Phillips 66 CEO on Fuel Demand, Venezuela, and What 'Landman' Gets Right | At Barron's

Key Concepts

• Downstream Operations: Refining, petrochemicals, and retail fuel sales – the processes following crude oil and natural gas extraction.
• Integration: The strategic alignment of different parts of the business (refining, midstream, petrochemicals) to maximize efficiency and value.
• Refining Capacity: The total amount of crude oil that can be processed into refined products globally. Currently tight, leading to favorable conditions for refiners.
• Renewable Fuels: Fuels derived from renewable sources, such as renewable diesel and sustainable aviation fuel (SAF).
• Midstream Operations: The transportation and processing of crude oil and natural gas liquids (NGLs).
• Fractionation: The process of separating NGLs into their individual components (ethane, propane, butane, etc.).
• Petrochemicals: Chemicals derived from petroleum or natural gas, used in a wide range of products.
• Activist Investor: An investor who uses their share ownership to push for specific changes in a company’s strategy or governance.
• Right of Way: Legal permission to use another person’s land for a specific purpose, such as building a pipeline.

Downstream Operations and Phillips 66’s Business Model

Phillips 66 operates exclusively in downstream operations, encompassing refining, midstream activities, chemicals (through a 50/50 joint venture with Chevron – Chevron Phillips Chemical Company or CPChem), and retail fuel sales. The company was spun out of ConocoPhillips in 2012. Downstream involves processing raw materials (crude oil, natural gas, NGLs) into finished products used daily, including gasoline, jet fuel, and petrochemical feedstocks. Phillips 66 maintains a significant retail presence with brands like 76 (West Coast) and Phillips 66 Shield and KICO (Midwest). They also have a global footprint with refineries in the UK and the US. The company focuses on maximizing value capture throughout the entire process, from gathering raw materials to delivering products to market.

Sector Overview and Refining Dynamics

The overall oil and gas sector is currently considered healthy, although crude oil prices have recently softened due to geopolitical factors. Refining, however, is in a particularly strong position. Global refining capacity is tight, having been rationalized (reduced) over the past several years, including the closure of a Phillips 66 refinery in California. Demand for refined products is growing globally at a rate of 1-2% annually, creating a constructive environment for refining businesses.

California Refinery Closure and Asset Redevelopment

Phillips 66 made the strategic decision to cease operations at its refineries in California (San Francisco and Los Angeles). The San Francisco refinery was converted to produce renewable diesel and sustainable aviation fuel. The LA refinery, a combination of two older facilities, was deemed inefficient and costly to upgrade. The company concluded that the 650 acres of land occupied by the LA refinery, located on the Port of LA, was worth significantly more than continuing refining operations. The decision required hundreds of millions of dollars in investment to maintain safe and reliable operation. The redevelopment plan has been positively received by local authorities and the California administration.

Consolidation and M&A Activity

The refining industry is seeing consolidation, with larger, independent refiners becoming more common. Phillips 66 differentiates itself through its integrated business model and its 50% ownership of Chevron Phillips Chemical Company (CPChem), a leading petrochemical producer. The two companies have cooperated for 25 years, creating a highly successful joint venture.

Integration and Competitive Advantage

Phillips 66’s integrated approach – combining refining, midstream, and petrochemical operations – is a core element of its strategy. This integration wasn’t a sudden combination of assets but rather a gradual development around the Sweeney complex in South Texas. This allows for maximized utility of the refinery, with petrochemical facilities utilizing feedstocks from the refinery and sharing resources. The midstream operations, including NGL fractionation facilities, provide feedstocks for petrochemical production. The Western Gateway pipeline project, a partnership with Kinder Morgan, exemplifies this integration, aiming to transport refined products from the Midwest to California, filling the supply gap created by refinery closures. This pipeline will move jet fuel, gasoline, and diesel from St. Louis to Santa Monica.

Western Gateway Pipeline and Infrastructure Challenges

The Western Gateway pipeline project leverages existing infrastructure where possible, reversing the flow on existing pipelines from Wood River refinery and utilizing Kinder Morgan’s existing rights of way. A new pipeline segment from Borger, Texas, to El Paso is currently being developed, with rights of way being secured. The company anticipates minimal challenges in securing permits, particularly in areas where pipelines are less problematic.

Governance and Activist Investor Engagement

Phillips 66 engaged with activist investor Elliott Management, adding four directors to the board in May 2023 – one existing director, two nominated by Elliott, and one independent director nominated by Phillips 66. The new directors underwent a rigorous onboarding process, gaining access to company information and personnel. The company reports that all board members are now aligned with the company’s strategy and are constructively challenging management. The board consists of 14 members, purposefully selected for their diverse expertise.

Performance and Future Strategy

Mark Lashier became CEO in July 2022. While the stock initially underperformed, it has since caught up to the S&P 500. The company is focused on improving refining performance, reducing costs by over $1 billion, and investing in low-capital, high-return projects to enhance margin capture. They are also focused on optimizing their midstream business and selling non-core assets, redeploying capital into higher-value opportunities. The company is committed to maximizing the value of every barrel of oil processed.

Demand Outlook and Regulation

Global demand for refined products is expected to continue growing at 1-2% annually, while refining capacity remains tight. North American demand is expected to plateau. Phillips 66 advocates for more consistent and predictable regulation regarding infrastructure projects, particularly pipelines, to ensure access to clean and affordable energy. They emphasize the need for a stable permitting process that isn’t subject to perpetual legal challenges.

Resource Diversification and Geopolitical Considerations

Phillips 66 emphasizes the importance of accessing a diverse range of crude oil sources for economic and national security reasons. Their facilities are designed to process both heavy and light crude oils, providing flexibility in feedstock selection.

Long-Term Outlook and the Role of Hydrocarbons

Phillips 66’s long-term outlook focuses on controlling costs, maximizing asset productivity, and engaging in the political process to advocate for favorable policies. The company acknowledges the importance of transitioning to a lower-carbon energy system but emphasizes the continued importance of hydrocarbons in the global economy. They are committed to making hydrocarbon production cleaner and more efficient.

"Land Man" and Industry Realism

Mark Lashier watches and enjoys the show "Land Man," but acknowledges that it is somewhat sensationalized, particularly regarding safety. He noted that Billy Bob Thornton’s character delivered a message about the importance of hydrocarbons that he has echoed in his own speeches.

Conclusion

Phillips 66 is strategically positioned within the downstream oil and gas sector, leveraging an integrated business model, a focus on operational excellence, and a commitment to adapting to the evolving energy landscape. The company is navigating a complex environment characterized by tight refining capacity, shifting demand patterns, and increasing regulatory scrutiny. Their focus on cost control, asset optimization, and strategic partnerships, coupled with a proactive approach to governance and political engagement, will be crucial to driving long-term value for shareholders.