Phillips 66 - Q2 2023

Transcript

Operator (participant)

Hello, welcome to the Q2 2023 Phillips 66 Earnings Conference Call. My name is Alex, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a Q&A session. Please note that this conference is being recorded. I'll now turn the call over to Jeff Dietert, Vice President, Investor Relations. Jeff, you may begin.

Jeff Dietert (VP of Investor Relation)

Good morning, and welcome to Phillips 66 Q2 earnings conference call. Participants on today's call will include Mark Lashier, President and CEO; Kevin Mitchell, CFO; Tim Roberts, Midstream and Chemicals; Rich Harbison, Refining; and Brian Mandell, Marketing and Commercial. Today's presentation material can be found on the investor relations section of the Phillips 66 website, along with supplemental, financial, and operating information. Slide 2 contains our safe harbor statement. We will be making forward-looking statements during today's call. Actual results may differ materially from today's comments. Factors that could cause actual results to differ are included here, as well as in our SEC filings. With that, I'll turn it over to Mark.

Mark Lashier (President and CEO)

Thanks, Jeff. Good morning. Thank you for joining us today. In the Q2, we had adjusted earnings of $1.8 billion or $3.87 per share. We continued to execute on our strategic priorities and returned $1.8 billion to shareholders through share repurchases and dividends. Our results reflect strong operating performance across our portfolio, demonstrating the commitment of our employees to maintain safe and reliable operations. We wanna thank them for their dedication to operating excellence and delivering on our mission to provide energy and improve lives. In refining, we continued to run above industry average rates. In midstream, we had record NGL frac volumes. We continued to run our Sweeney Hub fracs and export terminal at above nameplate capacities to meet strong demand.

We remain committed to operating excellence and continue to focus on our strategic priorities to create value and return cash to shareholders. Slide 4 summarizes progress toward our strategic priorities. Over the last 12 months, we've returned 14% of our market cap, or $5.4 billion to shareholders through share repurchases and dividends. We're on track to return $10 billion-$12 billion over the 10-quarter period between July 2022 through year-end 2024. In refining, we had another quarter of strong operating performance, with crude utilization of 93% and lower operating costs. As at the end of the quarter, more than $300 million of the $550 million run rate cost savings are attributable to refining. Kevin will provide an update on our business transformation progress in a moment.

We're executing our NGL wellhead to market strategy and capturing DCP integration synergies faster than expected. Our current synergy run rate is over $200 million. We've been successful in identifying additional opportunities to increase our target from $300 million to more than $400 million by 2025. In June, we completed the acquisition of DCP Midstream's public common units for $3.8 billion, increasing our economic interest from 43% to 87%. We ended the quarter with a net debt to capital ratio of 35%. We expect leverage to be within our target range by year-end. In refining, we're converting our San Francisco refinery into one of the world's largest renewable fuels facilities.

The capital to convert the facility to over 50,000 barrels per day of renewable fuels production is anticipated to be approximately $1.25 billion. This is an increase from our original premise due to higher than anticipated material and labor costs, as well as impacts related to weather and permitting. The revised capital cost of around $1.60 per gallon remains well below similar announced projects, and the expected returns are significantly above our refining hurdle rates. The overall project timing and scope remains unchanged. We expect to begin commercial operations in the Q1 of 2024. In chemicals, CPChem completed construction of the 1-hexene unit in Old Ocean, Texas, and expects to begin operations by the end of the Q3. The new propylene splitter at its Cedar Bayou facility is expected to start up in the Q4.

CPChem and QatarEnergy are jointly building world-scale petrochemical facilities on the US Gulf Coast and in Ras Laffan, Qatar. On the US Gulf Coast, the Golden Triangle Polymers joint venture has project financing in place. The Ras Laffan petrochemical joint venture expects to complete project financing later this year. Both projects remain on schedule to start up in 2026. I'll turn the call over to Kevin to review the business transformation savings and Q2 financial results.

Kevin Mitchell (CFO)

Thank you, Mark. Starting on slide 5 with an update on our business transformation progress. Our $1 billion business transformation target includes $800 million of cost savings and $200 million of sustaining capital reductions. We have identified over 2,700 initiatives to permanently reduce costs, with employees across the organization actively engaged in the transformation process. We have completed 1,200 initiatives that are generating value today. The chart on the left shows our progress toward the $800 million cost reduction target, with $550 million of run rate cost savings at the end of the Q2. The stacked bar shows our actual cumulative cost reductions for the year by category. Over the first half of 2023, we realized $260 million in cost savings.

The majority of these cost reductions relate to refining, which has benefited by about $0.40 per barrel. Business transformation initiatives range from optimizing services across our portfolio of assets, to establishing new tools to improve use of steam and energy. Organizationally, we've strengthened our centralized model for core functions to drive consistency and efficiencies. We continue implementing cost savings initiatives and are on track to achieve our run rate target by year-end 2023. We expect to realize the full $800 million of cost savings in 2024, which will include refining cost reductions of $0.75 per barrel. I'll move to slide 6 to cover the Q2 financial results. Adjusted earnings were $1.8 billion or $3.87 per share.

The $15 million decrease in the fair value of our investment in NOVONIX reduced earnings per share by $0.03. We generated operating cash flow of $1 billion, including a working capital use of $1 billion, and cash distributions from equity affiliates of $239 million. Capital spending for the quarter was $551 million, including $339 million for growth projects. We returned $1.8 billion to shareholders through $1.3 billion of share repurchases and $474 million of dividends. We ended the quarter with 445 million shares outstanding. I'll cover the segment results on slide 7. Additional details can be referenced in the appendix to this presentation. This slide highlights the change in adjusted results by segment from the Q1 to the Q2.

During the period, adjusted earnings decreased $199 million, mostly due to lower results in refining and midstream, partially offset by an improvement in marketing and specialties. In midstream, Q2 adjusted pre-tax income was $626 million, down $52 million from the prior quarter. The decrease was driven by the impact of declining commodity prices in our NGL business. This was partially offset by higher volumes in transportation. Chemicals adjusted pre-tax income decreased $6 million to $192 million in the Q2. The industry polyethylene chain margin increased by $0.03 to $0.20 per pound. However, this was offset by higher maintenance and turnaround costs in the quarter. Global O&P utilization was 98%.

Refining Q2 adjusted pre-tax income was $1.1 billion, down $460 million from the Q1. The decrease was due to a decline in margins, partially offset by higher volumes and lower operating expenses. Realized margins decreased primarily due to the decline in distillate crack spreads and narrowing heavy crude differentials, partially offset by improved gasoline cracks. In addition, realized margins reflect the impact of losses from secondary products due to declining NGL and coke prices. Marketing and Specialties adjusted Q2 pre-tax income was $644 million, an increase of $218 million from the previous quarter, mainly due to seasonally higher global marketing margins on continued strong demand. The corporate and other segments adjusted pre-tax costs were $12 million lower than the prior quarter.

The adjusted effective tax rate was 22%, consistent with the previous quarter. The impact of non-controlling interests was improved compared to the prior quarter and also reflects our acquisition of DCP units on June 15th. Slide 13 shows the change in cash during the Q2. We started the quarter with a $7 billion cash balance. Cash from operations was $2 billion, excluding working capital. There was a working capital use of $1 billion, mainly reflecting an increase in inventory, which included the impact of unplanned downtime at the Bayway Refinery and seasonal storage opportunities. Year-to-date working capital is a use of around $2 billion, primarily related to inventory, that we expect to mostly reverse by year-end. We funded $551 million of capital spending.

In June, we drew $1.25 billion on a single draw term loan to partially fund the acquisition of the DCP units for $3.8 billion. This transaction and the redemption of DCP's Series B Preferred Units of $161 million, are represented as repurchase of non-controlling interests. Additionally, we returned $1.8 billion to shareholders through share repurchases and dividends. Our ending cash balance was $3 billion. This concludes my review of the financial and operating results. Next, I'll cover a few outlook items. In Chemicals, we expect the Q3 global O&P utilization rate to be in the mid-nineties. In Refining, we expect the Q3 worldwide crude utilization rate to be in the mid-nineties and turnaround expenses to be between $110 million and $130 million.

We anticipate Q3 corporate and other costs to come in between $280 million and $300 million, reflecting higher net interest expense from funding the purchase of DCP units during the Q2. In 2023, we expect our full year capital spend to be above the $2 billion budget, reflecting approximately $200 million of additional spending on Rodeo Renewed. In addition, we just closed on a $260 million acquisition of West Coast marketing assets. This acquisition supports the high return Rodeo Renewed project by optimizing the full value of our renewable fuel sales to end customers. We continue to review our portfolio to determine if assets meet our strategic long-term objectives or if they provide more value to third parties.

Earlier this year, we divested the Belle Chasse terminal. Very recently, we sold our interest in the South Texas Gateway Terminal. Total proceeds from the 2 transactions are approximately $350 million. We will open the line for questions, after which Mark will make closing comments.

Operator (participant)

Thank you. We will now begin the Q&A session. As we open the call for questions, as a courtesy to all participants, please limit yourself to 1 question and a follow-up. If you have a question, please press star, then the number 1 on your telephone keypad. If you wish to be removed from the queue, please press star, then the number 2. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Again, if you have a question, please press star, then the number 1 on your telephone keypad. Our first question for today comes from Doug Leggate of Bank of America. Doug, your line is now open. Please go ahead.

Doug Leggate (MD and Head of US Oil and Gas Equity Research)

Thank you. Appreciate you all taking my questions. I- I'm not sure who wants to answer this, maybe Kevin, but we've obviously talked ad nauseam about what we think could be a new mid-cycle refinery outlook, but what we haven't taken into account is the continued upgrade to your synergy targets, the faster delivery of your cost reductions, and more importantly, the continued appearance of deferred taxes in your free-- in your operating cash flow. Kevin, I guess my, my somewhat convoluted question is: what, what do you think your sustainable mid-cycle free cash flow looks like for the company post these recent series of changes that you've introduced?

Kevin Mitchell (CFO)

Yeah, Doug, so, we had guided to $7 billion, increasing to $10 billion at Investor Day of cash flow. The reality is, some of the actions that bridge us from $7 billion to $10 billion, we have executed on. So at this point in time, on a traditional, our view of refining mid-cycle, we're probably somewhere in the $8 billion range, maybe a little bit higher than that, but we're not all the way to $10 because there are still other things we need to execute on. We're certainly making good progress from the $7 billion to $10 billion. Your comment on deferred taxes is a relevant one. This year, we actually expect to have a slightly larger than normal deferred tax benefit on cash flow.

I think I had previously guided to about $400 million-$500 million of benefit for the year. We expect that to be more like $700 million-$800 million, that's mainly because of the impact of DCP buy-in on that. After that, we should revert to a more traditional, so the $400 million-$500 million level.

Doug Leggate (MD and Head of US Oil and Gas Equity Research)

Just to be clear, you, you have not changed your view of mid-cycle margins. Is that right?

Kevin Mitchell (CFO)

That is correct. We have not changed our view of mid-cycle, but we would acknowledge that we are in a stronger than mid-cycle margin environment currently. We have been for the last year plus, year and a half. Barring any major economic downturn, we actually think that will continue for a reasonable period of time, just given the overall supply demand balances that exist globally.

Doug Leggate (MD and Head of US Oil and Gas Equity Research)

Okay. Thank you for that. My, my follow-up, just a quick one. The, the step up in the buyback pace, is that, is that a transitory, you know, perhaps as a consequence of the DCP process? I'm not quite sure what other things might have delayed you, but I guess my point is that if I look to the $5 billion-$7 billion buyback guidance you gave through 2024, two things come to mind, which is, well, it seems to us you could maintain an elevated pace and certainly a pace well beyond 2024. I could just wonder if you could just touch on the cash return strategy, and I'll leave it there. Thanks.

Kevin Mitchell (CFO)

Yeah, I think that's, that's right. I mean, as, as you know, we have been, other than during the COVID period, we have been consistently buying back shares since really 2012, when we started the program. The elevated pace in the Q2 was not so much an impact of the DCP transaction, more it was a function of we recognized that relative to our share price at the time and our outlook, which was quite positive in terms of the overall business fundamentals, it seemed like a good opportunity to up the pace from where we had been. Based on where things sit today, it looks like a good decision on our part. The $5 billion-$7 billion that we guided at Investor Day, that's a sort of minimum threshold that we expect to meet.

It doesn't mean to say we can't either hit that total return, $10 billion-$12 billion, before the end of 2024, and it certainly does not mean that we stop once we hit that threshold either. So I'd go back to our normal traditional sort of guidance of at least 40% of cash flow returned to shareholders through the dividend and buybacks.

Doug Leggate (MD and Head of US Oil and Gas Equity Research)

Helpful. Thanks. I appreciate the answers.

Operator (participant)

Thank you. Our next question comes from Neil Mehta of Goldman Sachs. Your line is now open. Please go ahead.

Neil Mehta (Head of Americas Natural Resources Equity Research)

Yeah, thank you. I want to stay on the topic of capital structure, the net debt to capital, as you guys indicated, kind of ticked up to 35%, but you indicated that you expect it to move lower by year-end. Talk about some of the things that are moving back into your favor, in addition to the strong margin environment, working capital or other items that we need to keep in mind, and how should we think about exit rate for that metric?

Kevin Mitchell (CFO)

Neil, I think we had given guidance that we expected our debt to cap to increase once we completed the buy-in of the DCP units, and so it wasn't a surprise to us where we landed on that number. The two big drivers that will bring that back between now and the end of the year are what you pointed to, working capital, so that's about a $2 billion inflow in cash that we expect to see between now and the end of the year, and then also just the ongoing ability to generate earnings, generate strong earnings, and build to equity. On, you know, on our math, we, we think we end the year at right around the 30% level. The top end of the range, but nonetheless, still within that overall target range.

Obviously, this thing will move around quarter-over-quarter, depending on what's going on in terms of market environment and cash items like working capital. Fundamentally, we think we're on a reasonable trajectory to be able to sustain in that target range.

Neil Mehta (Head of Americas Natural Resources Equity Research)

Yeah. Thanks, thanks, Kevin. Then the follow-up is just on Rodeo Renewed. Some changes, sounds like, in the capital scope here. Just can you walk us through the drivers of those changes? Then as we think about against the capital, the type of EBITDA that you can generate from the asset, how has, has your view of mid-cycle from that asset evolved as you spend more time on the project? Thank you.

Mark Lashier (President and CEO)

Yeah, Neil, it's Mark. I'll, I'll cover it at a high level, and then Rich can drill in a little bit. Essentially, what, what we've experienced there as we commenced the project execution, we had a lot of heavy rainfall. Of course, even the, the start of the project was, was deferred a little bit, because of permitting challenges. We believe, we recognize that the, the earnings from this are going to far exceed the earnings we realize today from the San Francisco Refinery, so we wanted to stick to the schedule. We incurred some more cost, to compensate for the productivity loss during bad weather and, and delays around permitting. We also saw some inflation. When this project was sanctioned, the, the big run-up inflationary pressures hadn't hit yet, and so we realized that.

Really is the only project, in our purview, where we're seeing that kind of impact or haven't accounted for the inflation at, at sanction, so we're, we're having to take care of that. We still, we still look at that $1.60 a gallon as incredibly competitive. The overall competitiveness of the asset is, is strong. The location, we've got competitive advantage. The pull-through with our retail presence is a competitive advantage. As you look at, as we bring this facility online, we're taking off almost as much traditional diesel as we're bringing in, renewable diesel to the market, so the market disruption will be, will be minimal. We, we really are bullish around this project, and we see that, the economics are still very robust, in spite of the cost increases.

Rich, do you, do you want to drill a little deeper?

Rich Harbison (EVP in Refining)

Yeah, I think you covered most of that, Mark. Maybe I can add just a little bit of color to it. You know, as we, as we talked about, the primary drivers for the increase were material and labor costs. When you think about the timing of this project, it was estimated and approved prior to the heavy inflationary period. We're realizing that the inflationary pressure that's, that's occurred over the duration of the development of the project. Half of those costs we'll experience this year, the other half will flow into next year's capital allocation. You know, as Mark indicated, the project is still very capital efficient at $1.60 a gallon, and we're very happy with that, and that is very competitive versus other announced projects.

We continue to work, full steam ahead on the construction, and it remains on track for commercial operation in Q1 of 2024. I know there's been a lot of focus around the lower LCFS credits over, over the recent change, but the, the reality of this, the, the, the economics around this project are, are centered around 4 programs, as well as the retail, price of diesel in, in the state of California, and other markets that, recognize renewable diesel. Those, those programs, 2 are federal and 2 are at the state level, and all of these seem to be working interrelationally with, with each other, as well as, impacting the feedstock costs as well.

When we look at the overall momentum and movement of all, all this interrelationship, we still see very strong economics for the project and continue to be very optimistic about the EBITDA returns on it.

Mark Lashier (President and CEO)

When you look at those increases across 2023 and 2024, it will re-require a modest increase in our capital, target of $2 billion for this year, but we will manage that additional cost within our $2 billion target going forward in 2024.

Neil Mehta (Head of Americas Natural Resources Equity Research)

Thanks. Thanks, everyone.

Operator (participant)

Thank you. Our next question comes from Roger Read of Wells Fargo. Your line is now open. Please go ahead.

Roger Read (Senior Energy Analyst specializing in Oil, Gas, and Broader Energy Sector)

Yeah, thank thank you. Good morning. I was hoping to follow up on the DCP transaction, just how that's gone so far. While I understand you've raised the, I guess, we would call it cost savings, another part of this transaction was on the revenue synergy side, building a, a truly integrated model.... I'm just curious what you've seen to date, what you maybe expect in the near term on that, or maybe even the medium term on that, in terms of how the transaction comes together as a, as a seamless organization?

Tim Roberts (EVP in Midstream and Chemicals)

Yeah, that's, you know, Roger, this is Tim. Thanks for the question. Hey, you know, we started working on this as soon as we closed the initial part of the transaction last year, so we got the integration teams together. At the beginning of this, you know, back in the fall of last year, we thought we had line of sight of $300 million that we could get, full value for all the way through the Q1 of 2025. That's when some contracts were rolling off that were going to third parties, and we could bring them into our system. But most of that we felt would be captured, by 2024.

As we dug in, and we got the teams involved, engaged, everybody's working together, now the employees have done a really good job of digging deeper and finding a couple more gems in there. Now that's why we're comfortable talking about an increase going to $400 million, and I'm actually hoping at some point I can give you, you know, more upside to that as we continue to dig, because this integration is gonna continue through the Q1 of 2024. The big driver right now, the teams are working together commercially, and probably worth setting a tone there is that early when we had a $300 million number, one-third was based on cost, two-thirds on commercial. We'll call it system optimization.

As we dug in and we've got to the $400 million number, now that is more 50/50 on cost. We found more in our procurement, more in our maintenance, more in our operations. Then 50% on cost and now 50% on, again, system optimization and commercial activities. That's kind of the breakdown. The real driver right now for us through the Q1 of 2024 is systems integration. A lot of good work being done by the team, but it just takes time, and you got to get it right. We are spending the time to do that, and we'll be done by the end of the Q1, and then we'll be in what I consider a normal operation, steady state mode, with regard to how we run as a business.

Mark Lashier (President and CEO)

Yeah, I'd just like to come in a little bit on that, the integration impact. You know, this, this really is a clear indication of how well the teams are integrating. The DCP team, the Phillips 66 teams coming together. As Tim noted, once we had operational control of the entity after the Enbridge transaction, we were able to really hit the ground running and start executing against our targets. Getting these teams integrated, one team, one culture, taking the best of the best and driving this, this is really the biggest visible measure of how successful that's been. We see those numbers move up, and we see teams excited about the future and looking at ways to capture more value, both from a cost perspective and a commercial perspective.

So this is gonna be what they are and what they do from this point forward.

Roger Read (Senior Energy Analyst specializing in Oil, Gas, and Broader Energy Sector)

Yeah, thanks for that. Then the unrelated follow-up is to come back to the $0.40 a barrel of refining the margin, cash OpEx savings, the goal to get to $0.75. Can you give us an idea of-- I mean, I, I know you mentioned, you know, seeing cost reductions, things like that, but, like, what is this process allowing you to do? Is it a, you know, best practices in one location being expanded, an overall centralized look at the cost structure? Just, you know, it's, it's a very impressive number. It's certainly sustainable. It adds up over time. So I'm just curious, you know, kind of where'd you start? How'd you get here? You know, how, how, how confident are you in, in the $0.75 on the timeline that you've set?

Rich Harbison (EVP in Refining)

Yeah, Roger, this is Rich. You know, we're well on our way, as, as you indicated, to our $0.75 per barrel savings target that we announced or committed to, during the Investor Day, last November. You know what's most exciting about this whole process for me has, has really been how the organization, the entire organization, is engaged in this process. So yeah, there is some oversharing, site to site of, of activity and best practices, but most of this activity is opportunities identified by that local organization, really accepting the challenge to improve the business, and they're uncovering these opportunities to be more efficient in, in their work process, right? And, and then fundamentally changing how that work process is occurring to drive inefficiencies out of the business, which ultimately reduce, costs out of the business.

If you think about, we, we talked about $0.40 a barrel already, year to date. That's calculated by... If you take our barrels that we've run, year to date and then calculate to the $0.40, you can, you can back into the number that, that, that we're seeing drive to the bottom line of our financial report there. That's been quite impressive. We've got a lot more in the queue, as Mark indicated on his comments with the run rate. You know, our target is $550 million. Over $300 million of that is currently assigned to refining. Of course, the run rate doesn't mean it's realized, right?

That just means it's identified, it's locked in, and now we got to drive it to the bottom line, and that's what's most impressive about the organization, really pushing to get these identified opportunities pushed to the bottom line.

Mark Lashier (President and CEO)

Yeah, you know, and if you, if you see some commonalities between the mindset in our refinery organization and the, and the midstream organization, it's, it's real. It's this business transformation process-

Brian Mandell (EVP in Marketing and Commercial)

It's, it's easy to talk about the cost impact, and it's easy to have those cost targets, but really the most phenomenal thing going on is the mindset change and the, you know, the drive that we see in the employees to get better at what they do every day. You're seeing that move on from, from cost focus to just where do we create the most value? How do we create the most value together? Whether it's the way we've organized and integrated our value chain optimization organization more synergistically across the refineries, having VCO folks sitting on the refinery leadership team, every day, you know, searching for ways to optimize and coordinate with other refineries.

It's, it's real, and that's it's that mindset, it's that drive that's gonna make these cost savings and the synergy capture sustainable for the long term. It's, it's just not gonna end. It's just gonna be the way we do business going forward.

Operator (participant)

Thank you. Our next question comes from John Royall of J.P. Morgan. Your line is now open. Please go ahead.

John Royall (Equity Research Analyst in Integrated Oils and Refining)

Hi, thanks for taking my question. My first question's on the Bayway FCC. I think your last official statement was around mid-July for the restart. We saw reports after that, that it was end of July. I'm not sure if that's been confirmed. If you can just update us on the status of the unit and, and when you expect it up and running full, if it's not now?

Rich Harbison (EVP in Refining)

Hey, John, this is Rich. FCC repairs were complete, and the unit is up and running as of July 20th. That's the actual date that it was back online, producing on specification material. The refinery itself is back to normal operation, so all, all the, all the units and all the assets there are running to our, to our plan. The Bayway team did a phenomenal job getting that repair work done very efficiently. Very excited about how they, they performed to complete that work. Additionally, you know, when, when Mark's just talking about, you know, this mindset activity, we saw other parts of our organization also really focus to help pick up our, our teammates that were struggling a little bit in Bayway, and we saw phenomenal performance in our refineries in Sweeney, Lake Charles, and Billings.

They each had record performance, as well as our assets on the West Coast, it all ended up in a system-wide utilization of 93%, which is our highest crude utilization since 2019. We're looking forward to building on this momentum and continuing that into the Q3.

John Royall (Equity Research Analyst in Integrated Oils and Refining)

Great. Thanks, thanks for the update. I, I know it's early on, but maybe, sticking with refining, you could give us, you know, possibly some expectations on some puts and takes around, captures for 3Q. Relatedly, maybe you can weave in your view on WCS dips from here. you know, we've widened out a fair amount off of bottoms, but still look very tight. Any views there into 2H would be helpful.

Brian Mandell (EVP in Marketing and Commercial)

Hey there, it's Brian. Maybe I'll just talk about product demand, give you a sense of what we're thinking for Q3. The strength in U.S. products basically starts with low inventories. Gasoline, we're under five-year averages by 7%. Distillate, we're under five-year averages by 19%. That's a lot. We have a lot of new capacity coming online in the U.S. We've had even more outages than the new capacity. For us, we're seeing gasoline demand up about 2% over last year in the U.S., and about 4% globally, that's strong demand. On distillate, we have the demand down a bit in the U.S., mostly on industrial manufacturing segments, globally, we have it up. We have lots of pockets of really strong distillate demand.

Latin America, up 9%, Asia, up 4%, and diesel cracks continue to remain strong. In fact, they've gotten a lot stronger, and we believe that they'll continue to perform throughout the year as we head into higher demand planning season and into winter. In the US, we're distillate over gasoline in every PADD now. Finally, on jet. Jets are also strong. Low inventories, increasing domestic, international travels. Global seat demand is essentially flat to 2019 levels. TSA throughput numbers in the US are flat to 2019 levels. Interestingly, US jet yields remain a little bit higher, so that should add some marginal strength to diesel. On the WCS, you're right, WCS has started to widen again, which is in, in our best interest here at...

We buy the most WCS of, I think, anybody there is. We've seen the widening mostly because of heavy crude dips in general have started to widen. We also see fall turnarounds in PADD 2 as being very strong. And then, if you'll remember, in September, which next month, we'll start to see butane blending, which will swell the volume of Canadian crude. All those things have been putting pressure and widening the dips to our advantage.

John Royall (Equity Research Analyst in Integrated Oils and Refining)

Thank you.

Operator (participant)

Thank you. Our next question comes from Ryan Todd of Piper Sandler. Your line is now open. Please go ahead.

Ryan Todd (Managing Director covering the Integrated Oils, Refiners, and Biofuels)

Good, thanks. I know we don't often talk that much about marketing, but your marketing business, as it continues to generally kind of exceed expectations on a regular basis, I think, you know, first half contributions are fairly in line with last year's first half contributions, which was, you know, a generally higher than expected year in marketing. Is, is that business maybe structurally, just, just structurally stronger than we have appreciated and maybe you've got it to? What do you attribute, kinda contribute, continued strength in the marketing side?

Brian Mandell (EVP in Marketing and Commercial)

Hey, Ryan, this is Brian. Exceeding expectations is a good thing. We're happy about that. We did have a strong quarter in Q2. We've added a bunch of retail JVs since 2019. We're roughly at 750 retail stores, which have really performed well since we've added them, and certainly in Q2. We had higher margins, as Kevin mentioned, in both the domestic markets and in our Western European business. We had U.S. volumes up a bit. Finally, in our lubricants business, the base oil business has been performing really well as the feedstock prices have been falling more than the base oil prices. I'd tell you for Q3, when you're thinking about Q3, our earnings should be in line with our mid-cycle expectations, assuming a kind of normal seasonal demand.

Tim Roberts (EVP in Midstream and Chemicals)

Yeah, I would just come over again and, and compliment Brian and his marketing team on the execution of, of the strategy that they've held for several years, is to go in and participate through these joint venture opportunities in markets that make sense for us, that if we have a competitive advantage, that there's strength to capitalize on. We don't go and do this everywhere. It's very surgical, it's very intentional, and it is exceeding expectations, so it's a well-executed strategy.

Ryan Todd (Managing Director covering the Integrated Oils, Refiners, and Biofuels)

Great, thanks. Maybe just a quick follow-up on, on Rodeo and seeing your comments from earlier. Are there as we think about kind of the pathway from here until startup in Q1 of 2024, are there any outstanding permits required, legal challenges that we should be looking at, or any... You know, how do you view kind of potential risks, that exist or things you're keeping an eye on, between now and commercial startup there?

Brian Mandell (EVP in Marketing and Commercial)

Yeah, Ryan. Permitting to complete any project in California is very challenging. Projects even to convert a conventional crude oil facility refinery to a lower carbon intensity transportation fuels production facility. We did recently receive news on an appeal to our Environmental Impact Report. That is the supporting document for permits. This was filed by a couple NGOs in the state. The good news is, the court ruling found several issues in the favor of Phillips 66. Notably, most notably, is the construction of the Rodeo Renew project can continue with the county work to resolve three issues. We're working closely with the county and the courts to provide necessary information to reconsider the open issues.

We remain very confident that the Rodeo Renewed project is on track to start commercial operation in Q1 2024.

Ryan Todd (Managing Director covering the Integrated Oils, Refiners, and Biofuels)

Great. Thank you.

Operator (participant)

Thank you. Our next question comes from Jason Gabelman of Cowen. Your line is now open, please go ahead.

Jason Gabelman (Managing Director in Integrated Oil, Refining, Midstream, and Biofuels Industries)

Hey, thanks for taking my questions. I wanted to follow up on Ryan's question just now on marketing and the outlook for 3Q. There were reports of droughts in the Rhine River, I think typically when that happens, you're positioned to supply that region well and take advantage of margin moves there. Have you seen any strength in 3Q, early 3Q, as a result of those outages? Would you expect, as a result, continued outperformance in marketing in 3Q? Conversely, what you're seeing on chems? We've seen chain margins fall into July. Just any views on the outlook there into 3Q, beyond that, when you expect chemical margins to move back to mid-cycle?

Brian Mandell (EVP in Marketing and Commercial)

Hey, Jason, it's Brian. Hey, so far in West Europe on the Rhine, we haven't seen water levels low enough to benefit us. It is true, if water levels do get low, we benefit from that, but the water levels haven't gotten there yet. Can't really predict where they're gonna go in Q3, but if they get lower, then we'll have some benefit.

Tim Roberts (EVP in Midstream and Chemicals)

Yeah, This is Tim Roberts on this. With regard to chemicals, to talk about the currently where we're at with chain margins. Yeah, it's been a, been an interesting run here. Obviously, you've got supply, plenty of supply available, and demand, they're not matching up. Therefore, you've seen chain margins been dropping over the last several quarters. Where you're at right now, I think IHS had it about $0.12 chain margins. Really, the way we would look at this and look at it going forward is, is that the high-cost producers, both in Asia and those that are in Europe, are gonna set the price, and those that are in advantage feedstock locations will keep running and probably run hard, which is what we're seeing right now in North America and the Middle East.

While those are having to shut in capacity or having to manage production or any of the other reasons I mentioned earlier. Fundamentally, though, you've got to get demand and supply to match up, and you've got to start working off inventory. Ethylene inventories here in North America are above five-year average, so that's, that's got a direction it needs to start working its way down. You're seeing the same thing in polyethylene, so two of the main products that we see with regard to our CPChem JV. We're running really strong here. Exports are strong as well with regard to in North America because you're advantaged on feedstock. Our outlook is, is that, yes, you got to hit the bottom before you can start working your way back up.

I can't say this is the inflection point, cash costs typically will drive where you get to the bottom and then how soon you can accelerate. Usually, as we would say, and it goes in a lot of different directions, is low costs, low prices solve low prices. Fundamentally, we do think that the outlook is still gonna be constructive, and constructive in that you still got population growth, you still have economies that have not been churning at the, at their all cylinders, China being one of them. That's not a position of saying they never will. Not at all. We think there are still gonna be good, solid economic growth. You're just not seeing it consistent global.

We do anticipate that that will happen, and that will help soak up some of the capacity that's out there, bring the markets back into balance, and you get back into more of a mid-cycle case.

Jason Gabelman (Managing Director in Integrated Oil, Refining, Midstream, and Biofuels Industries)

Great. That's, that's really helpful. My follow-up is just on acquisitions and divestments. You mentioned it at the top of the call that you continue to evaluate the portfolio. As you look across the, the various segments you operate in, any thoughts on, on where maybe, you have non-core positions or, or you have some portfolio gaps, and how are you viewing the broader M&A market? Thanks.

Mark Lashier (President and CEO)

Yeah, I think that, again, as, as Kevin mentioned earlier, we, we look across our portfolio, and there's, there's different, different dimensions across our portfolio where others may have some interest in, in our assets and may place a greater value because it's not strategic to us, and we'll continue to evaluate that. I wouldn't comment on any, any specific opportunities. Likewise, you know, as, as we did with, with marketing in California we, we made some relatively small acquisitions to enhance the, the opportunities around Rodeo once it's up and running, and we've done a series of those, and they're all doing quite well. We'll look at, you know, smaller opportunistic things. You think about where we've come from, we've done some pretty significant transactions in midstream. It's time to digest those and to drive value through those.

If we can find some very accretive, small, mid-sized kinds of things, we'd look at them. There's nothing, nothing in the queue and nothing that we'd want to comment on. We've got a great backbone there, and history has shown that a strong backbone in that industry can attract smaller investments that are quite attractive. You think in terms of small, very accretive, high return opportunities like we've done in marketing, would be on our scale. We're gonna stick with our discipline approach going forward. We've got a commitment around $2 billion for 2024, and anything around that would be very disciplined and high return.

Jason Gabelman (Managing Director in Integrated Oil, Refining, Midstream, and Biofuels Industries)

Great. Thanks for the color.

Operator (participant)

Thank you. Our next question comes from Manav Gupta of UBS. Your line is now open. Please go ahead.

Manav Gupta (Executive Director covering Integrated Oil, Midstream, and Biofuels)

I want to start on the East Coast. That was, like, a 52% margin capture. That's a significant drop from the last quarter. Was it primarily the outage at Bayway? Can you talk about some of the factors that led to such a significant drop on the East Coast in margin capture?

Rich Harbison (EVP in Refining)

Yeah. No, this is Rich. Over in that, what we refer to it as the Atlantic Basin, we, we did have higher volumes and lower costs due to less turnaround activity at Bayway quarter-over-quarter when you, when you look at those. A lot of those were offset by lower margins. The realized margin was lower primarily due to a weaker market crack. Configuration impacts also played into this, with the gasoline cracks increasing by $10 a barrel, and then the distillate crack decreasing by $18 a barrel. That played into, into the market capture quite a bit, and there was lower product, you know, lower product differentials there.

Then the, the other one that goes a little bit unnoticed in this, in this market is really the secondary product costs, and margins on those secondary products. In both the NGLs for both Bayway and Humber were, were lower, and then the petroleum coke that sold out of Humber also experienced lower product differentials. Those are the primary reasons you saw lower market capture there in Atlantic Basin.

Manav Gupta (Executive Director covering Integrated Oil, Midstream, and Biofuels)

Okay. Can you also talk a little bit about the TMX expansion? There's a lot of capacity coming on and moving the crude to the West Coast starting next year. How would that change the WCS-WTI differential outlook, in your opinion?

Brian Mandell (EVP in Marketing and Commercial)

Hey, Manav, this is Brian. Well, first, I think, our view is that TMX will probably come on later in the year, although line fill is forecasted for early Q1. I, I think the line will not be filled completely. That's our view. I think, those are on the lines. I feel like some of those barrels will be exported to Asia. We'll see if that happens. It's hard to get VLCCs there. In fact, you can't load VLCCs. You have to load them ship to ship outside of L.A. It's, it's, we'll see, we'll see what happens going forward, but certainly, it, it could be a benefit to the West Coast, having more of that crude.

Manav Gupta (Executive Director covering Integrated Oil, Midstream, and Biofuels)

Thank you, guys.

Operator (participant)

Thank you. Our next question comes from Matthew Blair of Tudor, Pickering Holt. Your line is now open. Please go ahead.

Matthew Blair (Managing Director in Refiners, Chemicals, and Renewable Fuels)

Hey, good morning. Thanks for taking my questions. On the midstream side, did Phillips unwind any of the DCP, NGL and natural gas hedges? If so, could you quantify the impact, the flow through the midstream EBITDA in Q2?

Kevin Mitchell (CFO)

... Yeah, Matt, this is Kevin. We did, kind of, we unwind them or if we let them roll off, but we have less of that. We don't have that same hedging on our exposure to the natural gas, NGL commodity price that DCP has historically had. In our overall portfolio, when you also factor in our position in refining as a consumer of those products, it felt more appropriate just to let the natural offsets flow through, so we have, we have done that. I don't think we've given a number either. Well, I know we haven't given any specific number out there.

What we have done is updated the sensitivities for midstream to reflect the fact that those hedges are no longer in place. You see a slightly higher midstream sensitivity to the commodity price than before.

Matthew Blair (Managing Director in Refiners, Chemicals, and Renewable Fuels)

Okay, sounds good. I don't know if I missed it, but did you give out a number for refined product exports in Q2? I think a year ago, it was 153,000 barrels per day. How did it trend this year? Are you seeing a mix shift with, with more barrels headed to Europe and fewer to Latin America?

Brian Mandell (EVP in Marketing and Commercial)

This is Brian. Yeah, we exported over 200,000 barrels this quarter, which was up in large part, our Sweeny Refinery was making some more higher sulfur diesel that we exported to Latin America. Like, like others have said, we have been exporting more distillate to Europe as trade flows from Russia change, and Russia is importing more barrels particularly into Brazil, 120,000-140,000 barrels, and we're, U.S., exporting more barrels to Europe.

Matthew Blair (Managing Director in Refiners, Chemicals, and Renewable Fuels)

Sounds good. Thank you.

Operator (participant)

Thank you. Our next question comes from Paul Cheng of Scotiabank. Your line is now open. Please go ahead.

Paul Cheng (Senior Equity Analyst in The North American Energy Sector)

Thank you. Good morning, guys. maybe this is-

Mark Lashier (President and CEO)

Good morning.

Paul Cheng (Senior Equity Analyst in The North American Energy Sector)

Good morning. I think this is for Mark. Mark, if we look at California, you still have the Carson and Wilmington, that combined refinery. Today, probably 60% of the diesel in California are being consumed by the renewable and biodiesel, and that in several years' time, you may end up that to be 100%. What's the role of that facility going to look like and how your configuration may need to change?

Mark Lashier (President and CEO)

Yeah, I'll, I'll help cover that at a high level, Paul. I think Brian has some views on, on what's, what's going on there as well. I think that at, at one end of the spectrum, we're, we're well connected to LAX from that facility and, and, and jet is a big opportunity there, and we'd certainly look at doing what we could to provide more jets. I think that, one mitigant of that is as we take the San Francisco refinery off line, that diesel production will go away and leave the market, and it's almost a gallon-for-gallon replacement with renewable diesel. That, that is, is an opportunity there as well.

I think that there are exports from California today, and, you know, Brian can comment further on that, but, but that's an opportunity to balance things out.

Brian Mandell (EVP in Marketing and Commercial)

Paul, I would add, the vast amount of distillate produced at L.A. is actually exported by pipeline to neighboring states. We don't make a lot of California distillate at that refinery. That is, for us, at least, a non-issue.

Paul Cheng (Senior Equity Analyst in The North American Energy Sector)

Okay. You think that. Do you think that on the longer-term basis, that should be part of your portfolio? Given the political environment and everything, I mean, is there any plan that to do something, if there are sadly, what you have done to Waddell?

Mark Lashier (President and CEO)

Well, yeah, Paul, we're looking at everything we can do to keep the LA refinery competitive in that environment. That it is, frankly, a difficult environment, and it's been very publicly, you know, politically challenging there, whether it's EV mandates, but we, we believe that it's gonna be challenging for California to implement their aspirations around EVs. I think that, that may be overplayed. Yeah, we're, we're watching the, the markets and environments very carefully and doing everything that's in our control to keep the LA refinery competitive and, and supplying products in that market.

Paul Cheng (Senior Equity Analyst in The North American Energy Sector)

Okay. A final one, I think this maybe is for either Rich or Kevin. When we look at your margin capture or that your margin realization in Central Corridor, you're actually doing better than we thought. Is there any one-off benefit that we see, or it's just normal market conditions and that recovery from the downtime in the Q1? Thank you.

Rich Harbison (EVP in Refining)

Hey, Paul, this is Rich. I'll, I'll start it off here with an answer. You know, the Central Corridor, you know, the, the primary reason that you're, you're seeing this is really strong performance from, from our facilities there at, specifically Ponca City and the Billings Refinery. Both of those facilities have been running very, very well, over the last several quarters and continue to operate, exceeding expectations on, utilization as well as, clean product yield, which is, improving the market capture there.

Mark Lashier (President and CEO)

Just to clarify, it's not a function of one-off items that are benefiting. It is all operational, as Rich described.

Operator (participant)

... Thank you. Our next question comes from Joe Laetsch of Morgan Stanley. Your line is now open. Please go ahead.

Joe Laetsch (Executive Director in Energy Equity on Major Integrated Oil and Gas)

Great, thanks for having me on. I wanted to go back to, to a couple topics we've already hit on, but first on chemicals. With the 2 CPChem projects starting up in the back half of the year, could you just give us a sense of earnings, contribution, and uplifts, probably, you know, 2024 on a normalized margin environment from those 2 projects? Just how, how we should think about that.

Tim Roberts (EVP in Midstream and Chemicals)

Yeah, on that, Joe, probably to clarify, those projects aren't expected to start up till 2026. So, you know-

Joe Laetsch (Executive Director in Energy Equity on Major Integrated Oil and Gas)

Oh, sorry. I meant.

Tim Roberts (EVP in Midstream and Chemicals)

hexene. Oh, on the hexene units, okay. with regard to the hexene unit-

Joe Laetsch (Executive Director in Energy Equity on Major Integrated Oil and Gas)

Yes, sorry.

Tim Roberts (EVP in Midstream and Chemicals)

Yeah, that one was completed. We're looking at that. My apologies here. I was thinking of the bigger projects. 1-hexene's been completed down in Sweeny. They'll be in startup mode through the Q3, and then you should probably start to see some level of earnings start to show up in the Q4. The splitter project, which is up at Cedar Bayou, that project also is in the final completion at this point, or they're gonna be ready to get everything completed by the end of sometime in the mid Q4. Excuse me. You're really probably not gonna see anything meaningful as they go through shaking out the units, getting them started up, and probably for both of them, you may be probably landing more towards a early Q1 before something really starts to show up there.

Mark Lashier (President and CEO)

Yeah, CPChem executed the hexene project and brought it in under budget as well, so I think that's notable in this environment.

Joe Laetsch (Executive Director in Energy Equity on Major Integrated Oil and Gas)

Great, thanks. Then, just going back to Rodeo. I, I know you all have talked about the potential to produce renewable jet fuel out of that facility as well. Could you just talk about any progress you've made there, any thoughts on timing when a decision could be made to produce SAF?

Rich Harbison (EVP in Refining)

Yeah, this is Rich. The project as it's designed, will be able to produce SAF. What's really missing from the whole equation is the market indicator to do that, and as soon as that's in place, we will quickly shift to a renewable jet/sustainable aviation fuel production. The facility will have the capability of producing 20,000 barrels a day of sustainable aviation fuel on the backbone of 10,000 barrels a day of renewable jet that's blended with traditional crude oil-based jet production, so.

Mark Lashier (President and CEO)

Yeah, that's not a saying a negative around SAF. We believe that SAF will, will be an important part of, of our, our path forward in renewable fuels. Today, at Rodeo, the economics favor renewable diesel, so we maximize renewable diesel. Produce some, you know, there's some that you just will, will produce just because of the yields. Any additional investment to produce more SAF would, would require something that would incent us to divert away from renewable diesel into SAF.

Rich Harbison (EVP in Refining)

There is capability to invest and increase that production level.

Mark Lashier (President and CEO)

Yeah.

Joe Laetsch (Executive Director in Energy Equity on Major Integrated Oil and Gas)

Great. Thank you.

Operator (participant)

Thank you. This concludes the Q&A session. I'll now turn the call back over to Mark Lashier for closing remarks.

Mark Lashier (President and CEO)

Thank you, Alex. Thanks to all of you for your questions. We delivered strong Q2 financial and operating results as we executed on our strategic priorities by focusing on the things we control, and most importantly, the commitments we made to our owners in November. We continued a healthy pace of returning cash to shareholders. In refining, we had another quarter of strong operating performance with above industry average crew utilization and lower operating costs. We're executing our midstream NGL well head to market strategy, completed the buy-in of DCP's units, and raised our synergy targets to over $400 million, wrapping up a series of foundational transactions to drive value creation in our NGLs business.

We're realizing our business transformation initiatives and are on track to achieve at least $1 billion of annual run rate savings by year-end, while driving a transformative mindset across the enterprise. As we deliver on our strategic priorities, we remain committed to financial strength, disciplined capital allocation, and returning cash to shareholders. Outstanding operational performance will position us to capture the current strong market environment in the Q3, and we look forward to updating you on our progress. Thank you all for your interest in Phillips 66.

Operator (participant)

Thank you for joining today's call. You may now disconnect your line.