Phillips 66 (PSX) Earnings Call Transcript

All right, we'll get here started on -- for what is always a highlight of this conference, is to have the leadership team from Phillips 66 here. Mark, Kevin, Don, Jeff, thank you so much for being here, and so much to talk about.

Maybe, Mark, we'll kick off, before we get into the macro, with an important announcement yesterday on the Midstream side with a $2 billion acquisition of EPIC. You want to talk to us about why this makes sense and what do you want us to know about it as an investment community?

Sure, Neil. First of all, thanks for inviting all of us to be here. This is always a great way to start the new year. Actually we got to escape freezing temperatures in Houston to come to Miami, believe it or not. But really, the transaction really fits directly into our whole position to be a leading integrated downstream energy provider. We believe that we're developing a more compelling investment opportunity as we move forward. So we've got the Midstream business that you saw the announcement yesterday that we're growing. Refining, Marketing, Specialties, Renewables and our Chemicals business. And we believe that, that combination of assets allow us to optimize across the platform, drive value enhancement, and really generate attractive returns across the cycle. And the capital discipline that you're seeing in Midstream is driven by our commitment to return at least 50% of our operating cash flow to investors. And we've been optimizing assets to support these acquisitions. And so the EPIC acquisition that we announced yesterday, Don can get into the details more, but from an investor logic, it was a great fit for us. It really is analogous to the Pinnacle acquisition that we did last year, where we can go and find high-value assets that we can generate more value than the incumbent could because of our existing system. We rolled in DCP a couple of years ago to create this wellhead-to-market position in NGLs. And now we're looking for opportunities to fill that out and to create even stronger position. And if you've seen in the press release and the charts that we have online that this pipeline that EPIC has flows right into our Sweeny complex. And so we've got a great position on the Gulf Coast now, both from fractionation capacity as well as transportation assets and delivering clean, pure products. And every transaction that we've done, every transaction we look at has to enhance Don's ROCE, it has to create value, and we have to find transactions that can deliver both cost synergies and commercial synergies. And this, we were clearly the natural owner for these assets, and we are committed to finding and extracting that value as we continue to fill out our midstream position.

Thanks, Mark. Don would love your perspective on the asset. How should we think about the multiple that was paid for and there was some growth on that asset as well. And so I would think that the implied multiple compresses. Talk about the strategic logic of the asset too?

Sure, Neil. And as Mark mentioned, when we think about these type of bolt-on acquisitions, they've got to be accretive to our ROCE. And they also got to be scalable and afford us the ability to do some advantaged expansions. And like Pinnacle, EPIC has some of those similar attributes where it has a very cost-effective, cost-efficient pipeline expansion program that is just now in flight that's going to add capacity over this year and next. I mean, right now, it's about 175,000 barrels a day pipeline system growing to 225,000 later this year, and then 350,000 by next year in '26. All of that is very accretive growth for us. When you think about our supply portfolio, and as Mark mentioned, bringing in DCP from a gathering and processing, and be able to have this NGL supply system from the wellhead to the market. The EPIC transaction really gives us that growth running room to continue to expand in the Permian. With Pinnacle, we've already announced a follow-on plant expansion that will come online later this year. So this Pinnacle -- or the EPIC system really gives us additional downstream capacity that we'll be able to fill with volumes that we're growing through our organic opportunities as well as volumes that we're continue -- right now flowing on third-party systems that we'll be able to bring into the EPIC system. The other part that we like about EPIC was it has a fractionation complex there in Corpus, and it is really well situated for a follow-on train, a fractionation facility to be placed next to the existing one. We think that is a very robust organic growth opportunity that's going to be available to us post-close, something that we're not committed to today, but something that we certainly think will be available to us post-close, probably a 2027 type startup if we were to execute on that. So that type of growth avenue that the EPIC system affords us, we think, is very strategic. And as Mark mentioned, it fits us like a glove. When you look at the map, we already have multiple connectivity both in the Permian Basin, but also down in the Gulf Coast. We take some of the Y-grade and some of the propane off that system today. So we already have a lot of familiarity with that team and with the operations. We think we are best suited to maximize the value of those assets when you combine them with our overall NGL value chain setup that we have today.

Kevin, and Jeff, do you want to talk about the financials of the transaction in terms of transaction multiples? And then also the financing of it, there's been discussion about what the optimal capital structure is. One of the tricky things, and we're talking about that last night, is as the business increasingly becomes a Midstream oriented business and less a Refining oriented business, the capacity of the organization to take on a little bit more debt is there, but it's always tough to talk about that evolution with the market. So your perspective on that, too.

Yes, Neil. So in the context of financing around the transaction, you're absolutely right that we have a significant portion of our EBITDA that is not refining and not subject to the volatility of refining margins. And while we have -- we've laid out objectives to reduce balance sheet debt and we still have those plans; we absolutely have the flexibility and capability to execute on a transaction like this without causing any undue challenges from a balance sheet or a leverage standpoint. And I do think it's important for folks to acknowledge that the proportion of EBITDA that's coming from the Midstream business, the Marketing business, which, on a stand-alone basis, those kind of businesses would support quite substantial leverage levels way higher than what we have as a corporation. And so we feel very comfortable that we can execute on this. I'd also remind everyone that we have proceeds from asset dispositions that will be received this year. These are previously announced dispositions. We still have other dispositions that we are working and are in progress. And so in the context of 2025, our capital allocation decisions are really not just around the operating cash flow the business generates, but also a significant inflow by way of disposition. So feel very good about that.

Thanks, Kevin. Let's start a little bit on macro and Refining and we'll come back to Midstream and some of the other segments here in a moment. But Mark, I'm curious on your perspective on the refining setup as we go into the new year, where are we relative to your view of mid-cycle cracks? And certainly, the year started off strong a year ago, but faded pretty hard. So I think your look back on what changed and how does that change the way that you're thinking about the path forward?

Yes. Certainly, Neil, the -- obviously, the crack spreads are under intense pressure right now. We think that was a buildup of a number of things going all the way back at the COVID. No one was able to do turnarounds, maintain things that they would like to maintain things, and then the economy surge coming out of COVID, refiners couldn't keep up because we had to all go in and do turnarounds and fix everything with a healthy workforce. And so that created some tightness. And it also created conditions where everybody had their assets in prime operating shape, everybody was hitting the ground running coming off of these strong margins, and still had a little bit of a heavier turnaround activity early this year that supported things. But then the stars aligned, and everybody is running extraordinarily well. And I think that created just enough overhang that -- when demand was moderately good but not great, that you created the conditions too, so you have margin compression. I think that those operating rates as an industry are not sustainable. You'll go back to a more routine kind of maintenance cycle that will have things coming in and out on a more routine basis. You also have some pretty substantial rationalizations on deck coming up from next year, ours included. We're taking our L.A. refinery permanently off-line late next year. But I think about 1 million barrels a day of refining capacity globally is coming out next year. You're seeing maybe 1.5 million of new capacity coming in and demand is growing by 1 million barrels a day. So demand is outstripping the net additions. And so it's, I guess, a little bit it's darkest before the dawn. Right now, margins are compressed. But we see over the mid to longer term really the macro conditions improving for refining and seeing that uptick. And the interesting thing is a lot of times in downturns, you see a buildup of inventory that has to be worked off before you've seen a recovery. There's really not any excess inventory out there today. So it's kind of a strange combination of really, really tight cracks, high operating rates and not any excess inventory out there.

So Mark, what you're painting is refining softness driven largely by a supply situation. Are you seeing any evidence, and maybe it's a question for Jeff as well, in your system in your wholesale system, of demand weakness?

Yes. I think we're seeing strong consumer activities across the economy and within gasoline holding up better than distillate demand. Diesel much more industrially driven, and that's been a little softer side of the economy. But the economy in the U.S. surprising to the upside. And so we're optimistic as we look into 2025.

Yes. Okay. And we've seen a tick up in European gas prices, which has certainly moved into the distillate crack on the Gulf Coast in particular.

Yes. It's -- U.S. has about a $3.50, $3.75 a barrel advantage on utilities with higher natural gas prices in Europe. We've got $4 to $5 a barrel advantage on crude cost relative to Europe. And so we see Europe continuing to be kind of the marginal supplier and where we could see more pressure for rationalization.

Yes. Sticking on Refining, let's talk about California. Phillips 66 made a decision to cease operations in Los Angeles. When you think about the outlook for that market, what should we be mindful of? And how should we contextualize the West Coast with all this renewable supply coming online?

Absolutely, Neil. Well, I think that there's been a lot of moving parts in California that have put pressure on refiners there. When you think about our evolution, the first step was converting our San Francisco refinery at Rodeo to renewable energy complex. And so we stopped processing crude oil. We're processing renewables now. It's fully up and operational, and selling renewable diesel out to retail outlets. And we introduced sustainable aviation fuel last year, and that's been successful as well. And the next step was we had a challenged asset at L.A. refinery. If you look at the stack of refiners there, it was -- I think from a competitive position, it was impaired. It was 2 older refineries that historically had been combined. So there wasn't a lot of heat integration. It had a lot of competitive challenges. And so we made the tough decision to shut it down permanently this year and look for opportunities to redevelop the property. It will substantially impact our cost structure in a positive way on an average across the fleet. And those activities are well underway. We're working with experts in redeveloping properties like that to make sure that we can maximize the value of the property once we rationalize the asset. And then...

Yes.

And I also want to make sure that everyone understands that we have a solid plan. We've already resupplied Northern California with the gasoline, because when we took Rodeo off-line to convert to renewable diesel, we ceased producing gasoline there, and so we've got a resupply plan based on imports. We're doing something similar in Southern California. We're taking some of the assets that would be useful for terminaling for importing CARB gasoline into Southern California. The plans have been well received by the California authorities. They're very supportive of what we have underway in our plans and they're helping us enable what we're doing.

Mark, when you came in 2 years ago, you said one of your primary focuses was improving operational reliability...

Yes.

And capture rates at the Refining business. Where do you think we are in that journey?

You can see the improvement in our numbers. You've seen our utilization rates improve over the last, I think, 7 quarters, we've been above average utilization rates at around 94%. I think the rest of the industry has averaged about 92%. And honestly, we still see room to improve our reliability. We are grinding away in enhancing our reliability and our systems to make sure that we're getting the most value out of every asset that we have. We've done a lot of work and improved our turnaround capability, our intervals through turnarounds, we've used a lot of innovative technologies to make sure that we're only opening up the equipment that needs to be opened up. And then that allows us to shorten the length of our turnarounds and do -- to enhance the length of time between turnarounds. We've been able to move some things out in a very fortuitous way. And so in a clean product make, you're seeing in addition to the enhanced utilizations, you're seeing higher clean product, better market capture. Now the margins aren't really there today, but we're going to continue to work away at those small kind of projects that allow us to produce more jet fuel and cleaner products to enhance the value of what we do. And we've got every employee's mind wrapped around the drive to create value with every decision that we make every day.

Yes. Last one on Refining, Canada. It's obviously a very dynamic environment. We're dealing with a little bit of tighter dips post TMX, but there's a lot of uncertainty also around tariffs. As you read the tea leaves of what's happening in Washington, you think common sense prevails? How do you think that plays out?

Tea leaves as in Trump leaves, is that the implication there? I think the -- certainly -- the President-elect is certainly, I think, actively positioning himself for some key negotiations. That's clear. And we take seriously what he says, but I think that you've got to do read the tea leaves, to not take literally everything he says. And we hope that he makes the best decisions for the U.S. economy. And there's certainly economic impact on the U.S. economy for any kind of adverse tariff activities on crude oil coming into the country.

Okay. We'll see how this evolves. Let's talk -- let's pivot back to Midstream, because this is becoming an increasingly important part of the business, and Don, it's great to have you here. What -- talk big picture about how you envision this business looking 5 years from now?

Sure. If you think back -- start in '23 when we brought in DCP and really built out this platform of a wellhead-to-market, captured over $400 million in synergies and bringing that in, it really set us up for what you're seeing us execute today, which is just a methodical process of continuing to grow and build out our value chain from the scale and scope. Obviously, we're very focused in the Permian because that's where we see a lot of follow-on growth opportunities. Organically, we're doing some of that with -- post our Pinnacle acquisition, building a second processing train there. We see more opportunities like that for additional growth. And really continuing to aggregate our NGL supply, feeding our downstream system where we think we have an advantaged setup with our Sweeny complex and our Freeport export market there, which is a great location. You package that all with what Phillips has from a capability, really a worldwide commodity managing type company where we have trading offices in Singapore, Calgary, London, where really, we are managing commodities across the globe. And you bring Midstream in and have that kind of volume and that kind of supply portfolio, it really affords us a lot of opportunities. So we see continued growth coming out of the Midstream segment. It's an important part of our growth story for Phillips 66. With this transaction, we've updated our mid-cycle guidance from $3.8 billion to $4 billion. We think, like I said, EPIC affords us a nice expansion opportunity around the fractionation facilities in Corpus. We see additional organic growth in the Permian. We think that $4 billion continues to grow with those type of opportunity sets that we have in front of us. These are very straightforward in terms of their execution, well within our wheelhouse, in terms of M&A and acquisitions. Those are really just, if they're enhancements, if they are strategic, do they give us scale, do they improve our ROCE, those are things that we'll think about from a growth standpoint. So we see we have a platform and a portfolio that is going to continue to generate opportunities of growth, continue to generate investment opportunities that are accretive. So we're very excited with where this goes over the next several years. This is, I think, a really going to be an important part of where Phillips 66 ends up from a growth trajectory.

And that $4 billion of earnings is very consistent, low-volatility earnings, high-quality earnings, and it really sets a base load that it protects our dividend, it protects our sustaining capital, it really positions us well to return to shareholders as well.