How This Refiner Is Seeking Stable Income Through Midstream Assets

Source: Wikimedia Commons 

The rise of fracking is what's on every energy investor's mind, and one refiner is seeking to rake in an extra billion dollars a year off of it by expanding into a different oil and gas segment. Phillips 66 (NYSE: PSX  ) is guiding to generate ~$1.5 billion a year in EBITDA from its midstream operations by 2017, which would be three times the amount it made in 2013, excluding income from its DCP Midstream operations. Through several growth initiatives, Phillips 66 hopes to reach that lofty goal in just four years. 

A partnership with tons of potential
While Phillips 66 is well known for selling gas and diesel through various retail stores across America, it also is a major player in the natural gas and natural gas liquids market. Through a joint venture with Spectra Energy Corp (NYSE: SE  ) in DCP Midstream, which owns 22.7% of DCP Midstream Partners LP (NYSE: DCM  ) , Phillips 66 has a stake in America's rapidly growing natural gas production. 

The 50/50 JV is owned by Phillips 66 and Spectra Energy, and has $13 billion worth of assets under its belt. $5.4 billion of those assets are owned by DCP Midstream Partners, which is owned by the JV (22.7%) and public unitholders (77.3%). This ownership structure can be confusing, just know that for all intents and purposes Phillips 66 and Spectra Energy have a sizable stake in DCP Midstream and DCP Midstream Partners' operations.

From 2010 to 2016, DCP Midstream and DCP Midstream Partners seeks to reward all parties involved through an $8 billion capex program that is already under way. By spending $8 billion, DCP Midstream and DCP Midstream Partners will grow its combined processing volume from 5.9 trillion Btu/d to 7.2 trillion Btu/d, NGL production will grow from 369,000 bpd to 525,000 bpd, and the length of its NGL pipeline system will more than double to 3,000 miles from 1,400 miles. 

So far DCP Midstream and DCP Midstream Partners have grown their respective asset bases substantially from $8.2 billion and $1.7 billion in 2010, which points toward the efficacy of the growth program.

Since 2010, DCP Midstream Partners' distribution has grown from $109 million to $296 million last year, with management calling for it to grow even further this year to $400 million-$420 million. While the dropdown of $1.15 billion of assets from DCP Midstream to DCP Midstream Partners will aid in its distribution growth, that doesn't translate into more cash flow generating projects for Phillips 66 and Spectra Energy. To keep up the organic growth trajectory, DCP Midstream Partners has two major projects planned over the next two years.

Dominating the DJ Basin
The DJ Basin is home to several booming shale plays located in Colorado, like the Wattenberg and Niobrara (which also extends into Wyoming and Nebraska). Through a $250 million investment, DCP Midstream Partners plans on building the Lucerne 2 plant in the DJ Basin to solidify its strong asset base in the region. The Lucerne 2 plant will have the ability to process 200 MMcf/d of natural gas, and would result in DCP Midstream Partners owning half of the 800 MMcf/d of processing capacity in the region. With construction expected to be completed in roughly a year from now, DCP Midstream Partners will be able to keep padding its DCF with new sources of income.

Deep beneath the water
In the Gulf of Mexico there is an offshore drilling bonanza under way, which opens up opportunities for DCP Midstream Partners. Through a $300 million investment, DCP Midstream Partners plans on building an additional 215 miles of gas gathering capacity in the Gulf of Mexico through its 40% stake in the Discovery System. The expansion is expected to be completed by the fourth quarter of 2014, and will also add nicely to its DCF.

Exporting the end result
Spectra Energy and Phillips 66's DCP Midstream enterprise has done a stellar job over the past few years, bringing new projects online while also successfully utilizing the assets that were dropped down from DCP Midstream. The ownership structure and the tax implications of these operations can be extremely confusing, but for shareholders and unitholders, all you have to know is that the DCP enterprise has a history of success and a solid long-term growth plan. Beyond the two projects mentioned above, DCP Midstream plans on expanding the recently completed Sand Hills and Southern Hills pipelines to boost capacity and thus DCF. 

Phillips 66 isn't putting all its eggs into one basket, it also plans on building an LPG export terminal and fractionator on the Gulf Coast so it can sell liquefied petroleum gas to overseas markets. The natural gas liquids used in the process will in part be sourced from its Sand Hills Pipeline, which connects the Permian Basin and the Eagle Ford to the Gulf. This project will cost around $3 billion, will grant Phillips 66 access to better international prices, and is guided to be completed in the third quarter of 2015. 

Foolish conclusion
Refineries live and die based on crack spreads they have no control over, which is why Phillips 66 is pushing into the midstream market, for stability. Building a new refinery will guarantee more revenue, but the profit margins remain to be seen as no one can say for certain where gasoline and crude oil will trade down the road. This is why it's a very smart move for Phillips 66 to move into a segment of the oil and gas industry that offers consistent, largely fee-based income with plenty of growth opportunities on the horizon. The ownership structure and tax implications can be extremely tedious, but they say nothing that's worthwhile is ever easy.

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