About Tesoro
Message from the CEO
(from the 2007 Annual Report)

For the past several years, strong global demand for petroleum products, changing product specifications and the lack of new or available refining capacity positioned the refining industry for banner years. However, during the latter half of 2007 we witnessed market changes and unprecedented market volatility as crude oil prices rose steadily to record highs. At the same time, product prices failed to fully reflect the high cost of crude.

Even with these changes in the market, our strategy delivered a 44% return to our shareholders in 2007, and our five year compound average growth rate has been 50%.

Our strategy focuses on creating a company that has (i) economies of scale, (ii) a competitive cost structure, (iii) effective management information systems that enable success and (iv) operational excellence and outstanding employees. Historically, we have driven shareholder value by making acquisitions to create economies of scale.

While we believe there will be future acquisition opportunities to improve our economy of scale, our capital investment strategy will migrate toward capital projects and initiatives that either lower our crude, energy and operating costs or that improve reliability. The focus will be to harvest the cost reduction opportunities that position us to provide a competitive return to our shareholders regardless of market condition. Additionally, we will continue to pursue non-capital initiatives that enhance existing revenue streams.

ECONOMIES OF SCALE

In early 2007, we announced the purchase of the Los Angeles refinery and 250 related Shell gas stations. On the same day, we announced that we had agreed to acquire 138 USA Gasoline stations in a separate transaction. The addition of retail outlets in California and a Los Angeles refinery completed the West Coast refining system that we began building in 1998.

With these acquisitions, we set a goal to achieve $100 million of synergies in our extensive West Coast system during the first 12 months of our ownership. We are on track to meet our goal as we realized synergies of $45 million in the first six months through crude, feedstock and marine optimization opportunities. The acquisition of the Los Angeles refinery also creates the opportunity to build additional shareholder value through a multi-year investment program.

Greater economy of scale was created as we more than doubled the retail network by adding nearly 400 high-volume Shell and USA Gasoline retail sites. And with the departure of a number of retail brands in the Northern Great Plains, we also aggressively expanded our branded presence there by adding approximately 90 stations, almost doubling our branded sites in that area. Our retail presence in California, Minnesota, North Dakota and South Dakota positions us to realize more value for products that we produce at our two California and our Mandan, North Dakota refineries.

We now operate five retail brands – Tesoro, 2GO, Shell, Mirastar and USA Gasoline – in 18 states where we meet the needs of our customers.

COMPETITIVE COST STRUCTURE

Recent investments have been focused on reducing the largest, single expense for any refinery – the cost of crude oil. Our objective is to create crude purchasing flexibility through both capital investments and change management. In the third quarter of 2007, we completed a $29 million Amine unit project and pipeline at our Anacortes, Washington, refinery that allow us to process higher sulfur, lower cost crude oil. And at our Martinez, California refinery, we completed a $26 million expansion project at our wharf which gives us the ability to receive 100% of our crude requirements by water thereby reducing our dependence on declining local crudes that are higher priced. The wharf project also included new crude blending facilities to permit us to process higher
sulfur, lower cost feedstocks.

In 2008, we have two additional projects that will focus on reducing crude costs - the delayed coker project at Golden Eagle and a $31 million selective hydrogenation unit (SHU) at Anacortes. The combination of the SHU and Amine unit projects will give us much of the economic benefit that was planned from a larger expenditure for a coker that was cancelled last year. Looking ahead, another cost goal is to reduce our energy consumption – approximately 40% of a refinery’s costs are energy related. In 2008, we expect to complete an assessment at each refinery that will identify potential energy savings projects.

PEOPLE DRIVING OPERATIONAL EXCELLENCE

Our employees are the heart of everything that creates value for our customers and our shareholders. In 2007, our employees delivered improved year over year safety performance and outstanding environmental stewardship. Our emphasis on “doing it right” continues to deliver positive results as several of our refineries reported record safety performance. Environmentally, several refineries made good progress in reducing incidents and our Mandan refinery achieved the outstanding accomplishment of zero significant environmental incidents.

Not only did we operate our refineries in a safe and environmentally responsible way, we also increased our throughput. This was particularly noteworthy at our newly acquired Los Angeles refinery where we met the objectives of having environmentally responsible operations for our neighboring communities and meeting our Southern California customers’ product requirements while running at some of the highest throughput rates in that refinery’s history.

High throughput and operational excellence requires reliable operations, which was the focus of several projects in Kenai, Alaska; Salt Lake City, Utah and Golden Eagle.

The completion of a $66 million hydrotreater at Kenai enables us to meet our customers’ ultra low sulfur diesel needs by producing 10,000 barrels per day.

At Salt Lake City, a $20 million project revamped our fluid cat cracker, which is expected to improve reliability, increase run length and allow us to process more cost advantaged local crude oil.

Finally, at our Golden Eagle refinery, we completed a four-phase $52 million project to modernize and consolidate an antiquated refinery control system which will allow us to improve both reliability and refinery yields.

To prepare for the challenge of evaluating, designing and managing future investments, we reorganized and added talent to our capital management team. These resources managed to fast-track the Golden Eagle coker project which has significantly shortened the delivery time of this project. It is expected to be substantially completed during the first quarter of 2008. The modified coker is designed to reduce air emissions by more than 3,000 tons per year while enhancing reliability, lengthening turnaround cycles and reducing operating costs.

In 2008, our capital expenditures are projected to be $1.1 billion, the majority of which are for both income improvement and environmental/regulatory projects. This is a 22% increase over the 2007 capital program, but total spending will depend on both market and engineering factors.

EFFECTIVE MANAGEMENT INFORMATION SYSTEMS

As we expand the scope of our operations, it is essential we have effective and efficient IT systems. One example is ‘Project Genesis’, a major effort that will improve information flow on our supply chain activities.

More than 100 business and IT personnel and a total of $40 million have been dedicated to Genesis during 2007, and we expect implementation to take place in phases during 2008 and 2009. Genesis will be the IT foundation of our risk management system, from deal origin to payment. We also expect to see inventory management benefits as well as the platform from which to increase trading around our assets.

In addition, we continue to develop programs to facilitate efficient management and perform tasks. Business performance management scorecards, personnel appraisals, corporate functional goals and improved financial forecasting and reporting allow Tesoro to achieve success.

2008 OUTLOOK

Our outlook for the beginning of 2008 is for weak margins with the persistence of many of the same factors that impacted the last half of 2007. Product margins have been negatively impacted by high crude prices and higher than average inventories, lower demand and climbing unemployment rates. We believe that offsetting factors include expected reduced supply from the slowing of imports due to low margins, higher than normal refinery maintenance in early 2008, lower refinery utilization rates and tight oxygenate blendstock supplies in the summer months. In summary, we expect to see a return to higher margins due to a rebalancing of supply and demand and product prices that are more reflective of the cost of crude.

For the company, the most significant challenges we face in 2008 are threefold. First, our Kapolei, Hawaii, refinery must return to a high level of profitability. We posted an $86 million pre-tax operating loss in the fourth quarter of 2007 due to rapidly rising light sweet crude costs and an unplanned reformer outage. We have developed and are already implementing an action plan to address the issues in Hawaii and expect the plan to produce positive results by mid-2008.

Our second challenge is to improve the profitability of the Los Angeles refinery. Despite outstanding performance by our employees and better than historical operational excellence, to date, the market environment has made it difficult to achieve expected financial results. Nevertheless, we are working on myriad initiatives to improve the gross margin at the facility. And third, the company will complete the Golden Eagle delayed coker project in the second quarter of the year which must perform up to our expectations.

A challenging environment, where excellent performance is better recognized and rewarded, can bring out the best in an organization. Since 1997 our goal has been to create a refining and marketing business that provides shareholders with competitive returns in any economic environment.

With flat West Coast gasoline demand, we expect to continue to deliver value for our shareholders by focusing on ways to lower our raw material and energy costs, expand our crude supply base and improve operational excellence.

There are challenges ahead but I believe we have the focus, talent and experience to deliver an outstanding year for our shareholders, customers and communities.

Sincerely,

Bruce A. Smith
Chairman, President and Chief Executive Officer
Tesoro Corporation