Phillips 66 (PSX) Earnings Call Transcript & Summary

Good afternoon. Thank you for everyone joining us -- returning to our session again. Our next presentation or fireside chat is the Phillips 66. We have the whole team here. And that we have Greg Garland, the CEO and the Chairman of the Board. We also have Mark Lashier, the President of the company. And then we have Jeff, and sorry that I missed the last one.

It's Bob Herman.

Jeff, can you help me out?

Yes, Bob Herman, EVP of Refining.

Yes. I'm sorry. Bob, I'm sorry that I couldn't see your faces while you're here. But anyway, so thank you, everyone, joining us. So with that, let me start.

Greg, energy transition has been the buzz word. So just curious that based on that, do you see any potential longer-term impact on your refining and midstream configuration? And how will Phillips 66 adjusts your overall investment mix over the next 5 years?

Yes. Great. Well, first of all, thanks for having us, Paul. It's good to see you again. Nice to be with you today. So look, I think energy transition is a subject that's on everyone's mind. And certainly, at Phillips 66, we believe we have a strong role to play in the energy transition. And we've got a lot going on around the portfolio in energy transition from the renewables that we're working on to the battery technologies, solid oxide fuel cells, the hydrogen work we're doing. So there's a lot of work around the portfolio just in terms of energy transition. As you know, we stood up a new group called Emerging Energy in our company to really help chart a pathway to a lower carbon future and a pathway where we can bring value, add value but earn returns above our weighted average cost of capital, which is important to us. So as you think about the transitions, they take decades, long time to achieve. And as I think about just the next couple of years and what we have going on, I think we're going to see more disciplined upstream investment in the U.S. I think that translates to less investable opportunities in our Midstream business. And we've just come through a super cycle of investment in Midstream for the industry and a heavy lift actually for Phillips 66, too. If you go back to 2012, we had $450 million of EBITDA in our Midstream business. Today, we're over $2 billion. So significant growth in our Midstream over this period of time that -- since we formed the company. But as we look forward, I think there's going to be fewer investable opportunities in Midstream. So I think our capital budgets will come down. And so this year, we're $1.7 billion. I suspect for the next few years, we're going to be $2 billion or less as we kind of look into the future and the opportunities that we have. So less investment in Midstream. In the Chemicals business, Marketing business, pretty much self-funding. We've got 2 nice big projects there that will -- they'll move forward over the next few years. In Bob's business, we're pivoting to renewables. So we have $700 million to $800 million investment in renewables to really convert Rodeo from processing crude to not processing crude but to processing essentially fats and soybean oils and beef tallows and used cooking oils to make 50,000 barrels a day of renewable diesel at that facility. So near term, those are the actions we're going to be taking. We continue to sell specialty graphite into the battery business to use in anodes for lithium ion batteries. We continue to work with battery manufacturers to tweak those formulations, get better battery performance. We're working on next-generation batteries. And so we see those coming kind of in the middle part of the decade. And then as you move out 2030 and beyond, I think hydrogen is a great molecule. I think there's a lot of technology development that's yet to be done in terms of that. We're working with the Gigastack consortium in U.K. taking renewable wind energy electrolyzers to make hydrogen that gets used in the industrial base at Humber side to lower the carbon footprint of fuels that we make there. But that's scaling a kind of a 5-megawatt to 100-megawatt facility. And so there's a lot of ground that's got to be covered really to drive that technology and to improve the investment case for green hydrogen. We're going to add 2 to 3 hydrogen fueling sites a year in Europe over the next couple of years. We already have our first hydrogen sites in. And so as I said, there's a lot going on around the portfolio. So there's plenty that's going to keep us busy, and we're excited about the energy transition and our role to play.

And Greg, to a large degree that I think Phillips 66 is unique among the refiners that you actually have your own research lab and research department, which is quite unique. And so when we're looking at energy transition, do you look at things that you are doing, whether you're seeing the battery, the solar, the hydrogen is generating offset of the carbon to your core business or that you think that could become a new business for you?

Yes. I actually believe that's true. I think that we study our own operations to look where we can reduce our impact, whether it's the air, the land, or water, it doesn't matter. We're interested in reducing our environmental footprint across all those dimensions. And our energy research and innovation center helps us do that with technologies. But I also think when you think about solid oxide fuel cells, that can be a new standalone business for the company where we're taking a methane or a propane stream and through a chemical reaction generating electricity, and we generate 2/3 less carbon. So we have some CO2 that comes out but also water are the primary products of that reaction that happens. But we also have learned that we can actually run that backwards. So we can actually take CO2 and water and run the fuel cell backwards and generate methane or propane. And so we just got a grant from the Department of Energy and we're working cooperatively with our partners at Georgia Tech to try to advance this technology. So this could be a form of direct carbon capture technology. So I think we're excited about that technology. There's more to do in that area. But ultimately, as we move into 2030, I think you'll see carbon capture really starting to emerge as a viable technology for industry.

Yes. And Greg and the rest of the team, over the last 12 months, I think we have experienced something that we have never seen in our lifetime. And so a lot of the business taxes or the operation has been changed accordingly. So just curious that what have you learned from that process? And is there any lesson you will be able to apply in the post pandemic to make your operation even more efficient or better? And also, from that standpoint, in a low-carbon world and in the post pandemic, do you believe you have the right human organization and the skill set or that you may have some area that you may need to make some changes?

Bob, why don't you take that kind of refining and maybe some lessons learned through chem -- you take chemicals, and then I'll come back with the organization.

Okay. I think one of the things we learned during the last 12 months is how low can you go, right? And I don't know that we've ever put as much technical effort into learning how to run such a low utilization rates, but still make quality products on the backside. So we had to be pretty agile going into this to be able to run low utilization rates but still make a slate of products that kind of balanced out the refinery. So I think that was good. The second thing was a little bit fortuitous for us, Paul, in that. Over the previous 18 months, we kicked off AE66, and we have done a lot of work around digitization of our processes and putting tools in people's hands that allowed refinery workers to be remote, which 18 months before that, I don't think we could have done that and had as successful outcome as we did. So I think one of the long-term takeaways, right, is we were able to springboard our use of technology throughout the refineries over the last 12 months to really do a lot more than we expected and to keep our initiatives on pace throughout the pandemic with a lot fewer resources on the ground. So I think that's one of the things we'll take with us and learn. Probably the last point I'll make is the resilience of our people. We ask a lot of our operating and maintenance folks and the folks that manage our refineries over the last 12 months, and it was truly a learn-as-you-go because the rules in Los Angeles were different than they were in Sweeny, and they were different than they were in Bayway. And we had to adapt very quickly to a changing landscape that seemed to change on us almost daily for the first couple of months of this thing. And so we've always known we had good people, but they really stood up and showed us how agile, how efficient they could be and how adaptable they are to a changing market. So if you fast forward 5 years down the road, we need to run refining differently than we run it today because the product slate is a little different or our export markets are different or whatever. We're very confident in that we've got the right people in place to figure it out and figure it out pretty quickly.

Mark, do you want to add?

Yes. I echo the same kind of comments that Bob had around the workforce resilience and the way that our workforce grows, the challenges that the pandemic presented. We kind of had the inverse of the -- on the demand side. We ended up running record rates, having record sales, record production because of our ability to adapt our production slate to the products that were needed in a pandemic. The things -- the containers that shifted from more industrial use, delivery of food to more individual use and delivery of food from the containers that -- Clorox for Bleach or other disinfected products that was right in our wheelhouse, and we were able to shift production to meet that demand pretty dramatically. Even things like recreational equipment. No one's going on vacations. Everyone's looking for things to do in their backyard and a lot of those things require some of our higher-end products. So it was our ability and our employees' ability to adapt and be agile, all that. And at the same time, we put some pretty strong requirements in place to focus on reducing costs and generating cash because our owners were in a very different place from a CPChem perspective. They were having operational challenges because of the collapse in demand. And so they were looking for cash to support their needs. And we were just in the early stages of our own processes analogous to AdvantEdge66. And we were looking initially to save around $100 million a year. Our team ended up targeting and hitting over $300 million a year in 2020 savings and the run rate is several hundred million dollars a year in run rate savings. And so they were able to, in spite of all the distractions around the pandemic and the threat of their family members being sick and will the economy collapse, they were able to focus and bring forth a lot of creative ideas and we're driving that on into the digital space as well. So I would say the watchwords there were resiliency and agility, and we're never going to turn back from those.

So the organization performed really well. All 14,300 people at Phillips 66. So we're approaching 50% Millennial/Gen Z, Paul, as a company. You've already pointed out, one of the differentiators for us is our energy research innovation center, and that's truly a hub of innovation for our company. And then we're 4 years into this digital journey, which has made us kind of rethink and reassess the way we operate, the way we work together from the systems we use to the way we make decisions, for instance, general interest decisions around the company where we buy our crude, where we process it, where we sell the products. And so I really think that the people at Phillips 66 today are really well positioned to participate in this energy transition and to do it very, very successfully.

Greg, since you mentioned about the digitalization, can you give us an update where is your program last? I think the year before in 2019 in your Analyst Day, you pop out the AdvantEdge66, where are we in that program? I mean, given the pandemic, are we seeing that being accelerated or that is being delayed?

Yes. I think -- well, so first of all, at the 2019 Analyst Day, we laid out like $1.2 billion of EBITDA that we think $600 million to $700 million fell to the bottom line, essentially, is what we said in 2019. So if you think about the $1.2 billion, about $500 million of that was around general interest. And so that's how we buy the crude to where we process it to how we sell it. And we changed all of our systems around that. We compensate people for a general interest decision versus just Sweeny refinery, let's say. And so that's a mid-cycle number, and we're probably $100 billion to $200 billion into it today. For mid-cycle margins, I think we'd be above $500 million of value. The next biggest bucket of cost was our -- what we call our business operating model. And again, this is how we make decisions, how we do work, a lot of transactional activity has been automated, Paul. A couple of examples here. One is -- so I go back 4 years ago, we had 2 million spreadsheets in the company, and people are downloading data out of the enterprise system, trying to make decisions and people may even show up at the same meeting, downloading the same information that have 2 different answers to the question. And so all that's been eliminated. And no longer our engineers, they're not data miners anymore. They -- we have the tools so we can tackle. They can use Tableau. The data is there for them. And now they can make smarter, better, faster, more agile decisions in the company. The other example is prior to AdvantEdge66, we ran everything on proprietary systems. We ran our own servers, and we had 0 in the cloud. Today, 90% of our enterprise solutions are in the cloud. And we probably cut 1/3 of the people that work in IT, 1/3 of the IT costs by moving to the cloud. And so we're more efficient for lower cost. And so another example of the business operating model. And then we probably saved $100 million or so in purchasing by just leveraging purchasing. With 12 refineries, we might buy 40 different gloves. Today, we probably buy 2 different gloves at all the same refineries. And then there was about $200 million in what we call digital operations and maintenance. And I'd like Bob take just a quick moment and talk about what are the kind of the 3 main points that we're able to do because this is really industry-leading, first-in-kind, best-in-class type of technologies.

Yes. And really -- so our AdvantEdge66 efforts in refining fall into 3 buckets. It kind of fall into equipment performance, human performance and then what I'll call leading-edge optimization. So if I come back to equipment performance, we've been successful in doing things like we've Wi-Fi'ed our first refinery completely. So anywhere in the refinery now has Wi-Fi reception. First refinery that we know of has been able to pull it off. So that allows -- opens the door on low-cost sensors. So pumps and compressors and things that used to get monitored by human maybe once a month or once a quarter, we can now put a continuous sensor on and that is monitored 24 hours a day, gives us a heads up. We've got advanced monitoring in some of our bigger equipment that is showing us incipient failures that are coming that we would have never seen until something broke. Now we know about it weeks in advance. We can plan it. We can take the equipment out of service. We can fix it before it breaks itself. On human performance, we've really gone after making our procedures and processes smart. So one of the biggest things we've been able to accomplish is we have digitized our workflow from the time an operator is doing his round, which he does now on an iPhone. He has all the tools on an iPhone to use to communicate with subject matter experts. So whether that's chat or whether it's text or whether it's making a video of a piece of equipment, attaching it to a work order, which goes to a planner, which goes to the field with an iPad, he never has to go back to the office or to his chair to plan the work, carries right on through our electronic work order. So we never lose the efficiency of what the operator needs done to what the mechanic is going to do. That has yielded huge benefits for us and just tightening up the communications within our operating rigs and the safety of our operating rigs. And that people know they're all on the same page, the tasks we're about to do. We built in automatic risk type tickers and things into the process. And then on the extreme optimization front, one of the things we've done is, so everybody has advance control, which looks at a million different process inputs on a unit, right, and continuously monitors it to make the most economic product slate of the day. We have now taken that to the next step where we've got multi units connected with neural networks. And now I've exceeded what I know to talk about, but really align multiple units to work together to optimize the slate. We've got examples, in Lake Charles refinery, where we have a very complicated naphtha processing system over there with multiple reformers and multiple splitters. For 2 decades, we've been trying to optimize that system. The neural network taught itself how to optimize in about a month and has been optimizing itself for the last year. That one allocation is $10 million a year of more profit on what comes out the back side. So we're deploying those kind of technologies across our system really as fast as we can go.

That's impressive. And Greg, just to that, I mean, I think ever since you've become a public company, you have been always a very unique and also a well-defined cash flow usage system, 60% reinvestment and 40% for distribution. And in the post-pandemic and also in the low-carbon world, do you think that, that distribution take sort of 60%, reinvest 40%, is that still a reasonable proxy going forward or that, that needs to be adjusted also? And also that from a balance sheet standpoint, even though you have had some debt during this downturn, I mean, you still have a good balance sheet. But as I said that, given the new world so to state, given the volatility in the market, do you think that on the longer-term basis that you really want to drive your net debt down significantly?

Yes. So I think that -- first of all, what we think about is a strong balance sheet. For us, that's BBB+ A3. And that's the most important metric in having a strong balance sheet. And we proved to ourselves and we've proved to others the benefits of having a great balance sheet through the COVID crisis. We're able to go add $4 billion of debt. We did it quickly. We had no pushback, and we did a very efficient prices and we're able to structure a lot of that debt where it can be repaid with no penalties. And so I think that demonstrates vividly the importance of having that strong balance sheet, Paul. And so as we emerge from the pandemic, we think the 60-40 still the right number. There's so many times when that changes. We've been 40-60 before, where we only invested 40% and we've returned 60% to our shareholders. We've done 50-50. But over a long period of time, we think 60-40 is still the right number. And indeed, if you look 2012 through kind of into 2020, we're almost right on top of that 60-40 split. And so we think that's the right split going forward. We get to back to mid-cycle cash, $6 billion to $7 billion of cash flow mid-cycle. We have $1 billion sustaining capital. We have $1.6 billion of dividend. And that in a $6 billion to $7 billion cash generation business, we have options about what we do. So we do want to start paying down some debt as we come into mid-cycle cash flow regimes again. Do we have to pay it all down before we get to some other things do? No. But we want to be on a good glide slope. We want to have credibility established that we're going to do what we say in terms of paying down our debt. We want to get back to raising the dividend. We want to get back to buying our shares back. And then at some point in time, there's going to be growth opportunities we're going to want to invest in. I just think the next 1- to 3-year period, growth is going to be constrained and you're going to see constrained capital budgets coming out of Phillips 66. And that gives us the optionality, the flexibility to really address these other issues we talked about, debt repayment, raising the dividend and getting back to share repurchases.

Wonderful. Greg, I mean, marketing is an area that has been a pretty strong contributor to your free cash flow and earning over the last couple of years. And how does that fit into your long-term portfolio under a low-carbon world? And then if at some point that the gasoline demand will come down, I mean how should we look at that business?

Yes. So yes, our Marketing and Specialties business has been a great business. It's pretty -- I mean, it's generated $1.4 billion to $1.6 billion of EBITDA every year and a very, very constant cash generation business. It's low capital intensity business for us. It generates 35% return on capital employed. So it's a strong business for us going forward. I should also point out, they're using AI to predict lifting terminals and what our customers are going to take. They have a mobile pay application that was developed in cooperation with some of our banking partners and other technology partners, but really an industry person in terms of a mobile payout at the filling station, service stations. But when you think about energy transition and what we can do with that network. So here's an example. In Europe, today, we're building hydrogen fueling stations in Switzerland. That's going to move to Germany and Austria. So that's an opportunity to build on that marketing network and provide alternative fuels. I think we're looking at electric charging stations also at those facilities. And so yes, we can take that marketing footprint and lever that into an energy transition and same thing with all the renewable diesel. We want to be in control all the way to the last mile, so that we get all the credit, the LCFS credit. So it's another great example of where that capture is so important in that total equation of creating value.

Well, that's wonderful. Right now is 2:25 in -- New York time. So I wish I have more time because that I can learn from you gentlemen, by that time I can talk for another 2 hours. But with that, I also want to keep you on schedule for your one-on-one. So we will end the session here, and thank you very much for your time and taking time out from your business schedule. We appreciate it. Thank you, Greg, Bob, Mark and Jeff. Have a good day.

Thanks, Paul. Good to see you.

Buh-bye.