Phillips 66 (NYSE:PSX)
Bank of America Merrill Lynch 2014 Refining Conference Call
March 06, 2014, 10:40 AM ET
Clayton Reasor - Senior Vice President Investor Relations, Strategy and Corporate Affairs
Greg Maxwell - Chief Financial Officer
Doug Leggate - Bank of America Merrill Lynch
Doug Leggate - Bank of America Merrill Lynch
Again, we're webcasting, so if you want to stay on the call, and I'm delighted to introduce our next speaker, Clayton Reasor, who is Senior Vice President of Investor Relations, Strategic and Corporate Affairs. But I would alert you to the fact that we also have Greg Maxwell here, CFO of the company. I hope he'll be available for Q&A. Clayton?
Thank you, Doug. Good morning, everybody. Pleasure to be here. Thanks to you Doug and Bank of America for this conference. And the people in the room and on the webcast, we appreciate your interest in the company.
So the obligatory Safe Harbor statement. We'll be making comment today, which may differ materially from what the actual events are. The risks are found here on this page as well as on our SEC fillings.
So we've been fairly consistent with our approach on strategy, I think this is what we put out there a couple of years ago, it's still the same group of five elements. Obviously, it begins with operating excellence. We understand the importance of taking care of our people, of our assets, the communities we operate in and the environment, and we'll always talk about operating excellence as a key strategy of the company.
We also had laid out a couple of years ago, the importance of profitable growth, so this is directed toward our midstream business and chemicals. And we've talked about, when it comes to refining, it's about improving returns. So we believe refining, a mature business, has had a good run here for the last few years. We'll continue to, but we don't plan on increasing capacity on refining rather the focused area is improving capital efficiency.
And we also understand the importance of distribution. So you should expect us to continue to increase our dividends annually as well as have a significant portion of our cash flows directed toward share repurchase. This is all underpinned by having a high performing organization.
So during 2012 and 2013, we generated significant cash flows. It allowed us to fund our midstream and capital growth, while increasing distributions. We've almost doubled our dividends. We've bought back close to $3 billion of stock to improve the exchange done recently on our flow improvers business, so about 10% of the company has been repurchased since May of 2012.
And we've paid down debt on our balance sheet. Debt to cap ratio is down in the little 20s. We paid down $2 billion of debt, reducing debt from about $8 billion to $6 billion. And in July of 2013, we launched our MLP, Phillips 66 Partners, which we'll use to help grow our midstream business.
As I mentioned, we have a history of operating excellence at Phillips 66 and we provide foundation that enable us to create sustainable value over time. And in 2013, Phillips 66 DCP Midstream and CPChem were again among the very best in their respective industries.
Environment stewardship perceives high level of attention and you can see the emissions reductions we've achieved over the past decade. These are just two indicators, but are representative of the broad set of metrics we use to measure our safety and environmental performance.
So when you think about Phillips, it's really four different businesses that are tied together. We have a leading midstream business, our global chemicals business and then diversified marketing and refining business. We think that this set of assets makes us uniquely position to capture opportunities created by the significant increase in North America oil and gas and NGL production.
The portfolio allows us to identify and evaluate investment opportunities and allocate capital quickly to areas with greatest potential for growth and returns. And this size and scale of our financial flexibility allows us to sustain this high growth rate, given a cyclicality of the business.
So the top part of the chart really are our growth businesses. To us, the midstream really consist of three difference elements. One is our transportation business. So when we talk about transportation that's refining logistics with moving crude oil and refined products around our existing refining business.
There is the Phillips 66 Partners, which is an MLP, which will help fund both our transportation and our NGL operations business. And then we also own 50% in DCP with Spectra, which is the leading NGL and gas processing business.
Our chemicals business is a leading olefins and polyolefins business. We have a large ethylene and polyethylene business that's primarily in North America, but also in the Middle East. Talk a little bit more about that later. But we also have aromatic's and styrenic's business, which is fairly competitive.
In the bottom part of the chart, talks about our plans in refining and marketing. You can see in refining, we are not focused on growing capacity, rather it's improving ROCE through the cycle and we continue to find new opportunities for advantaged crudes within our system, we'll talk a bit about that later, to increase exports and improve clean product yield.
Our marketing and specialties segment is really closely focused with our refining business. Our U.S. fuels business is designed to provide ratable and secure off-take. We have a wholesale of branded business rather than owning real estate. And we also have significant retail business in Germany and Austria and Switzerland, and we'll growth that in markets under the Jet brand in Europe.
So each of these segments has a leading return on capital employed. This is through the third quarter of 2013. Hopefully, we'll update that shortly and we'll have that available for the analyst meeting in April. But ROCE is a key metric that we pay attention to. So it's not just about growing midstream and chemicals, it's also about investing in them wisely.
I wanted to take a couple of minutes to talk about the macro environment that we see that really provides the baseline for investment in these businesses. I'll start with our view on NGL production, since it's important to how we invest in our midstream business. What we see, growing domestic natural gas liquid production is really reshaping the way, not only we, but the industry thinks. We go from an attitude of constraint to an attitude of abundance in the U.S.
There is a wide range of industry consultant forecast here, but all of them see significant growth in NGL between now and 2020. So this growth in NGL has really created the need for new infrastructure to move this production to market centers, and we expect somewhere between $100 billion to $150 billion of new investment to gather process and transport this new production of NGL.
On the chemicals side, the chart on the left really shows the growing supply of ethane in the U.S., in the bar, and we would expect some of that growth and supply will be offset by demand from new petchem facilities built. By the end of the decade, we see an additional 600,000 to 1 million barrels a day of additional ethane supply to the U.S. And U.S. ethylene producers will be at a competitive advantage to the most of the world's ethylene producing regions.
Ethylene production cost curve is on the right, and it compares the cost, and you can see clearly that Middle East and North America ethane production or ethylene production is at a clear advantage to naphtha producers in other parts of the world. So fundamentally, we believe that the olefins, ethylene, polyethylene business will be an attractive business for us and we've announced a significant project on the Gulf Coast that I'll touch on a little bit later.
Moving on to refining. These chart show the recent history of crude differentials, which impact our refining earnings and cash flow. These differentials in the refining environment have been and always will be volatile. I don't know why LLS is trading at the parity to Brent, so I'll just answer that question right now.
It's difficult to predict where crude differentials are going to be from day-to-day or even quarterly, but if we look back over a longer period of time and the changing dynamics of crude supply, we expect the next five years of crude differentials to be at a greater discount and margins to be better than they have been over the past five years.
This graph shows the displacement of crudes over the past three years, and as you can see, most of the crude imports that have been displaced have been light and medium crudes, that's shown in the red. And we would expect this to continue as U.S. production of light sweet crudes grows in the range of 600,000 to 800,000 barrels a day per year over the next two to three years.
So now getting into our specific businesses, I'll start with the midstream. And what we plan to do here is build on existing assets and facilities that tie together our existing operating businesses. So to the extent that we have refining or chemicals or existing gathering and processing facilities, we look at bolting on to those rather than going into new regions.
We'll grow our integrated transportation system and primarily tie it to our refining business, but there will also be some third-party emerging opportunities. The refining logistics business is around rail unloading, storage, refined product export facilities and then we'll use our MLP to fund both the investments in our refining logistics business and our NGL operations. And recently we've announced FID on intent to grow an NGL fractionation business and an LPG export facility around our Sweeny refinery.
In transportation or our marketing logistics business, we have several initiatives underway. We've recently received all of the 2,000 railcars that we had ordered in 2012. We had two Jones Act ships. We're repurposing existing pipelines for movement of crude and refined products, and we're using our existing system to bring liquids to market.
And the idea here in the transportation side is, not only is there value in the transportation EBITDA that we're growing, but also in the fact that we're supporting our refining system, because it's able to access advantaged crudes or increase our exports.
Also, we've announced two rail unloading facilities, one at Bayway, in Linden, New Jersey, another one in Ferndale, both will be operational this year. And we have a rail facility outside of our Rodeo refinery in California that we're in the permitting stage. It will continue to be something that we emphasize.
As I mentioned, we launched our MLP Phillips 66 Partners. It trades on the New York Stock Exchange under PSXP. It will own, develop, acquire, fee-based transportation assets. I would expect there to be both refining logistics assets in this MLP along with NGL type assets, fractionators, export facilities, so forth, but it will be fee-based.
As far as dropdowns, we had our first acquisition two weeks ago. I guess it was $700 million of the Gold Line System that runs from Borger to Wood River, and in several product terminals along that line. So we expect not only to benefit from the accretion that comes from moving EBITDA from the C-Corp to the MLP, but also the fact that this allows us to access relatively low cost of capital to fund continued growth both in the transportation and the NGL business.
We have 50% ownership of DCP along with Spectra. It does a terrific job around gathering and processing in an NGL pipelines, and this has been a real growth area over the last couple of years. And I would say, our established gathering and processing assets in this key shale oil producing areas as well as laying down pipeline to get new NGLs to market are really the backbone of that business.
We've got $2 billion to $4 billion of capital projects underway over the next couple of years and DCP will use its MLP, DCP Partners or DPM as its primary funding source of capital. So we would expect DCP to be self-funding over time.
Our own NGL business is probably the area where we see most significant growth in capital and EBITDA. The Sand Hills and Southern Hills pipelines have started out beginning to generate EBITDA. We're also evaluating butane and butylene storage hub in the Sweeny area and connecting that to Freeport. We announced FID on a 100,000 barrel a day fractionator at Sweeny to startup next year. And then our export facility would probably -- 150,000 barrels a day export facility would startup about a year later.
So we've got project approvals. We're moving forward and we would expect to see EBITDA next year coming from our new fractionator at Sweeny. So all in capital spend for this Sweeny hub is going to be around $3 billion, because I mentioned we announced FID in February of this year.
So kind of wrapping up the Midstream. Highest growth area will start to see EBITDA coming out of it next year. There is more to come. Our CEO had talked about the possibility of additional fractionators at another energy conference couple of weeks ago. So whether it's another two to three fractionators or condensate splitters, those are all things that we're working on and we look forward to talking to you more about on April 10.
The graph on the right, you can see our history, what our history of capital has been. And the bar chart on the left shows you the projects that will be coming on over the next several years.
Slide 17, starts the discussion around chemicals. So our chemicals, it's done through a joint venture with Chevron, CPChem. We believe it's recognized as one of the leading global petrochemical company. It has global market positions in polyolefins, aromatics and other specialties and it continues to execute its growth plans to capture advantaged feedstocks.
Growth plans are organic in nature using proprietary technology and ethylene and polyethylene conversion. Over the last 10 years, CPChem has built five mega projects in the Middle East, two in Qatar and three in Saudi Arabia. And the next wave of building for CPChem is really directed towards the U.S. Gulf Coast, given the shale oil and gas opportunities, advantaged NGLs, low energy cost and extensive existing logistics.
There is a good view of CPChem's feedstock advantage relative to some of the other peers in this space. You can see our portfolio is really concentrated in the U.S. and Middle East without any naphtha cracking capacity in Europe or Asia. And so the Middle East investments really improve CPChem's competitive position, early on the decade, but the difficulty in getting gas right now in the Middle East has forced us to look at other region.
U.S. Gulf Coast is the next best place to have a petchem. And as we show here on the next page, we have several projects that are happening at CPChem with 1-Hexene Unit that's starting up this year. We've added furnaces to our ethylene conversion or ethylene facilities at Sweeny. Normal alpha olefins expansion is happening as we speak and then our large project is the U.S. Gulf Coast chemicals project, which is about a $6 billion investment gross.
All of these projects are going to add about 25% capacity to CPChem over the next four years. We'll spend somewhere between $6.5 billion to $7 billion as the CPChem level, all of which will be funded out of CPChem. And here you see the projects lay down on the calendar as well as our total capital here. Obviously, this is our 50% interest capital requirement at CPChem.
Moving to refining. As I mentioned earlier, in the refining business, it's really the concentration on enhancing returns and improving capital efficiency. Over time, we talk about an improvement of 4 percentage point in ROCE, so historically ROCE, for the past five years our refining business is somewhere around 11%.
We'd like to move that to mid-teens and they're really around five area. So the first is process more advantaged crudes. We're up in the low 90s right now, we'd like to take that to a 100%. We'll increase our export capacity. Really need to have export ability out of the U.S., given the fact that demand in the U.S. is probably flat and we need to access markets that are growing.
We'll always work on our operating cost. And then we have a couple of refineries within the portfolio that does generate competitive returns and we need to take steps to, to either get those out of the portfolio or to make improvements in their returns.
This is our portfolio. 15 refineries globally, 11 of them in the U.S., 2.2 million barrels a day, 55% of our refining capacity is in the Mid-Con and Gulf Coast, which are really the refineries that are ideally located to capture the advantaged of shale groups.
We are integrating our transportation infrastructure to bring crudes to our facilities, doing a lot of work around the East in Bayway and also in West Coast of California. The system, as you can see is 65% light and medium and about 50%-50% between sweet and sour. So really don't see a need to invest in additional light, sweet crude refining capacity.
Doug mentioned earlier about the fact that we ran 74% advantaged crudes in 2013, up from 62% in 2012. That number was in the low-90s in the fourth quarter.
Our goal is to run 100% advantaged crudes, advantage to us it's trading at a significant discount to Brent. So we believe all these system that we have that provides us with optionality. So as spreads open and close, we're able to move crude from one region into another. We typically buy substantially more crude than we process, so that we're always in the market either buying or selling crude and that gives us optionality to take advantage of arbitrage situations.
As far as exports is concerned, we have seven coastal refineries, so three in the Gulf Coast, three on the West Coast, one on East Coast. In December, we exported about 250,000 barrels a day, two-thirds of which was diesel, and about a third was gasoline. We'll continue to invest to increase our export capability. This allows us to capture higher margins and also maintain a high utilization rates at our refinery. And looking to the future, we expect our exports will continue to grow.
The current growth in developing export market will offset U.S. gasoline demand decline. And many of our products today are going into Latin America, South America, with some going into West Africa or Europe. We expect U.S. refineries to continue to be highly competitive to the feedstock advantages and lower natural gas prices.
2014 CapEx for refining is about $1 billion, $700 million of that is maintenance capital, which would include the capital required for Tier 3 gasoline. Total capital program, including WRB, which is our 50-50 joint venture with Chevron around the Wood River and Borger refineries at $1.1 billion.
Our discretionary capital within refining is really limited to high return, fast payout projects and the growth projects in refining, we need to have a much higher return threshold given our opportunities to invest in the midstream space, which attracts a higher EBITDA multiple than what you would see in refining. So since 2010, CapEx spend has declined at about 9%.
I wanted to talk about our fourth segment, which is marketing and specialties. The largest piece is our U.S. wholesale fuels business. We have about 7,000 sites, Brent sites, designed to provide low-cost, secure refinery pull-through. And most of these refinery units are relatively close to our existing refining system. Our specialties business includes lubricants. It did include flow improvers, but that was recently exchanged. And there's also a specialty coke business.
Capital spending is modest, somewhere around to $100 million to $150 million a year. So a very stable earnings business, high returns. We'd like to be able to grow, but there are just limited opportunities to grow on all that kind of scale that the other opportunities provide.
Financially, you can see the volatility in earnings over the last five years. We take a very disciplined approach to capital allocation, so when we think about how much do we invent in the business versus how much do we distribute to shareholders, it's important that we keep the fact that we see this type of volatility and EBITDA in mind.
We remain committed to increasing our regular dividend annually. We plan to look back 10 years from now and have 10 increases in dividend. We supplement that dividend payment with share repurchases, as long as we trade at a significant discount to the intrinsic value.
We're committed to spending the required funds to keep our asset integrity in place and consistent with what we believe around operating excellence, and we'll also invest growth capital to build capacity in our higher-valued midstream and chemicals businesses.
So the chart shows the volatility of EBITDA, especially in refining and that's why it's important to have a very strong balance sheet that allows the financial flexibility and earnings diversity that's required in order to invest through the cycle and increase dividends annually.
Our capital structure has improved over this period. We paid down $2 billion of debt. Our debt-to-cap ratio is down in the lower end of the range that we wouldn't expect to pay down debt any further than we currently have. At this point, we have a debt on DCP, but a very little debt at CPChem, if any.
If you roll up our 2014 capital program, looking at not only the capital that we consolidated on our own Phillips 66 financials, but also the proportionate amount of capital that we're spending in the other areas, you'll see that on this chart, our total capital spending including this proportional JV spend is about $4.6 billion in 2014.
This was made up of $2.7 billion of consolidated capital spending for Phillips 66 and $1.9 billion of spending at the JV level. We would expect our CPChem, DCP and WRB joint ventures to sufficiently fund or to generate sufficient EBITDA to fund the capital programs.
As I mentioned shareholder distributions and growth in those distributions is very important to us. We believe it's a significant contributor to total shareholder return and we believe these dividends not only have to be secure, but they need to be competitive. So when you look at our dividends, you don't have to worry that there is a sufficient cash flow from operations to be able to fund it.
In 2013, our dividends represented somewhere between 15% and 20% payout ratio. So there is room to grow that. Since May of 2012, we've nearly doubled our dividend. In addition, our board has authorized $5 billion of share repurchase.
We've repurchased $44 million. So since then we've purchased about 44 million shares outstanding and as a result to the spend or as the exchange of specialty improvers business for free stock, we've bought about what we've exchanged about -- we received about 10%, brought back in about 10% of the company.
So this is our final slide. We really do believe that we're uniquely positioned, given the ability to fund midstream more quickly as a result of the cash flow that we generate in refining. All of our businesses are well-positioned. We're competitive. We've got opportunities to grow. We've got tremendous financial flexibility. And if some of our peers don't, we have a very strong balance sheet as well as a very durable earning stream.
We think our strategy make sense. We've taken steps to shift our portfolio into higher valued businesses. And with our experience in the cyclical businesses, we think we have competitive advantage to grow in the future. We've said, we'll have in April 10, analyst meeting, and we hope we see all of you there.
So with that Doug, I'll turn it over for questions.
Doug Leggate - Bank of America Merrill Lynch
Thank you, Clayton. Maybe you can get a chance to take a drink and thanks for battling through that, I really appreciate it. And thanks for being here. Again we should have a microphone, for anyone that's got any questions from the floor.
But, Clayton, maybe I'm going to be ourselves up a little bit here. And with my first question in that, you've obviously got a slightly or significantly more complex or diverse business relative to your peer group, the one which obviously has a lot of embedded value, if you look at the some of the parts. Market doesn't seem to want to recognize that. What do you think management can do? What do you think Phillips needs to do to get about some of the parts gap closed relative to share price?
So I think we've tried to increase the amount of disclosures we've been providing. We are complex and that we have two significant JVs, where we have ownership of two different MLPs, and we've got JVs inside of our JVs. So it's a complex structure. There are probably discounts being applied to the EBITDA that comes out of the JVs that we expect to be greater than those were if the income was consolidated.
I think there is also a perception that the growth is long dated and coming later. And we would point to some of the things that we're doing in the NGL operations business and the fact that our MLP will grow perhaps more quickly than some of our peers. And those will be sources of growth that maybe are recognized.
The other thing is relatively new. We haven't been around that long. It's not a long history of how we behave over a period of time. So there is some uncertainty there as well. I think that over time as we continue to provide clear financials and provide supplemental information on our quarterly earnings, that should reduced the complexity discount that we're seeing today.
Doug Leggate - Bank of America Merrill Lynch
Thank you. Again any questions from the floor?
I was wondering if you could talk a little bit more about Jones Act and how you're thinking about Jones Act owning vessels versus chartering vessels in and obviously there is a shortage of Jones Act vessels, is that a risk going forward? How you thinking about that?
I think when we look at Jones Act ship for rail cars or other forms of transportation, first of all it's thinking about our own system and what our own system would require. So we think about the amount of crude that we could run at Bayway out of the Gulf Coast, right. So right now there is probably a 100,000 barrels a day or so, if we had access to Jones Act ships, we may move Gulf Coast barrels into the East Coast. So our first thought is around how do we improve the amount or increase the amount of advantaged crudes that we're running within our own system.
To your first question, we charter ships. We don't own the Jones Act ship. You could say, if you own them then you had the ability to drop them into an MLP. If there were changes in laws, the value of those investments could deteriorate. So I think our approach towards Jones Act over time would be more of a charter or lease versus buy and it would be directed at our own facilities. So we have two 300,000 barrel ships today and we're adding another vessel in 2015.
Right, so the question was on Tier 3 gasoline spend and when it was growing, how much and how long?
We expect Tier 3 gasoline capital to be somewhere between $700 million and $800 million within our system in the U.S. Of the 11 refiners that we have, nine will need to make investments in. So the $700 million to $800 million is included in our $700 million maintenance capital annually. And we would expect those investment will be made over the next three years.
Clayton as a follow-on, does that mean your maintenance spend, it's actually simple math, $750 million over three years and $750 Tier 3, does that mean your actual maintenance spend beyond three years is more like $500 million?
Assuming there is no more regulatory requirement, that's correct. And when we talk about maintenance capital, we include regulatory compliance capital in that amount. Thank you.
Just a quick question on condensate, I know the company has interest in some condensate exporters, is it a product you expect to be able to export at some point versus a regular crude oil over the next several years? Do you think it will be treated different?
It's something we're studying. We're making sure that we do have the ability to export the outputs in condensate. The light end of condensate is going to be LPG. So whether that's propane, butane, pentane, we would expect to be able to export those products. The heavier end of the condensate would be the question. But then you have the option to run that through our refinery, if you had co-located the splitter next to an existing facility, but the intent would be to export the lighter end from the condensate.
Doug Leggate - Bank of America Merrill Lynch
Any other questions from the floor?
Clayton, if I may, the obligatory California question. I know you wrestle with it internally, but what is a way just thinking about how you address your California portfolio?
So we've got two very good refineries on the West Coast, one in San Francisco, one in LA, about 230,000 barrels a day of total capacity, 110,000 barrels a day of coking capacity. They are positive cash flow. They are positive net income. Capital requirements aren't that significant. So those refineries are well-positioned, but they're generating single-digit returns and struggle in as far as attracting capital.
We've talked about how do we improve performance in California, and for us it's around increasing the amount of advantaged crude. So how do we find ways of getting Canadian crude in California, we're in a comment period right now at Santa Maria, of 30,000 or 35,000 barrel a day unit train rail unloading facility, and hopefully that will be permitted.
We are also looking at other things in California to improve the performances for those businesses. But for us, we believe, California, will struggle being competitive in the export market, given the cost there and the lack of advantaged crudes. And longer-term, we look at California, and wonder if it's something that we need to continue to own in order to grow our chemicals and midstream business.
Doug Leggate - Bank of America Merrill Lynch
Thank you. Any final questions? Clayton and folks, thanks very much.
Thank you very much.
Doug Leggate - Bank of America Merrill Lynch
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