Phillips 66 (PSX) Earnings Call Transcript & Summary

Yes.

And so your view is by '24, we can start to get back towards mid-cycle?

I think you would start moving toward mid-cycle. Yes. Correct.

Because we still have to digest some new capacity coming in, including in North America.

Yes. Correct. And I think when we look at CPChem's U.S. Gulf Coast II, potentially RLPP, those coming on in '26 to '27, that turns out to look like a pretty fortuitous time to bring assets on because there's not a lot. You look at everyone pulled back hard through COVID, looking at capital investments. And if you wake up tomorrow and say, "Gee, I want to build a petrochemical complex." It's about a 10-year horizon. And so I think that the things that you would see come on in '26 and '27 have to be pretty well baked at this point in time, and there's not much going on.

Because as we talk to the majors and we'll hear from Aramco and others over the course of this conference, I think a number of them are looking at the demand profile exactly what Jeff said. Gasoline looks tough. It looks pretty good in chemicals. And so there's a tendency to move towards building out -- a desire to build out in areas where growth is more significant. But your point is, it's different to do the work and analysis around project versus getting to FID?

Correct. Correct. It's a long process to develop these, and there's a handful of companies that have the wherewithal to do it. So there's been a fair amount of discipline over the years.

So at your mid-cycle margin, how should we think about the returns on your recent Gulf Coast FID? And why are you excited about that project?

Yes. The Gulf Coast FID, it's going to be mid-teens, and we've always upside to those kinds of projects. There's always debottleneck opportunities. And so I think you -- and that's consistent with what CPChem has done over the last 20 years that we won't. We take a very conservative front view. The capital looks good. It came -- we worked hard to get it to where it is. The construction is going to happen at a good window. There's not a lot of other competing construction projects. We've got line of sight on labor. So we're comfortable with that. And inflationary pressures, I think, have been taken into account in that number, and we see those starting to ease by the time we really hit the heavy construction. So we're feeling pretty good about it.

If I can just add a little bit on the returns. So those -- that mid-teens is a project-level return, and that project is being financed at a sort of 50-50 level. So one, in terms of the effective returns to CPChem and to us is greater than that because of the benefit of the leverage but that also plays out in terms of the capital funding commitments to it. So you've got a 51%, 49% joint venture and then 50% financing. And so when you do the math and you then figure that's a spend profile over about a 4-year period. The capital commitments to CPChem really are very manageable. And in fact, less than -- quite a bit less than the original Gulf Coast project, which did not have financing and was 100% CPChem level.

Yes. CPChem will also be the marketer for the offtake. And so there'll be an uplift for them -- there as well. And they're also -- because it is located and will tap into existing CPChem infrastructure that they'll see additional return benefit there. It will be incremental above what the project was [indiscernible].

Okay. That is helpful. So then the question is the composition of the business. It's really been balanced across these 4 different pillars. If you look at some of parts equal weighted marketing, chemicals, refining, and midstream. Is there a conscious effort and decision here to say, all right, refining because we're worried about this on a long-dated basis? We're going to start investing a little bit more in chemicals and so one was going to make up for the other?

Yes. I think that it really is all about what you believe about growth and how you can position yourself to take advantage of growth and secure those returns that our investors expect, and that will drive it. And so we see the growth in NGL. We see the growth in chemicals. We see modest opportunities. And I like what John said about bullets versus cannons in renewables because that's exactly what our strategy has been. We've put our toe in the water of several places. Renewable diesel is a lot closer to home. We've got assets that are very amenable to that. So that's been a bigger step for us, but the other renewables are longer term. We're not -- we're continuing to press down that path, but we're going to be cautious on some of the more long-term, more exotic opportunities. And so you're going to see that balance. Some of those things may show up in refining like Rodeo or if we do anything in sustainable aviation fuel, but you're going to see chemicals, obviously, attracting more capital, NGL attracting more capital. Marketing has been low capital, high return and we continue to look. We've got a very specific strategy, targeted strategy there that we like that's been successful across COVID, across a number of different market conditions. And so we're going to continue to make modest investments there as well.

Yes. Let's talk about marketing. That has been a consistent surprise relative to our model, and you did raise your mid-cycle view of that business. What's going on to drive higher cents per gallon effectively?

Yes. The higher cents per gallon because we're getting more exposure in targeted markets to retail margin, and we're focused on markets where is a retail margin to capture. And we've partnered with entities that know more about running the convenience store part of it than we do. And we bring strength to complement that. And so you've got an evolution going on in the marketing where we used to supply gasoline, diesel to literally moms and pops that were out there running these stores. And they've grown to these [Technical Difficulty]-- 50, 60, 100 stations, but maybe the third generation is not interested in it. So we know the business really well. We know the assets. We know the environment really well. And so we're partnering with those that know how to run convenience stores, but we can then participate in the [Technical Difficulty]. And we do it in a very [Technical Difficulty] -- in that. We've got -- we know what we're looking for in specific markets to take advantage of that.

What are you seeing in terms of real-time demand through your marketing system?

So we're seeing gasoline demand down about 5% relative to 2019 levels and diesel down about 4% recently. So we've seen demand softened a little bit. Relative to last summer, we were approaching 2019 levels.

Yes. And those are -- that's published government numbers across the industry, not us specifically.

And as you've done the analysis and you kind of tried to ascertain why we're trending lower than pre-COVID levels despite the economy being bigger than where we were back then, is it the remnants of COVID? Is it work from home dynamics? Is it the consumer wallet being impacted by inflationary forces? How do you think about that?

Yes. There's some of all of that. I think we've seen it hit on the East Coast and the West Coast more significantly than the central part of the country. We've not seen commuters go back to that 33% that was pre-pandemic component of overall U.S. gasoline demand. There's been more in the press about Gavin Newsom, trying to take ICE vehicles out by 2035, the concern over inventories on the East Coast, it's been in the news a lot more. And we know that when it's in the news, it tends to impact consumer behavior, where it's been not as much in the news in the Central Corridor and the Gulf Coast. So it hadn't had as big an impact. So I think all those are variables.

Yes. And I think that you still -- the airlines were perhaps hit hardest during COVID, their demand destruction and the industry was able to ratchet back and make jet fuel go away in different ways. But I think the rapid recovery in travel, I think the airline industry has struggled to keep up with that. And I think it's still limiting the growth in jet demand is just the capacity of the airline industry to keep planes moving to keep everybody happy. It looked like it's getting better and then maybe 2 steps forward, 1 step back.

Jet's actually the tightest market today. Jet cracks are the highest in diesel and gasoline is lagging.

Now that's been interesting to see the difference between the distillate complex and the gasoline complex. Gasoline is basically at the 5-year this time of year, diesel in jet trading is very strong. You have a [ nifty ] heavy refining kit. Are you running max diesel right now? And how do you think about that spread between these 2 products? Especially in an environment where European gas is still elevated, but it's not $12 a barrel elevated. It's $6 a barrel elevated.

Right. Right. I think -- hit me with the first question again.

How do you think about the spread between...

Yes. So diesel we maxed diesel all year last year. I think the industry did as well. There was incentive [Technical Difficulty] which historically, we max gasoline yield in the summer months. But even -- so we ran hard through the summer. There was a heavy turnaround season in late September, October. And then the industry ran hard November and December. We looked up early December, the industry was running 95% utilization. Typically, in December, we're running 88%, 89% utilization. And so gasoline inventories recovered somewhat but they're still 7% below the 5-year average, and we see heavy maintenance this spring and go -- likely to go in with pretty tight inventory situation into the summer driving season. Again, even -- so we're expecting to max diesel throughout the year.

Okay. That makes a ton of sense. So let's spend some time on low carbon and we'll finish off on the fun stuff, how we think about your mid-cycle cash flow because I think that's going to be really important for investors to think about how to value your businesses. What is the low-carbon strategy? And help us -- I think it was at this conference, Jeff, right, 3 years ago that you guys announced that you were starting to develop -- 2 years ago, you're starting to develop a low-carbon -- that low carbon platform. What is -- what's your EBITDA expectation from that business and target? And how should we think about your strategy there?

Yes. We've talked about a $2 billion EBITDA by the end of the decade. I think that we're not going to move heaven and earth to realize that. We really are focused on how do we get the kinds of returns that we expect that our shareholders expect from emerging energy opportunities, from energy transition opportunities. And that landscape is evolving. And so really, from a lower carbon perspective, it starts with our existing hydrocarbon business. How do we lower the hydrocarbon - or the carbon footprint of our hydrocarbon business? So we've got goals in mind there. We've published our Scope 1, Scope 2, Scope 3 emission targets there. But then our next nearest neighbor to that is our aspirations around renewable fuels and primarily the first move is renewable diesel, taking used cooking oil, vegetable oils, animal fats, converting those to renewable diesel. We've got an asset in California that's being converted today, our Rodeo facility. It's got hydrotreating capacity that's perfect. It's almost as if it was just put there for this purpose. We can put new catalysts in there, put a front end on that to clean up all these different cats and dogs that we'll bring in to process there. It's in a great market, great logistics location. We've got access to feedstocks. And there's a unit running today, unit 250 that is proving the concept. So we've got great company there. It's going to be a high-return project. The next nearest neighbor to that is sustainable aviation fuel. There's strong market demand for sustainable aviation fuel. Every airline has made net zero commitments and really the only opportunity for them out there today would be sustainable aviation fuel, and there's not enough go around. And so there's a market pull, there's government support. So that's starting to look interesting as well. I think the key there is to not compete for the same feedstocks that renewable diesel consumes into sustainable aviation fuel. We do produce a small amount of sustainable aviation fuel, co-processed in Rodeo. We do produce a small amount in our Humber facility in the U.K., but longer term, I think it's going to be on purpose production of sustainable aviation fuel. Then you start looking at things like hydrogen and carbon capture. I personally believe that carbon capture is going to be very important because it's going to be hard to get away from the high energy density of liquid hydrocarbons for a very long period of time. And the only way to mitigate that carbon that the Scope 3 emission is carbon capture. So we believe that carbon capture is going to be important. We're not doing fundamental research in carbon capture, but we believe that the technologies are out there and they are going to become very important and necessary. Hydrogen, we know a lot about hydrogen. We know a lot about the cost of hydrogen, how hydro is produced. And I think hydrogen is over the horizon a bit. From a cost perspective, moving to an entire hydrogen economy is -- I think it's going to require nuclear fusion or something like that long before that happens. But we are shooting bullets in that direction. No cannon balls yet, but we're tracking that. We've got technologies that we're looking at around hydrogen. And we've got our battery opportunities. We could believe both EV batteries, lithium ion batteries for EVs as well as storage batteries to facilitate the use of wind and solar power are important. We aren't investing in wind. We're not investing in solar, but we certainly are looking at helping others invest in wind and solar around our facilities, so we can again lower our carbon footprint of what we do today.

Yes. I'm not even -- I'm not sure if I'm even allowed to ask you about needle coke given all the sensitivities and how much of the market you're involved in. But just talk about the contribution from that business. It does seem to us that pricing has firmed up a little bit there.

Yes, pricing has firmed up. And I think that you look at the scarcity of materials to meet the world's aspiration around lithium ion batteries, one of those that are challenged, most is graphite, synthetic graphite. And our needle coke goes into synthetic graphite production, it's a very good precursor to synthetic graphite. So we're -- that's why we are looking at that value chain to find out where is -- where can we capture the most value. Is it at the needle coke? Is it synthetic graphite? Is it somewhere further down the battery value chain? But again, we're walking before we run. We've made our investment in NOVONIX. We're learning a lot about that business today. There's going to be ecosystems built up around lithium-ion batteries in North America and in the -- in Europe, and we're well positioned from Lake Charles and from Humber in the U.K. to supply those ecosystems or participate in them if it looks like the right thing for us to do.

Yes. From a demand perspective, we're optimistic as well. Obviously, electric vehicle market is growing, and we serve that. But also the steel manufacturing, electric arc furnace has a smaller carbon footprint than traditional steel manufacturing, and we are seeing the addition of new electric arc furnaces into the market. So both aspects of demand look positive.

Great. We only have a couple more minutes. I want to make sure people get food before -- for lunch as well. But I thought Kevin, I'll finish with you on just the numbers, right? You always do a good job of helping bridge from mid-cycle cash flow to thinking about how you're going to use the cash. So walk us through the numbers.

Yes. So what we laid out at Investor Day, mid-cycle cash flow on a 2022 basis of $7 billion. Obviously, 2022 actual cash generation significantly stronger than that. But on a mid-cycle basis, $7 billion, growing to $10 billion by 2025. So that's $3 billion increment. And it comes from a combination of the midstream growth that is driven primarily by the acquisition and integration of DCP. There are some other components to the midstream growth but that's a large piece of the $3 billion in cash flow growth. We also see Rodeo renewed coming online in 2024 and that's another approximately $700 million of EBITDA, which is going to translate into about the same from a cash standpoint. And then the third major element to that is the business transformation efforts. And so the business transformation, by that point in time, it's a $1 billion run rate, of which there's a couple of hundred million of sustaining capital, $800 million on the cost side of it. And so when you put all that together, you're at this approximate $3 billion growth in cash generation. But I think what's really important when you measure that against our commitment to returning cash to shareholders, we actually can deliver on that commitment based on the 2022 mid-cycle. So that $7 billion, the dividend is just under $2 billion, and we're committed to competitive, secure and growing. So you can continue to expect to see an increase in the dividend on an annual basis. And effectively, that will get funded -- that increase will be offset by the impact of share repurchases. So $2 billion on the dividend, the capital program at a $2 billion level, approximately $1 billion of sustaining and $1 billion of growth. You saw the capital budget that we laid out for this year, very consistent with what we said on that. And so that's $4 billion that's consumed. That leaves $3 billion for share repurchases, any incremental work you want to do around the balance sheet. But it gives us a lot of flexibility, especially when you consider that we're actually in an above mid-cycle environment. We were significantly above mid-cycle last year. We will go into 2023 with a strong cash position. And yes, we got the DCP buy-in to fund. But the DCP buy-in also funds a sizable component of that cash generation growth. And so that will start accruing to us pretty soon once we're able to get that transaction completed and announced. And just one other comment from a balance sheet standpoint. We did -- you may have noticed in December, we paid off $0.5 billion of debt at the Phillips 66 level. That was debt that was maturing anyway early this year. At the DCP level, we also redeemed $500 million of preferred equity. That became callable in December. At that point, it also went from a fixed coupon structure to a variable rate structure, which would put it at about a 10% cost of funding. So that was a very straightforward financial transaction. It also goes to continue to help clean up the balance sheet. So I think we can do all of that and stay within our stated objectives of a 25% to 30% net debt to capital level, which we feel very comfortable given that, that will include the -- and we already have consolidated the DCP debt and the funding associated with that.

And Neil, just to put that in perspective, $10 billion to $12 billion for a company with a $45 billion to $50 billion [Technical Difficulty] returning 20% to 24% to shareholders over 2.5 years, 10 quarters.

Yes.

That's great. Well, thank you. The story is very, very clear post the Investor Day, well done. I wish you guys a wonderful '23, and thank you for coming to Miami.

Thanks for having us, Neil.

We got food outside, and then we've got Cheniere coming up on the stage. Thank you so much, everyone.