The 1 Refiner in All the Right Places

There are several large, long-term within trends in the North American energy revolution. This refiner has good exposure to all three and little exposure to low-margin, low-growth businesses.

Jun 5, 2014 at 3:32PM

Refiner Motley Pic


Investing in energy can often be a complicated matter, and many retail investors, unwilling to deal with the complications and risks, simply throw their hands up and buy one of the supermajors. Unfortunately, the supermajors have largely missed out on the biggest growth story in at least a few decades: the North American energy revolution. 

For those who want to go beyond the supermajors and get some exposure to the energy revolution in North America, there are a myriad of choices to make. Here are some of the bigger, overarching trends of the energy revolution going on in 2014:

  • Demand for dry gas and natural gas liquids is steadily increasing, thanks to their abundance. The biggest beneficiaries of this abundance are end-users such as petrochemical companies. 
  • Meanwhile, new supply areas of dry gas and NGLs have caused dislocation in the traditional gas transportation infrastructure. This is also somewhat true for oil. 
  • While the U.S. continues to import oil, production of light and sweet crude, which is the oil most commonly found in shale, will soon surpass demand. Because there exists a ban on crude oil exports, this could cause significant price volatility.

Wouldn't it be nice to have an established, well known company exposed to all of these trends? Well, look no further than Phillips 66 (NYSE:PSX). Phillips 66 is best-known as an oil to gasoline refiner, but since its spinoff from ConocoPhillips, Phillips 66 has been moving to position itself as a premium refining, midstream and petrochemical business. Unlike many other refiners, Phillips 66 has kept itself mostly in businesses that are beneficiaries of overarching trends. 

Advantaged crude
The North American crude oil market is largely walled-off from the rest of the world thanks to refining constraints and export bans. As crude production has increased in North America, the spread between global and domestic crude prices has widened.

The biggest beneficiary of this is crude oil refiners, and that is Phillips 66's legacy business. Phillips 66 buys the crude at discounted domestic prices, refines it into gasoline and other products, and then sells those refined products for global prices. There aren't many communities in the U.S. willing to accept a refinery in their own backyard, so the company's eleven U.S. refineries provide quite a wide moat. 

Chemicals and midstream
Phillips 66's plan for growth includes a three-year, $6.7 billion self-funded capital program in the company's chemicals business. The company will build an additional natural gas liquids, or NGL, fractionator in its plant south of Houston. It will also build an export terminal in Texas, and in 2017 will build additional pipelines, splitters and fractionators. Phillips 66's chemicals company is actually a joint venture with Chevron (NYSE:CVX). Like refiners, the chemicals company benefits from low input costs, and petrochemical producers in the U.S. currently enjoy the lowest feedstock costs in the world.

Finally, Phillips 66 further benefits from crude oil price differentials through its transportation business. The company's pipeline systems in the Rockies, mid-continent and Gulf Coast, along with its marine transportation network, collect fees to move crude from wellhead to refinery. As crude production grows in non-traditional producing areas such as North Dakota, there will be an acute need for midstream infrastructure. This is why Phillips 66 is spending the largest share of its capital expenditure on its midstream business. 

Psx Enterprise Value

Source: Phillips 66 Investor Relations

All the right places
As you can see, by 2018 Phillips 66's midstream business will be about as important as its refining business. Most important, however, is what's not on here. The low-margin marketing and sales business (gas stations and convenience stores) is a small and shrinking piece of the pie. This gives Phillips 66 a significant advantage over refiners such as Marathon Petroleum. As a refiner, petrochemical and midstream company, Phillips 66 has all of what you want, and almost none of what you don't. 

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Casey Hoerth has no position in any stocks mentioned. The Motley Fool recommends Chevron. 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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