Why Phillips 66 Has a Leg Up on Its Peers

Phillips 66 (NYSE: PSX  ) , the Houston-based independent downstream energy firm, had a solid year, with strong showings from its midstream and chemicals segments helping mitigate its underperforming refining and marketing segment. To shareholders' delight, the company recently approved a new $2 billion share buyback program and raised its quarterly dividend by 25%.

With plans to boost 2014 capital spending by 40%, let's take a closer look at what Phillips 66 has planned for next year and why it has an advantage over its downstream peers.

Solid midstream and chemicals assets
The biggest differentiator between Phillips 66 and other companies involved in the downstream business is its robust midstream and chemicals business. The company boasts a truly massive portfolio of midstream assets through DCP Midstream, a 50/50 joint venture with Spectra Energy (NYSE: SE  ) . DCP has midstream operations including 63,000 miles of natural gas pipeline, 62 owned or operated natural gas processing plants and treaters, and 12 NGL fractionation facilities.

In addition to its midstream assets through DCP, Phillips also boasts stakes in numerous fractionation plants and has a 25% interest in the Rockies Express natural gas pipeline, along with Sempra Energy (NYSE: SRE  ) , which also has a 25% stake, and Kinder Morgan Energy Partners (NYSE: KMP  ) , which commands a 50% interest in the 1,679-mile pipeline that stretches from Colorado to Ohio.

Next year, the company plans to invest $1.4 billion in its natural gas liquids operations and transportation business lines, representing an increase of more than $800 million over 2013, to finance the construction of two major facilities along the U.S. Gulf Coast, as well as several rail offloading facilities and other projects aimed at improving the company's access to advantaged crude feedstocks. The company will also develop new gathering and processing projects next year, as well as increase gas-processing capacity in the Denver-Julesburg Basin, through its DCP joint venture.

As for its chemicals segment, Phillips' chemicals assets are part of CPChem, a 50/50 joint venture with Chevron (NYSE: CVX  ) . With roughly 80% of its production capacity located in the U.S., CPChem benefits greatly from advantaged access to low-cost feedstocks such as ethane. Next year, Phillips' share of CPChem's 2014 capital budget is expected to be $1 billion, up meaningfully over this year's level.

The increased spending will mainly fund the development of a 3.3 billion-pound-per-year ethane cracker and two 1.1 billion-pound-per-year polyethylene facilities in Old Ocean, Texas, that are slated to start up in 2017. The CPChem joint venture also expects to bring online its massive 1-hexene plant in Baytown, Texas, which will have a production capacity of up to 250,000 metric tons per year, in the first half of next year.

Improving refining business
Though Phillips 66's refining business was a relative underperformer this year, its performance should gradually improve over the years, thanks to the company's heavy investments in rail and other logistics assets. Through ventures with third-party operators, the company plans to boost shipments of cheap inland oil to its refineries nationwide by as much as 130,000 barrels a day, which should help reduce feedstock costs over the long term.

For instance, Phillips has an agreement in place with Enbridge Energy Partners (NYSE: EEP  ) that will allow rail shipments of as much as 35,000 to 45,000 barrels of Bakken crude oil to its East Coast and West Coast refineries. It also has a deal with Magellan Midstream Partners (NYSE: MMP  ) that will provide its Ponca City, Okla., refinery greater access to crude oil produced from the nearby Mississippi Lime play.

Phillips has also boosted access of cheap crude oil to its Bayway refinery in Linden, N.J., which now receives some 90,000 barrels of Bakken crude, up from next to nothing a year ago, and is currently constructing an offloading facility that will allow Bayway to directly receive even more Bakken crude. Similarly, the company was recently given the green light to proceed with a rail offloading facility capable of processing 30,000 barrels per day at its Ferndale, Wash., refinery. Both offloading facilities at Bayway and Ferndale are slated to go into service in the second half of next year.

The bottom line
Though Phillips 66 is generally viewed as a downstream company, investors shouldn't overlook the company's significant and growing midstream and chemicals assets, which will represent a much bigger share of total earnings and capital expenditures in the future. These segments are both a major source of differentiation from its peers and a catalyst for medium-term and longer-term growth, since they have not only generated higher returns for the company so far, but are also less volatile than its refining segment and tend to generate more steady, dependable cash flows.

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