Will Phillips 66's Big Bet on Midstream Pay Off?
Phillips 66 is not like most refiners. Formed in 2012 through ConocoPhillips' spin-off of its refining, midstream, and chemicals division, Phillips is much more heavily invested in midstream and chemicals than its downstream peers -- a focus that has provided it with a major competitive advantage over pure-play refiners.
As highlighted by its recent purchase of midstream assets in Texas, the company is investing heavily to further expand its midstream and chemicals business lines. Will this strategy pay off? Let's take a closer look.
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Phillips 66 to purchase Beaumont terminal
Phillips 66 recently announced an agreement to purchase a 7.1 million-barrel storage capacity terminal located near Beaumont, Texas, from a subsidiary of Chevron , the latest move in the company's midstream expansion strategy.
Due to its strategic location, the Beaumont Terminal, which will become the largest terminal in Phillips' portfolio once acquired, is well positioned to benefit from the growing volumes of crude oil being shipped to the US Gulf Coast region.
It provides multiple interconnections with key crude oil and refined product pipelines and features 4.7 million barrels of crude oil storage capacity and 2.4 million barrels of refined product storage capacity, two marine docks and one barge dock, and rail and truck loading and unloading facilities.
Though it's hard to assess the transaction from a valuation standpoint since Phillips 66 did not disclose the terms of the agreement, the purchase should be an incremental positive for the company because it will provide another source of stable income by tapping into the high and growing demand for crude oil and refined product storage capacity in the Gulf Coast region.
Stable, fee-based revenues
The soon-to-be-acquired Beaumont terminal should generate predictable, fee-based revenues, likely from storage service fees, throughput fees, and ancillary service fees, expanding Phillips 66's current portfolio of fee-based midstream assets and providing the company a higher degree of insulation from the historically volatile refining business.
Since customers generally pay service fees for reserving storage space for an agreed-upon volume of product irrespective of the actual storage capacity they end up using or the volume of product throughput, revenues from Phillips 66's Beaumont terminal would likely have virtually no volumetric risk and would therefore be highly predictable.
Further, demand for storage space on the Beaumont terminal will likely be extremely high, based on data from another major Gulf Coast storage terminal operator, Oiltanking Partners . Currently, capacity on Oiltanking's two major terminals -- Beaumont and Houston -- is 95.5% and 99% contracted, reflecting the glut of crude oil and petroleum products in the region.
Growing midstream presence
Phillips' announcement fits perfectly with the company's strategic expansion of its midstream and chemicals businesses, whose improved margins and stronger profitability has been crucial in offsetting the company's relatively weak refining margins in recent quarters. Within five years, midstream and chemicals are expected to account for roughly two-thirds of the company's enterprise value.
This year, Phillips plans to direct roughly 70% of its $4.6 billion capital budget for the year toward these business lines, which feature stronger and more predictable rates of return. Through its 50/50 joint venture with Spectra Energy called DCP Midstream, the company plans to construct an NGL fractionator and a liquefied petroleum gas export terminal along the U.S. Gulf Coast, both of which are slated for completion this year and will be meaningful contributors to EBITDA once they come online.
Improving Gulf Coast refining fundamentals
In addition to a positive outlook for its midstream and chemicals businesses, things also look brighter for Phillips' refining segment thanks to its presence in the Gulf Coast region. Given the current glut of crude oil in the U.S. Gulf Coast area, price differentials between domestic crude benchmarks like Louisiana Light Sweet (LLS) and Brent are expected to widen considerably, which should boost margins at its three Gulf Coast refineries -- Alliance and Lake Charles in Louisiana and Sweeney in Texas.
Over the next few years, Phillips 66's growing midstream and chemicals presence should continue to provide the company with a major competitive advantage over its downstream peers. The stronger and more stable incomes associated with these business lines should also insulate the company from any downturns in its refining business. While shares of Phillips aren't exactly cheap -- currently trading at 10.5x forward earnings, a slight premium to its peer group -- the company's 2.40% dividend yield and good prospects for dividend growth could make it a reasonably attractive long-term buy.
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The article Will Phillips 66's Big Bet on Midstream Pay Off? originally appeared on Fool.com.Arjun Sreekumar owns shares of OILTANKING PARTNERS LP. The Motley Fool recommends Chevron and Spectra Energy. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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