Phillips 66's Role in Providing Reliable Energy and Growing to Meet Industry Needs

Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Jason Gabelman:
This is Jason Gabelman, energy equity research analyst at TD Cowen covering integrated oils, US refiners, and US midstream, coming to you live from TD Cowen's third annual energy conference in Austin. Pleased to be joined by Kevin Mitchell, CFO of Philips 66, to discuss what Philips' role is in the global energy landscape. Kevin, thanks for joining us.
Kevin Mitchell:
Yep. Thank you, Jason. Great to see you. Great to be here.
Jason Gabelman:
So to start, what do you think is the most misunderstood or underappreciated part about the current energy complex?
Kevin Mitchell:
I think when you look at the global dynamics of what's going on in the energy markets, it's quite remarkable to see how resilient and dependable the US energy system is proving to be. And you see that across so many of the interrelated value chains across energy, whether it's natural gas production, crude oil production, the refining system, and all of the infrastructure that connects all of those assets to where, despite all of the turmoil that's going on globally in energy, we are producing as much as a country, we're producing as much oil as we ever have done. Same with natural gas. The refining system is running full. We're able to supply the US economy with all of the fuels that it needs.
And at the same time, we can also be a provider of energy products to the world in the form of certain products and chemicals, petrochemicals as well as part of that extended value chain. And that's something that is probably underappreciated, the extensiveness of that infrastructure and the resilience of that infrastructure that really comes to bear and proves to have extensive value in a situation like this.
Jason Gabelman:
Yeah, no, we take for granted that when we go up to the gas station every day, the gasoline's going to be there. We don't really have to think about it. It's a great point and Philips has played a big role in that. Your availability at your refineries, your utilization has improved the past few years. So really supporting the overall viewpoint that you just laid out.
Kevin Mitchell:
Yeah, that's exactly right. And we look within our company at two primary value chains, the crude to products value chain, and the NGL, the gas to NGL value chain. And those value chains offer slightly different propositions for us in the more midstream oriented value chain. It's a lot about the infrastructure we have in place, the pipeline, processing plants, fractionation, export capabilities, and the growth opportunities we see within that business. We've invested quite a significant amount in that business over the last several years and we continue to see good opportunities in that. And then you put that against the refining business, where we have done a lot to enhance the quality and capabilities of that set of assets we have.
But at the same time, we're not looking to grow just for the sake of growth because of the long-term trends we see for refined products on the demand side, but that's a very valuable business that at times like this can be very strong from a cash generation standpoint that we can put to good use. So we have to run those assets well, be cost efficient, safe, reliable, strong operators, and continue to view that as a core part of the portfolio. So those two value chains together side by side have a lot of value creation potential for us.
Jason Gabelman:
Yeah, and you mentioned growth, and given the current environment, there is a lot of focus on energy security, security of supply. How is Philips' growth contributing to the North American energy security?
Kevin Mitchell:
Yeah, so it really speaks to what we've been doing in refining and in midstream, where we're investing in infrastructure that is enabling the US energy system to thrive. We are connected to, really, all of the best, what I would consider the best hydrocarbon corridors in the country, and arguably they're some of the best in the world, whether it's the Permian, it's the heavy Canadian crude coming out of Canada, the D-J basin. So we are tied into those hydrocarbon basins and able to move, transport, process those molecules, and ultimately those turn into higher value products that enable the US and the global economies to run and do all the things that need to happen. So we're integral to that build out of this energy system that is creating the US as a true economic energy powerhouse on a global basis.
Jason Gabelman:
We're in kind of unprecedented times here in terms of energy markets with the Strait of Hormuz close. There is a tremendous amount of commodity volatility day-to-day. How do you manage that day-to-day volatility and how do you factor that into your long-term strategic planning?
Kevin Mitchell:
Yeah, so that's a great question and there's a couple of elements to this. One is, given the underlying volatility in the energy markets, we need to, one, ensure we've got strength of balance sheet and flexibility to be able to deal with whatever might come from the rapid changes that we have experienced and we can see that happening. So we want to have that balance sheet strength capability to be able to deal with that. We also need to have our finger on the pulse of what's going on around the world in these markets, and we do that through our commercial organization, which is quite extensive. We have offices in Calgary, Houston, London, Singapore, and that connects, they are the fabric that connect all different aspects of our businesses and have the insights into what's going on around the world in these markets to where we can make decisions to optimize within our own portfolio or take advantage of certain trading opportunities that they can see and do that.
And a good example around that is on freight. You've seen freight costs, another example of volatility, freight costs have gone up significantly this year through this situation. During the course of the last 12 to 18 months, we could see not what was going to happen in terms of the Strait of Hormuz, but we could see this situation arising where freight costs were on an upward trajectory. So we had proactively been out there putting in place time charters on vessels. So that then, come situation like this, we're able to leverage those assets, that infrastructure that we have access to, to really be able to optimize across our system and create value for the company, for shareholders.
Jason Gabelman:
And that feels more day-to-day activity, which is super helpful to manage the business. How do you layer that into your long-term planning as you think about spending and capital projects, mitigating the really large commodity risk and band that commodities can trade within?
Kevin Mitchell:
Yeah, that's a great point because while all of what I said is absolutely true and we're doing those things on a day-to-day basis, big picture, we're running the company for the long term and we're making investment decisions for the long-term, not just chasing the current market. So we are making investments in our midstream business and in our refining business that will continue to enhance the quality of those businesses and grow our earnings and cash generation. And if you look at our portfolio, we have the midstream business and what I would say the marketing and specialty business, both of which have much less earnings volatility than the refining business, the renewables business, and even the chemicals business.
And that provides a base level of cash and earnings generation that we can use to fund a lot of the corporate cash outflow commitments. So think of that as the sustaining capital, approximately a billion dollars per year, the dividends, $2 billion per year, and even also cover at least a component of the interest expense. And that investment we're making in midstream, we're growing the midstream EBITDA, that enables us to backstop future growth in, for example, the dividend to shareholders. We can backstop that on the more stable earnings generation. And then the more commodity exposed businesses, like refining, just provide cash flow upside for other uses, whether it's incremental cash returns to shareholders, additional opportunities that arise from an investment standpoint. So that's more of the view to the long-term positioning of the company, while at the same time we're doing everything we can to optimize around the current market dynamics.
Jason Gabelman:
Yeah, and it's a great point. Philips is unique to your peers in the fact that you do have cashflow that you could recycle from refining, which maybe doesn't have the same growth prospects as midstreaming chemicals, and put it into value enhancing projects in those other segments.
Kevin Mitchell:
Yeah, that's right.
Jason Gabelman:
And on that topic, how do you balance spending on growth versus taking the cash you're generating and returning it to shareholders?
Kevin Mitchell:
Yeah, so what's key is to be disciplined around it. Consistent and disciplined. Our capital allocation construct I think is quite simple and it has worked well for us so far, and it starts with 50% of operating cash flow will go out to shareholders in the form of dividends and buybacks. The dividend currently sits about $2 billion per year. The capital budget, we stay disciplined around what we're reinvesting in the business, and that's to ensure that we're only doing the right projects and the best projects and we don't get caught in this sort of chasing growth for the sake of growth's sake. So that's historically been about two and a half billion, two to two and a half billion dollars per year. That will go up with the Western Gateway project as we look ahead, but still within a very manageable level. So very disciplined about how much we're reinvesting in the business.
And just for context, the sustaining capital, I think I mentioned earlier, is about a billion dollars per year, and then the extra is the growth capital that is split between refining and midstream primarily, with midstream the larger share of that given the long-term nature of the growth opportunities in that business. And then we also, as you know, have a debt target. So we've been reducing debt. We laid out a $17 billion debt target by 2027. Given the cash generation we're seeing this year, I expect we'll hit that early, should hit that this year. And quite frankly, as cash generation continues at this sort of level, we will continue to deploy some of the excess cash to the balance sheet, but we will stay true to the 50% or greater of operating cash flow going back to shareholders. So given that the dividend is relatively fixed at $2 billion, as the cash flow goes up, then half of that incremental cash flow at least is going to buybacks and the rest to balance sheet.
Jason Gabelman:
Does the current environment we're in in the Middle East conflict, also the Russia-Ukraine war, does it create more investment opportunities for you, or for now are you just happy to generate that excess cash?
Kevin Mitchell:
Yeah, I think we stay consistent with our overall framework. If we see opportunities that arise, we won't be looking at them through the lens of we're doing this because of what's going on in the Middle East because we really don't know how long that lasts or what that outcome ends up being. But if it's something that arises because of this and we say, "You know what, this is actually going to be a good thing to do for the long-term view," then certainly we will entertain that. But I think what's important is we are building a business for the future, we're making investment decisions looking through the cycles and not trying to just get caught up chasing the current environment, chasing the current margin environment. We're taking a more longer term view.
Jason Gabelman:
We've talked a lot about the external factors that are driving some of the decisions that you're making, but also want to talk about what's going on inside the company. You've taken a lot of costs out of the system, maybe gives you a platform to talk more broadly about how you deploy AI within your company. Is that helping to reduce costs, improve performance of assets, and does it create additional investment opportunities for you?
Kevin Mitchell:
Yeah, it's a great question. And you're right, we have had a big push on costs over the last several years. It's real, it's showing up. We're not where we need to be. This is not a declaration of victory. We know we have more work to do, but we're on a good trajectory here. The 550 per barrel refining target has been talked about at length over the last two or three years, and I expect we'll get to where we need to on that. And honestly, we won't stop there. This is somewhat of a continuous process. AI is a fascinating topic. We're focused on AI in three different areas. First off is we did an analysis of what we thought the highest impact AI focus areas needed to be. In other words, where could we have the greatest impact on, whether it's operating performance, margin capture, really chase the dollars?
So there's two areas. One is literally operations. We have a portfolio of large, complex assets with variable inputs. In other words, we can run different crudes, different product make, and units that can operate under different parameters. So a lot of data and decisions on exactly how to run those assets. And AI can be deployed to help us optimize and maximize the output from those assets, including from a maintenance machine monitoring, taking all of that data and analyzing the data in a fraction of the time that you could do manually, and so that we optimize the maintenance programs, repair equipment before it fails, but also optimize around the feedstock slates, how we set the units, how we run the units, the products we make, and where we place them into markets. So that's one area which I make that sound like it's small and simple, but it's actually large and very complex, but that is one of the focus areas.
The other one is around the commercial business. So we're in the market every day, we're buying crude oil, we're selling products, we're moving LPGs around the world. We have offices in several different locations I mentioned earlier. That gives us a lot of insight into markets. And how do we pull all of that together and the data that brings for us to enable us to optimize all of those decisions and help us be faster and smarter in how that commercial organization can create incremental value for us across the different businesses? And then the third one is more broad and general, which is how do we get AI into the hands of just employees at large? And we want employees to view AI as an opportunity, not as a threat.
This particular part of the AI objective is not based on a cost takeout objective. It's how do we make lives easier for employees? They can get more work done faster, take the menial tasks and have those done by an agent, and let the employee focus on the more interesting and value adding work. So we have what we call it AI central, which basically enables the employee to log in. When you fire up the computer in the morning, you have an AI central page and it has access to all of your files, documents, emails, and it can do a lot to just simplify tasks that need to be done, can be menial and time-consuming, and it just aids in productivity.
Jason Gabelman:
Yeah, it sounds like a very useful tool. I want to get you out on this one. At this particular time in this recording, there's a lot of headlines about a diesel export ban. So not only addressing that, but as you reflect on what the US administration has done, what other administrations have done to battle the inflationary effects of the Middle East conflict, what have you seen that has worked well? What are you thinking that isn't working as well? Just any color on that?
Kevin Mitchell:
Yeah, so the current administration has done a lot to emphasize energy and the capabilities of the US energy system, and I touched on some of this earlier, when you look, it doesn't matter which part of energy you refer to, whether it's refining or production coming out of the Permian or gas production, LNG exports, it's pretty incredible where we are as a country from an energy standpoint. And the administration deserves a lot of credit for that, as well as the industry in itself for doing all that it's done. But at the same time, this global dynamic creates challenges in the system and I think the administration has done some things that have really helped, and we've been able to leverage those.
So for example, the Jones Act waiver has enabled us to move product from US Gulf Coast to Eastern West Coasts in a more cost-effective way than we could have done before, and in fact, actually avoid some of that product just being exported. So we've kept product in the US. Likewise on crude, we've been able to move, and we've never done this before, we've been able to move domestic Permian crude from the Gulf Coast round to our Bayway refinery in the Northeast, where traditionally that has always been an import crude business. So we've been able to do those kind of things with that. Likewise, you've seen some easing on the RVP front, that's helped a little bit from a gasoline, getting more gasoline into the market. So I think those have all been well thought through and been implemented well.
There's talk about banning diesel exports, some form of restriction on exporting diesel. Let's say this is a solution to not what I would call a problem, but really an item of success with regard to US energy. We produce more diesel than we need. We have great infrastructure, access to different crudes, high quality refining assets that can upgrade these heavy crudes and make a significant amount of distillate more than we need in the country. So we can be a dependable supplier of fuels to the world, just as we are with LNG and in fact crude oil exports as well. So it's a reflection, the talk about it is a reflection of a success story in all honesty.
And it would be tough to absorb a ban on those export of those fuels because they need to go somewhere. And if there's not a place for them to go, then the refining system will have to back off run rates, which will reduce the production of gasoline and jet fuel and the like. So this is a delicate situation. We understand the challenge around it, we understand the concerns around diesel prices, but it's a delicate item that we need to navigate through.
Jason Gabelman:
Yeah, it certainly is. A really informative discussion, Kevin. Thank you for taking the time.
Kevin Mitchell:
Great. Thanks very much.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.