanges. The plan assets categorized in Level 3 of the fair value hierarchy represent insurance contracts, the fair value of which is provided by the insurer.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

•

Foreign currency contracts consist of foreign currency exchange and purchase contracts entered into for our international operations to manage our exposure to exchange rate fluctuations on transactions denominated in currencies other than the local (functional) currencies of those operations. These contracts are valued based on quoted prices from the exchange and are categorized in Level 1 of the fair value hierarchy.

•

Environmental credit obligations represent our liability for the purchase of (i) biofuel credits (primarily RINs in the U.S.) needed to satisfy our obligation to blend biofuels into the products we produce and (ii) emission credits under the California Global Warming Solutions Act (the California cap-and-trade system, also known as AB 32) and similar programs, (collectively, the cap-and-trade systems). To the degree we are unable to blend biofuels (such as ethanol and biodiesel) at percentages required under the biofuel programs, we must purchase biofuel credits to comply with these programs. Under the cap-and-trade systems, we must purchase emission credits to comply with these systems. These programs are described in Note 20 under “Environmental Compliance Program Price Risk.” The liability for environmental credits is based on our deficit for such credits as of the balance sheet date, if any, after considering any credits acquired or under contract, and is equal to the product of the credits deficit and the market price of these credits as of the balance sheet date. The environmental credit obligations are categorized in Level 2 of the fair value hierarchy and are measured at fair value using the market approach based on quoted prices from an independent pricing service.

There were no transfers into or out of Level 3 for assets and liabilities held as of December 31, 2018 and 2017 that were measured at fair value on a recurring basis.

There was no significant activity during the years ended December 31, 2018, 2017, and 2016 related to the fair value amounts categorized in Level 3 as of December 31, 2018 and 2017.

Nonrecurring Fair Value Measurements

As discussed in Note 3, we concluded that the Aruba Terminal was impaired as of June 30, 2016, which resulted in an asset impairment loss of $56 million that was recorded in June 2016. The fair value of the Aruba Terminal was determined using an income approach and was classified in Level 3. We employed a probability-weighted approach to possible future cash flow scenarios, including transferring ownership of the business to the GOA or continuing to operate the business.

There were no assets or liabilities that were measured at fair value on a nonrecurring basis as of December 31, 2018 and 2017.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Other Financial Instruments

Financial instruments that we recognize in our balance sheets at their carrying amounts are shown in the following table along with their associated fair values (in millions):



		December 31, 2018				December 31, 2017
	Fair Value Hierarchy	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Financial assets:
Cash and cash equivalents	Level 1	$	2,982	$	2,982	$	5,850	$	5,850
Financial liabilities:
Debt (excluding capital leases)	Level 2	8,503		8,986		8,310		9,795


20.	PRICE RISK MANAGEMENT ACTIVITIES

We are exposed to market risks primarily related to the volatility in the price of commodities, and foreign currency exchange rates, and the price of credits needed to comply with various government and regulatory programs. We enter into derivative instruments to manage some of these risks, including derivative instruments related to the various commodities we purchase or produce, and foreign currency exchange and purchase contracts, as described below under “Risk Management Activities by Type of Risk.” These derivative instruments are recorded as either assets or liabilities measured at their fair values (see Note 19), as summarized below under “Fair Values of Derivative Instruments,” with changes in fair value recognized currently in income. The effect of these derivative instruments on our income is summarized below under “Effect of Derivative Instruments on Income.”

Risk Management Activities by Type of Risk

Commodity Price Risk

We are exposed to market risks related to the volatility in the price of crude oil, refined petroleum products (primarily gasoline and distillate), grain (primarily corn), soybean oil, and natural gas used in our operations. To reduce the impact of price volatility on our results of operations and cash flows, we use commodity derivative instruments, such as futures and options. Our positions in commodity derivative instruments are monitored and managed on a daily basis by our risk control group to ensure compliance with our stated risk management policy that has been approved by our board of directors.

We primarily use commodity derivative instruments as economic hedges, which are not designated as hedging instruments, and we use fair value and cash flow hedges from time to time. We had no commodity derivative instruments outstanding as of December 31, 2018 and 2017, and no activity during the years ended December 31, 2018, 2017, and 2016 that were designated as fair value or cash flow hedges.

Our objectives for holding economic hedges are to (i) manage price volatility in certain feedstock and refined petroleum product inventories and fixed-price purchase contracts, and (ii) lock in the price of forecasted feedstock, refined petroleum product, or natural gas purchases and refined petroleum product sales at existing market prices that we deem favorable.

As of December 31, 2018, we had the following outstanding commodity derivative instruments that were used as economic hedges, as well as commodity derivative instruments related to the physical purchase of

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

corn at a fixed price. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels, except those identified as natural gas contracts that are presented in millions of British thermal units, corn contracts that are presented in thousands of bushels, and soybean oil contracts that are presented in thousands of pounds).



	Notional Contract Volumes by Year of Maturity
Derivative Instrument	2019	2020
Crude oil and refined petroleum products:
Futures – long	149,470	224
Futures – short	143,826	671
Options – long	26,500	—
Options – short	26,500	—
Natural gas:
Futures – long	5,000,000	—
Corn:
Futures – long	26,025	—
Futures – short	55,395	875
Physical contracts – long	27,109	875
Soybean oil:
Futures – long	137,518	—
Futures – short	285,957	—

Foreign Currency Risk

We are exposed to exchange rate fluctuations on transactions entered into by our international operations that are denominated in currencies other than the local (functional) currencies of these operations. To manage our exposure to these exchange rate fluctuations, we use foreign currency exchange and purchase contracts. These contracts are not designated as hedging instruments for accounting purposes and therefore are classified as economic hedges. As of December 31, 2018, we had forward contracts to purchase $441 million of U.S. dollars. All of these commitments matured on or before January 31, 2019.

Environmental Compliance Program Price Risk

We are exposed to market risk related to the volatility in the price of credits needed to comply with various governmental and regulatory environmental compliance programs. To manage this risk, we enter into contracts to purchase these credits when prices are deemed favorable. Some of these contracts are derivative instruments; however, we elect the normal purchase exception and do not record these contracts at their fair values. Certain of these programs require us to blend biofuels into the products we produce, and we are subject to such programs in most of the countries in which we operate. These countries set annual quotas for the percentage of biofuels that must be blended into the motor fuels consumed in these countries. As a producer of motor fuels from petroleum, we are obligated to blend biofuels into the products we produce at a rate that is at least equal to the applicable quota. To the degree we are unable to blend at the applicable rate, we must purchase biofuel credits (primarily RINs in the U.S.). We are exposed to the volatility in the market price of these credits, and we manage that risk by purchasing biofuel credits when prices are deemed

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

favorable. For the years ended December 31, 2018, 2017, and 2016, the cost of meeting our obligations under these compliance programs was $536 million, $942 million, and $749 million, respectively. These amounts are reflected in cost of materials and other.

We are subject to additional requirements under GHG emission programs, including the cap-and-trade systems, as discussed in Note 19. Under these cap-and-trade systems, we purchase various GHG emission credits available on the open market. Therefore, we are exposed to the volatility in the market price of these credits. The cost to implement certain provisions of the cap-and-trade systems are significant; however, we recovered the majority of these costs from our customers for the years ended December 31, 2018, 2017, and 2016 and expect to continue to recover the majority of these costs in the future. For the years ended December 31, 2018, 2017, and 2016, the net cost of meeting our obligations under these compliance programs was immaterial.

Fair Values of Derivative Instruments

The following tables provide information about the fair values of our derivative instruments as of December 31, 2018 and 2017 (in millions) and the line items in the balance sheets in which the fair values are reflected. See Note 19 for additional information related to the fair values of our derivative instruments.

As indicated in Note 19, we net fair value amounts recognized for multiple similar derivative contracts executed with the same counterparty under master netting arrangements, including cash collateral assets and obligations. The following tables, however, are presented on a gross asset and gross liability basis, which results in the reflection of certain assets in liability accounts and certain liabilities in asset accounts.



	Balance Sheet Location		December 31, 2018						December 31, 2017
		Asset Derivatives			Liability Derivatives			Asset Derivatives			Liability Derivatives
Derivatives not designated as hedging instruments
Commodity contracts:
Futures	Receivables, net		$	2,787		$	2,681		$	886		$	966
Options	Receivables, net		5			—			8			3
Physical purchase contracts	Inventories		—			5			—			6
Foreign currency contracts	Receivables, net		4			—			—			—
Foreign currency contracts	Accrued expenses		—			1			—			7
Total			$	2,796		$	2,687		$	894		$	982

Market Risk

Our price risk management activities involve the receipt or payment of fixed price commitments into the future. These transactions give rise to market risk, which is the risk that future changes in market conditions may make an instrument less valuable. We closely monitor and manage our exposure to market risk on a daily basis in accordance with policies approved by our board of directors. Market risks are monitored by our risk control group to ensure compliance with our stated risk management policy. We do not require any collateral or other security to support derivative instruments into which we enter. We also do not have any derivative instruments that require us to maintain a minimum investment-grade credit rating.

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Effect of Derivative Instruments on Income

The following tables provide information about the gain or loss recognized in income on our derivative instruments and the line items in the statements of income in which such gains and losses are reflected (in millions).



Derivatives Used as Economic Hedges	Location of Gain (Loss) Recognized in Income on Derivatives	Year Ended December 31,
	2018			2017			2016
Commodity contracts	Cost of materials and other	$	(165	)	$	(278	)	$	(86	)
Commodity contracts	Operating expenses (excluding depreciation and amortization expense)	7			—			—
Foreign currency contracts	Cost of materials and other	56			(40		)	16

VALERO ENERGY CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)


21.	QUARTERLY FINANCIAL DATA (Unaudited)

The following tables summarize quarterly financial data for the years ended December 31, 2018 and 2017 (in millions, except per share amounts).



	2018 Quarter Ended
	March 31		June 30		September 30		December 31
Revenues	$	26,439	$	31,015	$	30,849	$	28,730
Gross profit (a)	1,062		1,535		1,451		1,546
Operating income	801		1,253		1,219		1,299
Net income	582		875		874		1,022
Net income attributable to Valero Energy Corporation stockholders	469		845		856		952
Earnings per common share	1.09		1.96		2.01		2.26
Earnings per common share – assuming dilution	1.09		1.96		2.01		2.24

	2017 Quarter Ended
	March 31		June 30		September 30		December 31 (b)
Revenues	$	21,772	$	22,254	$	23,562	$	26,392
Gross profit (a)	732		1,049		1,614		1,110
Operating income	528		860		1,332		843
Net income	321		572		863		2,400
Net income attributable to Valero Energy Corporation stockholders	305		548		841		2,371
Earnings per common share	0.68		1.23		1.91		5.43
Earnings per common share – assuming dilution	0.68		1.23		1.91		5.42


(a)	Gross profit is calculated as revenues less total cost of sales.


(b)	During the quarter ended December 31, 2017, we recognized an income tax benefit of $1.9 billion related to Tax Reform as described in Note 15.

Previous: Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK · Next: Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE