Fitch Ratings Revises Outlook On Tesoro Petroleum To Negative

Business Wire, May 14, 2002

Business Editors

CHICAGO--(BUSINESS WIRE)--May 14, 2002

Fitch Ratings has revised the Rating Outlook on the debt of Tesoro Petroleum Corporation to Negative from Stable. Fitch rates Tesoro's senior secured credit facility 'BB' and subordinated debt 'B '. Although Fitch remains comfortable with Tesoro's current ratings, the unexpected changes in the terms of the Golden Eagle acquisition combined with weaker forecasts by Tesoro have raised Fitch's concerns with Tesoro's liquidity and prompted the change in Rating Outlook. Management anticipates closing on the acquisition of Valero's 168,000-bpd Golden Eagle refinery and 70 associated marketing sites by the end of this week.

On April 2, 2002, Fitch downgraded the ratings on Tesoro's debt due to the significant debt required to finance the Golden Eagle acquisition combined with Fitch's expectations for Tesoro and the oil industry over the next several quarters. At the time of the downgrade, Fitch's forecasts were significantly more conservative than those of Tesoro and have not changed. Although the change in terms will significantly improve Tesoro's expected liquidity at closing, any additional unexpected issues for Tesoro or a significant draw on Tesoro's revolver could result in a downgrade.

Due to the downturn in the industry cycle over the last six months, Tesoro had to draw on its revolver more than management was comfortable with ahead of closing on the Golden Eagle transaction. Rather than close into a too-tight revolving credit situation, Tesoro management renegotiated the final terms of the Golden Eagle transaction with Valero Energy to, (a) reduce the total price by $50 million, and, (b) issue deeply-subordinated seller's notes for another $150 million, reducing the cash requirements at closing by $200 million. Tesoro has already issued $450 million of new subordinated notes in addition to the issuance of $250 million of equity in March to finance the acquisition.

The new seller's notes have zero coupons for a significant period and are non-callable. Based on the net present value, the new notes will be recorded as $65 to $85 million on Tesoro's books. The reduction in the acquisition price, combined with the zero-coupon portion of the notes should significantly improve Tesoro's short-term liquidity position. At closing, Tesoro expects to have nothing drawn on its new $225 million revolver and will likely be long cash on the balance sheet.

As for Tesoro's debt covenants, management is working with lenders to amend the secured credit facility. The substantial 1st quarter loss has resulted in a debt-to-earnings ratio that exceeds the maximum permitted under the secured credit facility requiring a waiver to the existing financial covenant. The amended and restated covenants after closing the Golden Eagle transaction will reflect the weaker margin environment experienced in the first quarter of this year.

The amended and restated credit facility places restrictions on Tesoro including a limit on capital spending and required de-levering from non-operating sources. By the end of 2002, Tesoro is required to raise net proceeds of $125 million from a combination of mandatory divestment of assets or issuance of equity. The funds raised will be used to pay down debt.

In addition, Tesoro must also limit current year cap-ex to $275 million and 2003 is capped at $302.5 million. Tesoro has already reduced 2002 capital plans by $70 million from $337 million to $267 million. The reduction in cap-ex should not interfere with upcoming environmental requirements.

The addition of Golden Eagle provides Tesoro with a complex refinery in the high-margin state of California. Although Fitch views the acquisition as a significant positive from an operational and geographical diversification standpoint, the acquisition requires the addition of a significant amount of debt. The Golden Eagle acquisition follows closely behind Tesoro's debt financed acquisition of two refineries and associated retail assets from British Petroleum (BP) in September 2001 for $670 million.

At closing, total debt for Tesoro will be over $2 billion versus $350 million outstanding last September immediately prior to the purchase of the two BP refineries. Adjusted debt-to-capitalization (including 8.0 times (x) gross rental expense) should be 70%. Going forward, Fitch expects credit protection, as measured by EBITDA-to-interest to be above 3.0x, with debt-to-EBITDA of 3.0x to 4.0x.

Tesoro operates five wholly owned refineries with a total combined capacity of 390,000 bpd. Tesoro refocused its business strategy in the late 1990s, becoming primarily a downstream player in the oil industry. The Washington and Hawaii refineries were acquired in 1998 and, in late 1999, Tesoro sold its exploration and production assets to EEX Corp., effectively exiting the upstream end of the business.

Tesoro sells refined products wholesale or through approximately 675 retail outlets and is beginning to market through the Mirastar brand at Wal-mart sites in 17 states in the western United States. Tesoro is also the largest operator of marine terminals along the Louisiana and Texas Gulf Coast with 16 terminals and operates several marine terminals on the West Coast as well.