Fitch Affirms & Removes Valero Energy's Ratings from Watch Negative.

CHICAGO -- Fitch has affirmed and removed from Rating Watch Negative the debt ratings of Valero Energy Corporation (Valero) in anticipation of the company's acquisition of Premcor, Inc. (Premcor). The Rating Outlook on the debt of Valero is Stable. Fitch rates the debt of Valero as follows:

-- Senior unsecured debt 'BBB-';

-- Unsecured credit facilities 'BBB-';

-- Mandatory convertible preferred securities 'BB+'.

With the closing to the transaction, Premcor, currently on Rating Watch Positive by Fitch, will become a wholly owned subsidiary of Valero. Valero will be guaranteeing the senior unsecured debt of the Premcor Refining Group (PRG). PRG will also be providing an upstream guarantee to Valero's debt. PRG is a wholly owned subsidiary of Premcor. Port Arthur Finance Company L.P. (PAFC) and the Port Arthur Coker Company L.P. (PACC) are wholly owned subsidiaries of PRG. Fitch anticipates raising Premcor's ratings as follows:

Premcor Refining Group:

-- $1 billion secured credit facility withdrawn;

-- Senior unsecured notes upgraded to 'BBB-' from 'BB';

-- Senior subordinated notes withdrawn.

Port Arthur Finance Company L.P.:

-- Senior secured notes upgraded to 'BBB' from 'BB+'.

The Rating Outlook for PRG and PAFC is also expected to be Stable.

Valero is acquiring Premcor Inc. in a transaction valued at more than $6.5 billion plus the assumption of approximately $1.8 billion in Premcor debt. Consideration for the equity portion of the transaction is being financed with cash for 50% of the total diluted shares of Premcor (fixed at $72.76 per share) and Valero stock for the remaining outstanding shares of Premcor at an exchange ratio fixed at 0.99 shares of Valero stock for each share of Premcor. The total cash consideration of approximately $3.4 billion, as well as transaction costs, will be financed through proceeds from a new term loan and cash on hand from the combined companies, which totaled $2.4 billion at the end of the second quarter. Valero does not expect any issues to result from the Federal Trade Commission review of the transaction. The closing is expected to immediately follow the expiration or termination of the Hart-Scott-Rodino waiting period at midnight today.

With the acquisition of Premcor, Valero will become the largest refiner in North America with approximately 2.8 million barrels per day (mmbpd) of crude oil capacity (including the Aruba refinery off the coast of Venezuela) with a total 18 refineries. Valero currently operates 14 facilities with a total of 2.0 mmbpd of crude capacity, and Premcor adds four refineries with approximately 800,000 bpd of capacity. Valero will also have approximately 1.8 mmbpd of heavy and medium sour crude capacity. The company expects to achieve significant synergies through the combined asset base as well as improving the operations at each of Premcor's refineries. Of note is that Premcor's Lima and Memphis refineries have historically run well below throughput capacity, and the expansion of the Port Arthur refinery is expected to be completed in mid-2006.

The rating action also recognizes the continued strong performance of both companies reflected in the generation of significant free cash flow in recent quarters. Refining margins, which have spiked in recent days due to the impact of hurricane Katrina, are expected to remain strong and, when combined with the deep discounts for sour and heavier crudes, could give Valero the ability to quickly repay the term loan. Fitch notes that several factors suggest that run-in margins are sustainable, strong U.S. and global demand across refined products, heightened concern over global crude supplies, the lack of new U.S and global refining capacity, heightened concern over unplanned refining shutdowns, the substantially stricter sulfur levels on U.S. gasoline, and diesel in 2006, among others.

Offsetting factors to the ratings include continued concerns with the significant debt that will remain both on and off Valero's balance sheet at close. With the addition of Premcor, Fitch estimates that balance sheet debt will increase to more than $7.0 billion. Off balance sheet debt will likely total $4.5 billion resulting in total adjusted debt of $11.5 billion. Combined with the additional debt is the risk to Valero of a drop in refined product demand, particularly given the run-up in crude and refined product prices. While the industry has a history of volatility in margins, there has yet to be a significant impact reflected in the overall industry fundamentals. The transaction valuation also reflects the significant escalation in refining valuations over the past several months. The consideration values Premcor's assets at more than $11,000 per barrel of operable crude capacity. For comparison, Premcor acquired the Delaware City refinery in May 2004 for $4,319 per barrel of crude capacity. The risk applies to future transactions for Valero as the company is expected to remain acquisitive. The sector also remains highly capital intensive due to the significant investments being made for ongoing maintenance, the low sulfur fuels, and other regulatory requirements as well as for strategic investments. Capital expenditures for Valero are expected to be more than $3.0 billion in 2006 and will likely remain high going forward.

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