菲利普斯66 (PSX) 2016 Q2 法說會逐字稿

Welcome to the second quarter 2016 Phillips 66 earnings conference call. My name is Erica and I will be your operator for today's call.

(Operator Instructions)

Please note that this conference is being recorded. I will now turn the call over to Rosy Zuklic, General Manager, Investor Relations. Rosy, you may begin.

Thank you. Good morning and welcome to the Phillips 66 second quarter earnings conference call. With me today are Greg Garland, Chairman and CEO; Tim Taylor, President; and Kevin Mitchell, Executive Vice President and CFO. The presentation material we will be using during the call 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. It is a reminder that we will be making forward-looking statements during the presentation and our question-and-answer session. Actual results may differ from today's comments. And factors that could cause those differences are listed here as well as in our filings with the SEC.

With that, I'll turn the call over the to Greg Garland for some opening remarks. Greg?

Thanks, Rosy. Good morning, everyone, and thank you for joining us today. We're committed to our strategy of growing our high-valued businesses and our focus on performing well. Operating excellence remains a top priority. Operating safely, running our assets well, and managing cost.

During the quarter we delivered solid operational excellence performance. Refining performed at record rates achieving 100% utilization. For the first half of the year, our personal safety metric, which we believe was already among the best in our industry, improved 16%. And our process safety metric improved 75% compared to the prior year.

In chemicals, CPChem completed three major turnarounds this quarter. The [global] olefines and polyolefines businesses operated at 91% of capacity. TCP and GL volumes were up and reliability of operations improved.

Total adjusted earnings for the second quarter were $499 million. The market environment remained challenging as low margins continued to impact our DCP Midstream, NGL trading and refining businesses. However, our fee-based midstream business performed well and we continue to see good demand in chemicals.

Although demand for refined products is up relative to last year, the weighted average market crack was more than $5 per barrel below where it was a year ago and crude differentials remained tight. We remain focused on executing our strategy in those areas under our control. Our growth projects are all progressing well and we continue to see great value and opportunity long-term.

During the second quarter, the Dakota access pipeline project began laying pipe and is expected to be completed by the end of the year. Once in service, the [Dapple Epcot] pipeline is expected to provide the most economic option for moving Bakken crude to the Gulf Coast. In the Gulf Coast, the Beaumont terminal expansion is ongoing. We have 3.2 million barrels of new storage capacity under construction, 2 million of which should be in service by year end. We have plans to ultimately expand this facility to 16 million barrels.

Also in the Gulf, development of the first phase of the Sweeny hub is nearing completion. Sweeny Fractionator One is operating well. However, volume mix across all of our fractionators remains impacted by heavier NGL feedstock as a result of continued ethane rejection.

We expect construction of the 150,000-barrel per day Freeport LPG Export Terminal to be completed later this year. Our [master] limited partnership, Phillips 66 Partners, remains an important part of our midstream growth strategy and is a significant source of attractive funding. In May we completed a $775 million dropdown and PSXP successfully issued over $650 million of public equity. PSXP increased its limited partner distributions by 5% in the second quarter and remains on track to achieve its growth objective of a five-year, 30% distribution compound annual growth rate through 2018.

DCP Midstream is making progress on its strategic initiatives. DCP expects to achieve cash breakeven at NGL prices below $0.35 per gallon this year. DCP is working on its cost structure, reducing capital and converting comodity-exposed contracts to fee based to improve financial strength. We expect DCP to be self-funded going forward.

CPChem continues to advance the US Gulf Coast petrochemicals project. It is now 80% complete with an expected start-up in the second half of 2017. Once running, CPChem's global ethylene and polyethylene capacity will increase by approximately one-third. As capital spending is reduced, we should see increased distributions from CPChem starting next year.

During the quarter, we advanced several refining projects. At the Wood River refinery, we're undergoing debottlenecking and are on schedule for completion in the third quarter. At the Billings refinery, efforts are underway to increase the amount of heavy Canadian crude we can run to 100%. At Bayway, work on the FCC modernization is progressing. These are all high return, quick payout projects.

Our marketing specialty segment is the highest returning in our portfolio. In the US, we are increasing branded and unbranded volumes and we're selectively pursuing incremental growth opportunities in Europe. We're mindful of the current market environment and we've maintained our capital disciplined approach in terms of how we allocate capital. We continue to target a long-term 60/40 split between reinvestment in our business and distributions back to the shareholders.

During the quarter, we generated over $1.8 billion in cash from operations in a PSXP equity offering. We returned over $570 million of capital to shareholders through dividends and share repurchases in the second quarter and increased our quarterly dividend by 12.5%. This represents our sixth dividend increase since the formation of our Company with a 33% compound annual growth rate.

We've returned $12.3 billion to shareholders over this four-year period through dividends and repurchase or exchange of 118 million shares. We reinvested $620 million into our businesses during the quarter. We're looking at all of our projects in our portfolio to ensure that we only advance projects that meet our return expectations. We've made a decision to defer FID on frac 2. We're also working with our partners through project finance Dapple Epcot.

We're going to give you some more detail around our 2016 capital expenditures later this summer, but at this point we expect our capital expenditures for the year to come in below $3.3 billion, well below our $3.9 billion capital budget.

So now I'd like to turn the call over to Kevin Mitchell to review the quarter results. Kevin.

Thanks, Greg. Good morning. Starting on slide 4, second quarter net income was $496 million. We had two special items that netted to a loss of $3 million. After removing these items, adjusted earnings were $499 million or $0.94 per share.

Cash from operations for the quarter was $1.2 billion. Excluding almost $600 million of working capital benefit, operating cash flow was $560 million. Undistributed equity earnings totaled almost $350 million. Capital spending for the quarter was $620 million with approximately $340 million spent on growth, mostly in midstream.

Distributions to shareholders in the second quarter totaled $571 million, including $329 million in dividends and $242 million in share repurchases. At the end of the second quarter, our debt-to-capital ratio was 27%; after taking into account our ending cash balance our net debt-to- capital ratio was 22%. Annualized adjusted return on capital employed was 6% for the first half of 2016. Our adjusted effective income tax rate for the second quarter was 31%.

Slide 5 compares second quarter and first quarter adjusted earnings by segment. Quarter-over-quarter adjusted earnings were up $139 million driven mainly by improvements in chemicals, refining, and marketing and specialities.

Next, we will cover each of the segments individually. I'll start with midstream on slide 6. After removing the noncontrolling interest of $22 million, midstream's second quarter adjusted earnings were $39 million, in line with the first quarter.

Our transportation business is composed primarily of fee-based assets. Transportation adjusted earnings for the quarter were $65 million, down $7 million from the prior quarter, driven by higher operating costs including seasonal maintenance. Equity earnings from Rockies Express pipeline were lower due in part to contract restructuring to lengthen the term of a commitment. These items were partially offset by improved volumes.

In NGL, adjusted losses were $17 million for the quarter. The $6 million decrease from the prior quarter was largely driven by project expenses related to the Freeport LPG Export Terminal and lower earnings due to timing effects of seasonal storage. These decreases were partially offset by the benefit of higher fractionation volumes compared to the first quarter.

Adjusted losses for DCP Midstream were $9 million in the second quarter, a $12 million improvement compared to the previous quarter. This was primarily due to improved operational efficiencies, higher recoveries, continued cost savings, and increased commodity prices.

Turning to slide 7. In chemicals, industry chain margins increased during the quarter as demand for polyethylene remained strong. Second quarter adjusted earnings for the segment were $190 million, up $156 million from the first quarter. In olefins and polyolefins, adjusted earnings increased $25 million largely due to higher margins driven by increased polyethylene sales prices.

In addition, equity earnings also improved due to stronger margins. This was partially offset by higher operating costs from planned turnaround activity. Global O & P utilization was 91%. Adjusted earnings for SA & S rose by $9 million on higher equity earnings from increased sales prices.

In refining, we ran well with 100% crude utilization for the quarter. In addition, clean product yield increased from 82% to 84% with gasoline yield at 45% for the quarter. Pretax turnaround costs were $69 million, $31 million lower than guidance, due in part to the deferral of certain maintenance activities.

Despite higher market cracks in all regions, realized margins were $7.13 per barrel, roughly the same as in the first quarter. This was primarily due to higher losses on secondary products and lower clean product differentials.

The chart on slide 8 provides a regional view of the change in adjusted earnings compared to the previous quarter. In total, the refining segment had adjusted earnings of $152 million, up $66 million from last quarter. Regionally, earnings were higher in the Atlantic Basin, Central Corridor and West Coast, reflecting the benefit of higher margins and volumes. Earnings were lower in the Gulf Coast as the benefit of higher volumes was more than offset by lower margins caused by lower product differentials and higher secondary product losses.

Next, we will cover market capture on slide 9. Our worldwide realized margin was $7.13 per barrel versus the 3, 2, 1 market crack of $13.84 per barrel resulting in an overall market capture of 52%, compared to 67% in the first quarter. Market capture is impacted in part by the configuration of our refineries and our production relative to the market crack calculation. With 84% clean product yield for the quarter, we made less gasoline and slightly more distillate than premised in the 3, 2, 1 market crack.

Losses from secondary products of $3.41 per barrel were $1.51 per barrel higher this quarter as the price differential between crude oil and lower-valued products such as coke and NGLs increased. Feed stock advantage was slightly higher than the first quarter, but crude differentials generally remained tight.

The other category mainly includes costs associated with RINs, outgoing freight, product differentials and inventory impacts. These costs were higher than the first quarter, primarily due to lower clean product differentials and higher RINs prices.

Let's move to marketing and specialities where we posted a strong second quarter despite the rising commodity price environment. Adjusted earnings for M & S in the second quarter were $229 million, up $24 million from the first quarter. In marketing and other, the $37 million increase was largely due to higher margins in international marketing and higher domestic gasoline volumes. Specialties' adjusted earnings decreased by $13 million, primarily as a result of lower base oil margins partially offset by higher lubricants volumes.

On slide 11 the corporate and other segment had aftertax net costs of $111 million this quarter, an improvement of $16 million from the first quarter. Net interest expense decreased by $2 million, while corporate overhead and other expenses decreased by $14 million, primarily due to lower legal and remediation accruals and lower taxes.

Slide 12 shows cash flow for the year-to-date. We began the year with a cash balance of $3.1 billion. Excluding working capital impacts, cash from operations in the first half was $1.3 billion. Working capital changes increased cash flow by $100 million.

In May, Phillips 66 Partners raised $656 million in a public equity offering. We funded $1.4 billion of capital expenditures and investments, and we distributed nearly $1.3 billion to shareholders in the form of dividends and share repurchases. We ended the quarter with 523 million shares outstanding. At the end of June, our cash balance stood at $2.2 billion, up from $1.7 billion at the end of the first quarter.

This concludes my review of the financial and operational results. Next, I'll cover a few outlook items. In the third quarter in chemicals, we expect the global O & P utilization rate to be in the mid-90%s. In refining, we expect the worldwide crude utilization rate to be in the mid-90%s and before tax turnaround expenses to be between $100 million and $120 million.

We expect corporate and other costs to come in between $115 million and $125 million aftertax. And Company-wide, we expect the effective income tax rate to be in the mid-30%s.

With that, we'll now open the line for questions.

Hello, Erica. We're now ready for questions.

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

Your first question comes from the line of Blake Fernandez from Howard Weil. Please go ahead.

Folks, good morning. I had two questions for you. One, I wanted to clarify the CapEx comment. I just wanted to make sure that below $3.3 billion was indeed for 2016. And assuming that is the case, with these project deferrals that you've mentioned I'm assuming that alleviates some of the pressure on 2017 spending, so any kind of thoughts or outlook on 2017 will be helpful.

You're correct, the kind of guidance of below $3.3 billion was for 2016. We're still working 2017, Blake, but we've been saying for most of this year that we're on a glide slope to about $3 billion, maybe slightly under. So we'll give you some updates in the fall of where we're going to be in 2017. But I think around $3 billion, pretty good number for 2017.

Great. Thanks, Greg. The second question is on economic run cuts. Obviously we have your guidance here in the mid-90%s which is below 2Q but still pretty healthy. Some of your smaller peers are already talking about run cuts in 3Q. I'm just curious, does your guidance contemplate any run cuts or do you envision that happening?

I think that I'll let Tim jump in on his view on the industry. I think most of ours is reflective of turnarounds at this point in time. We run our LPs pretty frequently and we'll make those decisions as we get into the third quarter, but I think my personal view is we've got a lot of inventory stacked up. I think the industry's going to be facing run cuts in the second half of the year.

Yes, Blake. I guess we look at it and we think about the inventories heading in and it's a global issue as we think about where the supplies come on this year. And ultimately the way to rebalance the product side of the market is that run cuts will come.

So I think everyone's kind of looking at their own kit, configuration, and will make those calls. But I think that that is something that will happen to kind of rebalance the whole supply side. That said, the demand side's been good. So that's been the strength of it. We've definitely responded as a global industry with a lot more supply.

Appreciate it, guys. Thank you.

Take care.

Your next question comes from the line of Paul Sankey from Wolfe Research. Please go ahead.

Good morning, all.

Hey, Paul.

Afternoon all. Afternoon and morning. The project on the Gulf Coast, the cracker, is that ahead of schedule or are we still looking at a sort of mid-2017 type start in?

Yes, Paul, there's two pieces of the cracker project. One is the derivatives project, the polyethylene plants at Sweeny and the second is the cracker at Bay town which is just east of Houston. The derivatives plant, those projects are still online, they come online actually before the second half of 2017 to be complete.

The cracker is now looking like it's going to complete in the second half of 2017. And that's really the change that we're seeing, primarily related to productivity and the complexity of that project we're seeing several months delay. So continue to progress on both of those very well but the cracker is behind where we're seeing the derivatives project at this point.

Yes, forgive me. I've somewhat lost track. I think originally it was an end of 2017 start-up overall, wasn't it, or --?

We were thinking, probably, start-up we were saying mid-2017. (Multiple speakers) Yes, we were. And so I think this from an ethylene standpoint pushes it out in the second half of the year. But the derivatives piece will be up earlier.

Understood. Are you implying the costs are higher than you had anticipated?

I think that generally in line but with a delay you would expect maybe some increase in cost, but I think certainly well within the scope of what we're thinking. I would anticipate that it's higher than what we had thought when we hit that mid-2016 or 2017.

Somewhat related just a (inaudible) question that's also related to another business division, but what's your view of the NGL market here and the availability for those projects of cheap feedstocks and the general -- and if you could just update us on your general view of what you're seeing in NGLs, that would be great. Thank you.

Okay. So on the NGL side, we had pretty strong response in the second quarter. Ethane started coming out of rejection, but we've actually seen kind of NGL prices begin to fall. And I think that the real key on this is, A, export demand and the pet chem demand in the industry. So we're still seeing supply and we're still seeing ethane in rejection that's there to feed the new cracker start-up. Until those crackers start-up on the ethane side, we think that will be the main driver starting to pull more ethane out of the gas stream which should strengthen the ethane price.

On the propane side we've had strong exports and that's kept the propane market really connected to the international pricing in the international markets. We saw some short-term cancellations I think this summer as really the differentials between the US and some other markets start to close. We're starting to see corrections. Our view is that long term you still have excess length in both ethane and propane and propane has to lead the market to rebalance and clear.

And so I think that what you see is you see the market start to readjust and we're starting to see some of that now in the prop pricing this month in July. So I think we're still, overall, still seeing a lot of value in that LPG value chain and growing production as soon as crude oil production, gas production resumes out in the future.

Thank you.

The only thing I'd add, Paul, just short-term we think it's going to be pressured here in the back half of the year, both crude and NGLs.

Yes, I know what you're saying. Thank you.

Okay. Take care.

Next question comes from the line of Jeff Dietert from Simmons. Please go ahead.

Good morning or good afternoon, I guess.

Hey, Jeff.

Depends on where you are. On the refining side, you've got a diverse portfolio across multiple regions and different types of refineries. Could you talk about which regions, which types of refineries might be most impacted as far as refinery runs in the type of market environment that we're in now.

Yes, Jeff, this is Tim. I think fundamentally simpler refineries that run on light sweet crudes are going to be the most impacted. Clearly, there's been a sustained differential on the heavy light side, the bias toward the heavy, medium crudes are pretty available.

So I think that as you think about the system, we would expect the heavier oriented refineries to be very competitive and the real pinch point comes on the lighter refineries around the globe and then that depends a lot on their configuration as well. And clearly, as usual, if you think around the world, the Atlantic Basin's going to be a pinch point and possibly some of the operations in Asia as we think about that.

Secondly, marketing and specialty performance was stronger than we had anticipated. Could you talk a little bit about the strength in that segment, maybe categorize some of the seasonal strength, some of the RINs influence, maybe just comment on what some of the stronger aspects were in that segment.

Well, it begins basically with good demand, right? You've got good pull-through in terms of demand, a response that we've seen globally by the consumer certainly in the US. Our volumes were up across some of the same store sites roughly 2.5%. So we produced more. We actually are moving to the markets. I think it reflects the strength on the demand side.

So we were able to capture a little better margin in terms of the value, if you will, of our distribution wholesale market. I think it speaks to strength there. The RINs are always interesting in terms of what's the impact in terms of the cost and the capture as it moves with the price. But I think that put a bias into the price of the product as well.

And I think we're able to capture some of that. It certainly shows up as a cost in refining. But it's a tailwind as well. You generate the RIN in marketing. Fundamentally, the spread, the wholesale margin was improved. I think that really reflects in our mind the strength of the consumer gasoline market. Distillate remains rather flattish from our perspective.

You mentioned product exports, 174,000 barrels a day in a quarter which was a strong quarter for exports. Maybe a quick comment on that and I'll let you go.

Well, you know, we did. We were able to bring up exports about 50,000 barrels a day. Good opportunity. And so I think we just look at the decision as a better inland placement or export sale. Clearly the Gulf Coast for us is a big piece of that.

We're very well-positioned to supply the demand in Latin America as we've seen some reduction in the run rates down there so it was a good market and then you had the RIN value on top of that, it provides some incentive as well. I think the export markets will likely stay strong for US refiners on the Gulf Coast.

Thank you.

Thanks, Jeff.

Your next question comes from the line of Doug Leggate from Bank of America. Please go ahead.

Thanks. I think this morning it's amazing how much controversy thus is causing this quarter. Good morning, guys. Greg, I wonder if I could ask first of all about a decision to defer the second cracker. Can you explain for us a little bit, has that been driven by yourselves, your partners? What was the basis of the decision there? And maybe now that you don't have the associated capital, what do you expect the free cash flow swing to be on CPChem next year?

So let me just clarify a point. It was the frac two we've deferred, not the second cracker. Although we can certainly talk about the second cracker.

I see. Sorry. (Multiple speakers)

Tim, if you want to talk about the cracker, go ahead.

Yes. On the cracker --

I apologize. That's what I was referring to, yes.

We actually continue to do engineering work, do site studies. Still like North America and we think about the long-term supply as we look around the world for that. But I don't see FID on that cracker until sometime 2018, 2019, just as we do development work and look at things.

So to the second part of your question, so next year capital spending at CPChem will decline with the completion of the first cracker. That may be in the order of $1 billion a year on that. And then in 2018 as you ramp up the production on the new cracker, you're likely to see at the CPChem level, both of those numbers, another $800 million to $1 billion with some upside depending on how the market is.

Substantial cash flow swing at CPChem if you think about free cash flow. We're anticipating we'll get strong distributions back from CPChem here beginning particularly in 2018.

I appreciate. Apologies for my confusion. I guess what I was thinking was that when you talk about the swing to positive dividend, I always assumed that the capital in 20 -- for the second project would be -- would start in 2017. I didn't realize the timing had been pushed. So if you deduct [those] dollars that you're talking about, that's a gross number at CPChem?

Yes.

Yes. That's the change, kind of roughly just from the cracker impacts.

Got it. Thank you. My follow-up if I may is really going back to the capital question broadly. It seems you're maintaining the return of capital to shareholders whereas the capital seems to be taking the flex on the environment.

I'm just wondering, is that the right interpretation going forward? In other words, how do you see your buyback strategy as it relates to use of proceeds from future PSX (inaudible) equity sales and dropdown and so on? Is that something we should expect to be (inaudible) (multiple speakers) --

So let me take that and talk about them both. I think that we've said, in terms of the capital spend at PSX, we've always been on the glide slope towards $3 billion. There's no question our capital the last two years has been very high as we've tried to advance the midstream business and get PSXP to scale quickly.

That was a decision we took really kind end of 2012, coming into 2013. When we think about share repurchase, we think about intrinsic value and as long as the shares are trading below intrinsic value, we're going to be in the market buying. We're in the market every day buying. Some days we buy more than others. That's true.

And I'd say consistent with our guidance that we've been giving in 2016, we're going to be between $1 billion and $2 billion of share repurchases this year.

Is that (inaudible) you can give for 2017, though?

We haven't given outlook on that. But I would say we'll probably be within that same range in terms of share repurchase for 2017.

Appreciate your answers, guys, thank you.

Absolutely.

Your next question comes from the line of Ed Westlake from Credit Suisse. Please go ahead.

Yes. First a small one. Just in the quarter -- good morning, everyone -- the cash flow ex working capital obviously was weak. What would be the three things, aside from, I guess, refining margins that you'd point to?

Yes, Ed, this is Kevin. So bear in mind that the almost $350 million of undistributed equity earnings, so that's reflected in the earnings number, but the distributions aren't coming back. The bulk of that is in CPChem. But you also see it at WRB JV, XL power lubes and then the several other smaller JVs.

Some of those, it's reflective of the investment that's taking place inside of those JVs that's consuming that cash. Some of it, a portion is just a timing effect, the distributions aren't necessarily ratable. So when you think about the $560 million of cash flow excluding working capital, if you were to add back the undisputed equity earnings to put it on a sort of consistent basis, that's just over $900 million of operating cash flow, which then lines up with what you'd expect from the earnings generated, given the environment.

All right. Okay. And then I do want to touch on NGL frac two. So is that just a function of matching upstream customer plans? Is it because cash flow in the short term's a little bit weaker because of refining or is it because there's maybe better things to do out in the broader MLP space, given you've got PSXP and obviously your own balance sheet that you could use?

We've always consistently said we'd never build a speculative frac. I think our view is that NGLs will continue to grow but they're going to grow slower than what we thought two years ago. And so I think that the decision to push the FID on frac two simply reflects that, Ed.

Right. Okay. And then a broader comment then on the second part of that around the opportunity set to look at inorganic growth across the portfolio in the MLP land.

I think that's always something we look at every day in terms of the inorganic growth. The other thing I would say is we think we still have a pretty good backlog of organic projects we can invest in around our own infrastructure, whether it's more terminals, butane blending, ethanol blending, more pipes. I think that just around the portfolio we still have a really good backlog of investable opportunities for the MLP.

There's no question, when you think about the long-haul, third-party where their crude pipes or NGL pipes are fracs, I think those opportunities are probably diminished versus what we thought two years ago.

Thank you.

And, Ed, just to comment, we purchased additional small interest in Explorer pipeline as one of the opportunities we look at inorganic. But that's a pipeline we've been -- it's in PSXP today, but predecessor to PSXP, Phillips, we've been investors in that pipe for a long time, so it fits strategically.

But I think those are kinds of inorganic bolt-ons that we look at that say they can add value and they fit strategically with our overall footprint that PSX and PSXP.

Thank you.

Your next question comes from the line of Roger Read from Wells Fargo. Please go ahead.

Good morning.

Hi, Roger.

I guess kind of coming back to some of the cash flow questions, obviously PSXP is a significant contributor year-to-date and would expect so going forward. Any way to think about what the contributions from that to the overall PSX cash flow statement should be as we look out through 2017?

Yes, Roger, it's Tim. So if you look back in history and you think about our spend, we anticipate about $2 billion a year of funding or purchases, if you will, at PSXP. To the extent that those are PSX, it's a project, just what we do. I think that's kind of to meet our target on distribution growth and our planned $1.1 billion of PSXP, you're kind of roughly in that $2 billion a year range of purchases. So that will be a source that equity and debt financing that will finance that.

Okay. And so I'm just trying to think from a modeling standpoint we could essentially assume a majority of that being available to PSX, but probably not wise to consider 100% of it?

Yes. I mean, the majority of -- we have a large backlog of organic that we're developing that would fit logically in the MLP. So that's been the strong connection so far with smaller bolt-on outside inorganic. But, yes, so the majority of that I think you can think about as PSX and -- but we're always looking at opportunities to add to the value through outside opportunities as well.

Okay. Great. And then what --

Roger --

Sorry. Go ahead.

Run rate EBITDA of $400 million at PSXP today. We feel really good by end of 2018 being a run rate EBITDA of $1.1 billion. We see a clear path to get there. Don't see an issue at all in getting there.

Perfect. My other question, this kind of ties back into the run-cut question and the guidance of the mid-90%s and then in just the second quarter kind of undershooting on the expected -- I guess it's called maintenance expense or the turnaround expense. What specifically on the maintenance side was deferred? And since the guidance makes it sound like it's a pretty modest amount of spending in Q3, I'm assuming deferred out of Q3.

I was under the impression a lot of this is not something you can defer. So I'm just sort of curious what changed in the operations on the refining side and maybe do we have to think about 2017 as a higher turnaround year?

So basically our major maintenance turnaround's still on schedule we planned. These are relatively small unit turnarounds that just were able to defer. They just move around sometimes on planning basis.

But the fundamental way that we go about the major turnaround planning is unchanged. So I think our guidance where we typically get to on turnaround expense is pretty consistent year on year. Flexes a little depending on which refinery, but we really haven't changed our philosophy on turnaround expenditures and timing of those.

Okay. Thank you.

You bet.

Your next question comes from the line of Brad Heffern from RBC Capital Markets. Please go ahead.

Hi, everyone.

Hi, Brad.

I wanted to circle back on some of the CapEx conversations from earlier in the call, Greg, respecting that you said you'll give more detail later this summer, I think. But I'm curious why the CapEx is coming in so low? Obviously you cited the frac two deferral, but I wouldn't think there was any CapEx in the budget for that. It sounds like the major projects are on budget. So what exactly is it that's leading to the lower numbers?

Well, it's several projects in midstream beyond frac two that we're looking at. I also mentioned the project financing of DAPL Epcot. And so that's going to be a very classic type project finance and so our share of that would be somewhere around $600 million-ish, I would say.

Probably most of it would be in 2016, maybe a little bit spilled over in 2017. But you just kind of sum all that up and that's really how you get to a $3.3 billion level. And frankly, we're still working the numbers and I suspect it's going to come in below $3.3 billion when we give you guidance in a couple months.

Okay. Thanks for that. And then I was wondering if you could just talk a little about the dynamics in the Atlantic Basin on the refining side right now? Obviously the arm has been opened, but it seems like products going nowhere but in the tanks on the East Coast. So something seems to have to give on the refining utilization side, and since you guys see both sides of the market there, how do you see that playing out?

You're right. We've had a lot of build of inventory in pad one in New York harbor. There's been an incentive on Europe to continue to run. I think that reflects storage economics right now. But that is a place that needs to rebalance. Somewhere between the US East Coast and some of the European refineries, we still look at that, say there needs to be some balancing on the inventory side or the production side to balance that out.

And that typically tends to be a more marginal or higher cost area, another reason we think about that. So a lot of dynamics in play around that and we'll have to see how it shakes out. No matter how you cut it, some plays you've got to get the production and demand back in balance a bit more on the refining side. That's why we anticipate that run cuts come and that would seem to be one of the places that we look at that think that could occur.

Okay. Thanks. And then quickly kind of related, is there any update on Whitegate? Is that still in the sale process?

I would say we're still in process on Whitegate. I think I would tell you we're pleased with the progress to this point and hopefully, as I said I think on last quarter, our intention is we get this closed this year.

Okay. Thanks.

You bet.

Your next question comes from the line of Ryan Todd from Deutsche Bank. Please go ahead.

Great. Thanks. Maybe just one -- a follow-up question regarding some of the PSX and PSXP strategy. Just curious as to whether organic cash flow business at the base business, if you were to continue to see weakness in refining of the midstream or so on through 3Q and 4Q, does the level of organic cash flow accelerate or change the pace at all of PSXP drops in terms of how you see the timing play out in 2016?

No. I think, again, we look at PSXP. We talked about our $1.1 billion targets. You've got to continue to progress to make the distribution coverage. So we have a strong backlog of MLP-able income available and so we're going to continue to grow that, hit our target there in 2018. So we're continuing to see good midstream cash flows in our fee- based assets and that's a key component of what we want PSXP to do.

Okay. Thanks. Maybe one on M&A. In your strategic update portion of the note, you hint that you're evaluating all parts of your portfolio, which is something I hadn't seen in prior releases.

I guess, can you expand any more on that? Things that you're looking at in the portfolio? Would you be considering selling anything that's in the portfolio? And, if so, is there anything you can comment in terms of non-core things that might potentially be on the table?

I think my comments earlier were around the capital budget and the projects that we have on deck and ensuring that any project we do meets our hurdle rate expectations. In terms of the overall portfolio, of course, we have the process on Whitegate we just talked about. I think as we come to the end of the Whitegate process, I don't think there's a lot more in the portfolio that we have on deck. Certainly for 2016 or thinking about it into 2017.

In terms of potential M&A, we look at every day. I would say that prices still look relatively high to us, relative to the organic opportunities we may have in front of us. We would look at that. If we can find assets for the right value, we're certainly willing to do that. I think the Explorer one was a good example. But that was done at the PSXP level and I think, in terms of midstream, you'll see us doing more and more activity at the PSXP level.

Great. Thank you.

You bet.

Your next question comes from the line of Faisel Khan from Citigroup. Please go ahead.

Good afternoon, thank you for the time.

Hey, Faisel.

Hi. Greg, I just wanted to go back to -- and Tim -- your prepared comments around the Freeport export facility. I think that is beginning the commissioning phase right now. If I remember right, I think the contracted volumes were, I think, six cargos a month. Just wanted to make sure I understood some of your commentary around that. I think you were talking about a lower number in the commissioning phase.

Yes. So we're about 97% complete on the LPG terminal. There's different pieces. So we're actually right at the front end of our commissioning and drying out process, getting it ready. So we anticipate that we'll be operational toward the end of the year. We are actually essentially completing construction and now working into the commissioning piece of that business. So that's about to become operational.

On the market side, you asked about the contracts, we continue to work the contracts. Greg said the commodity environment's challenged today. So I think that the commercial arb or opportunity is narrower than what we had originally planned in the short term, but we still fundamentally see that strength. And as I said, it's got to clear the market here somewhere to really make everything balanced just based on the demand side.

So we feel pretty good about the longer term fundamentals there with some stress short-term, I think, on the commercial side of that. But the load across that looks really solid to us. We continue to work that.

Okay. Do the contracts support the ramp that you guys talked about, the $200 million to $400 million in EBITDA? Is that something -- the current situation in the market doesn't impact sort of how we model those cash flows ramping up into the first half of next year.

We said that the EBITDA on that project, $400 million to $500 million, 20s% or so would be commercial opportunities and so the ramp-up schedule really relates more to the fee. And I think that what we're seeing is that opportunities for that are going to be a bit lower, but in the commercial arb really where we're seeing most of the compression in terms of that run rate. But we're ready to ramp up when that thing becomes operational as these contracts start to kick in and we get the asset in play, but that takes a bit of time as you bring up the operation.

On the marketing and specialty side, obviously that business continues to remain strong and generate high returns on capital. It looks like you're investing a little bit more capital in that business, if I'm looking at some of the commentary correctly. The upgrading of sites, buying more additional sites in Europe, and I was just wondering if you could comment about whether you are increasing the amount of capital into that business with sort of the addition of sites and sort of improvement of branded sites across your network

So, Faisel, most of that capital, the capital investment in sites is in Europe. We have a great market position, good return. But it's going to be modest, just given the size of the market and the rate at which it's growing. So it's really, I think, a level that we see continuing to go forward.

On the US side, a little bit of capital on the marketing side for that. But most of this is done through our dealers and our marketers, our customers. And so it's part of our marketing structure but making good progress in terms of revamping the sites, particularly on the 76 and the Phillips 66 brand and we're seeing increased pull-through to the branded chain. So we're strengthening that really through our marketing and commercial relationships versus a capital investment piece that we're driving.

Last question from me. You guys talked about sort of the headwind from secondary product pricing during the quarter. Is most of that now resolved, now that sort of crude's flattened out and come off a bit? I just wanted to make sure I understand if that headwind is still continuing into the third quarter or has it completely been sort of resolved?

Yes, crude ran up quite a bit in the second quarter and so as it comes off, the margin between, say, a coke and the crude, that differential widens back out. That said, some of the other products are LPGs. To the extent that NGL prices -- I mean, propane prices come down significantly here recently. And so as you see that, it's kind of a moving target. But generally we do better with lower crude prices in terms of the secondary product loss, if you will. That narrows. It's basically a boost or tailwind for our margins.

Okay. Great. Thanks for the time.

You bet.

Your next question comes from the line of Paul Cheng from Barclays. Go ahead.

Hey, guys.

Hey, Paul.

Just curious, for the -- is there a you number that you can share on the fractionator one that seems to come onstream late last year, what's the contribution in the second quarter? And also when the LPG Export Terminal up and running, should we assume that the entire Sweeny NGL hub is going to reported under NGL business or is that the LPG terminal is going to be in the transportation segment?

It should all be in NGL. Let me take maybe a 30,000-foot view on this question, if I can, and then Tim can come in behind me and give you some of the details. So I know you have a concern around this and we understand that.

If I can just go to the 30,000-foot level and just talk about the Sweeny hub in general, we still think that that's a great project and we see value creation opportunity there. You think about NGL pipes coming out of the Permian, West Texas and Eagle Ford and going by Sweeny. You think about a world class refining, world class petrochemicals. We have the largest single site ethylene facility at Sweeny.

We're building 2.2 million tons of polyethylene capacity. We're building the fractionator. We're building the caverns. We're building the interconnecting pipes to Bellevue and on to [Preport], and then 150,000-barrel-a-day LPG export facility. We still like that concept and what we're creating there. I think short term, what you're seeing in the market, there's going to be stress in the LPG side of it.

The frac is running well. It's running to design limits. We're seeing certainly heavier feed than what we premised. So we're running about 80 a day at the frac today versus 100%. But it's completely loaded in the back end of the frac.

The other thing I would say is as this project is coming up, we have a lot of project expenses that are hitting us beyond just the frac. So think about the pipes and the caverns and the commissioning, the start-up of the LPG export facility. So you should expect to see those costs continue through the end of 2016.

But when you talk about the frac itself, we dropped it, all of it. It's at PSXP today. The EBITDA's about $100 million. So $25 million a quarter. There's a little bit of leakage that goes to the noncontrolling interest. So then you take that and bring it to a net income level and that was more than offset by the project expenses we had and the seasonal trading activities that we had in our NGL business. So I think of that.

But we're not worried about this whole NGL complex that we're building at Sweeny in terms of it coming up and we're looking forward to getting the LPG export up later this year. We'll start commissioning activities actually in the next couple weeks as we start thinking about that. And so I just want to say that we still really like this project a lot. And, Tim, if you want to fill in anything I missed, you're welcome to do that.

No, I think it really is about the total. And Paul, so you know, it's a PSXP asset today. Greg said we're down a little bit with the ethane. As the ethane comes out of rejection, that comes up naturally. It also starts to load more of a pipe in the caverns that are there.

Relatively small contribution but it's up and it's running a lot better. We have had great operational improvement the second quarter and so that's what we're focused on and then we've got to get this LPG up and get the entire value chain going on that one.

Kevin, do you have a number you can share? What is the RIN cost and (inaudible) in the resell for the refining segment? And what is the RIN benefit that (inaudible) in the marketing segment in the second quarter?

Paul, we haven't disclosed our specific RIN costs in refining or benefits in marketing. But you highlight the situation, so we do have the RIN exposure in refining. We have an offset in marketing. Obviously as RIN prices increase, that's hurting refining more and you see that reflected in our capture rates. But there's offset in marketing. But we don't provide the actual numbers.

And in the page 9 of your presentation as you guys go through that was mentioning that the inventory impact on the margin capture rate. Can you elaborate what exactly we're talking about here?

So the inventory impact is -- so to the extent there's an inventory impact in our capture, it's reflected in that other bar. The actual effect in the quarter was --

I understand. I just think that you mentioned that bar is related to inventory impact. I'm just trying to understand what is that impact? What's causing that impact or how big is that? That number is over $2 per barrel is a pretty big number.

Yes. So it's a combination of your RINs expense, product differentials, outbound freight costs, any inventory effect. They are all in there and inventory is normal.

So the inventory is not a major cause on that one?

No. No.

Okay. And team -- when you run through your LP, is Bayway or Whitegate or Alliance, those (inaudible) refinery, is it still make sense to run that through or actually look like you should doing some run cut?

We don't disclose individuals but, yes, I think, as I made the comment, I think we think about it and look at the light sweet and say where would that incrementally be and based on the products and the configuration. So rather than -- just go ahead and say we always look at that and we'll look at that, make sure that incremental barrel has incremental profit. And to the extent that we don't, we'll cut crude runs.

But you haven't seen it yet for those three facilities within your portfolio?

No.

Okay. Thank you.

Thanks, Paul.

Your next question comes from the line of Phil Gresh from JPMorgan. Please go ahead.

Yes, hi there. My first question is you talked about the $400 million of income at PSXP going to $1.1 billion. I just wanted to clarify, is that all, I guess, project-related EBITDA growth or is some of that drops? I guess what I mean is I'm trying to understand how much midstream EBITDA growth you're expecting from 2016 to 2017, given that you have a lot of one-time costs that you're incurring this year to ramp the projects.

So the $1.1 billion is a target of both existing assets when we began as well as our growth projects, as we think about the composition, so exactly what we drop when is something that we always look at. So it's going to be a combination of both of those. But as you look at the midstream EBITDA we put out in 2018, we grow from around $1 billion, say, in refining and midstream income when we started in 2013, 2014, pushing that up over $2 billion. So that's really the growth that's there.

Some of that's commodity as well. So there's some -- depending on the commodity markets, could be some of that about 20%. And that's really how we think about it is that look through EBITDA, you've got $1 billion plus of EBITDA growth over that period. But what you put into PSXP is a mixed question that we really don't address specifically.

Okay. So if I strike the PSXP part of it, do you have a view on how much EBITDA growth you'll get out of these midstream projects between 2016 and 2017? For example, the [400 to 500] from the Sweeny hub and the other projects.

So the end of 2017 you put the Sweeny hub, you've got DEPL Epcot, you've got Bayou Bridge coming on. You're pushing up well over $500 million of incremental EBITDA in the midstream, both a combination of PSXP as well as PSX.

Okay. Thanks. My second question is just for Kevin on the balance sheet. In the past we've talked about whether you consolidated balance sheet or ex PSXP.

Generally curious how you're thinking about that today. With this macro environment we're seeing in the back half that could be potentially worse than the first half on free cash flow, general willingness to use the balance sheet in an interim period to continue buybacks, noting that 2Q buybacks were the lowest we've seen in a couple years.

So, yes, so debt to cap, 27% fully consolidated at the end of the second quarter. On a net basis, 22%. When you exclude PSXP, I think it's 25% total; 19% on a net cash basis. So still a fair amount of headroom from a balance sheet standpoint, balance sheet capacity to weather the ups and downs in the market.

Most of the capital programming -- Greg talked about $3.9 million capital budget coming to something $3.3 million-ish for the year. But a lot of the capital is locked in and so that's where having the balance sheet capability to deal with that over that time period certainly helps us. The MLP model is a critical part of the overall funding. So as we continue to grow the ML P dropdown assets, you'll see cash coming back to the PSX level. And it's going to be in the form of --you'll see equity raises like we did in the second quarter and you'll see debt going on the MLP as well.

Just one thing, Phil, that I would add to that. We're kind of on a glide slope to $3 billion. So think about kind of $1 billion-ish of sustaining capital and $2 billion of growth. Most of that growth is really directed towards midstream and we fully expect that we can fund that coming out of the MLP.

Got it. Okay. Thank you.

You bet.

Thank you. We have now reached the end of our Q&A session. I will now turn the call back over to Rosy for closing remarks.

Thank you, Erica. Thank you all for your interest in Phillips 66. If you have additional questions, please feel free to give C. W. Mellon or myself a call. Thank you.

Have a good day.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.