Phillips 66 (NYSE:PSX) is a diversified energy manufacturing and logistics company. That diversification was on full display last year when none of its four business segments contributed a majority of its adjusted earnings. That said, last year was a bit of an outlier for the company due to very challenging conditions in the refining market. Those challenges masked the fact that Phillips 66's primary profit driver is its refining business.
Drilling down into Phillips 66's profitability
As the following chart shows, last year was a tough one for Phillips 66 as all four of its operating segments were under pressure:
Those challenges provided an opportunity for its more stable marketing and specialties business to jump into the lead as the biggest profit driver last year, contributing 43% of the total. That said, it typically produces a much lower percentage of the total and is usually the third largest profit driver.
One reason marketing and specialties rose to the top last year was due to an atrocious showing from the refining segment, where profitability crashed nearly 90%. In fact, during the fourth quarter, the company recorded an adjusted loss of $95 million, which was a huge decline from the prior year when the segment reported a $134 million profit. Fueling its fourth-quarter loss was a combination of lower margins, higher costs, and weaker volumes due to turnaround activity at its Los Angeles Refinery, causing utilization at that facility to average just 45% last quarter.
The biggest driver of last year's earnings decline, though, was a significant drop in the market crack spread, which is the difference between the price of oil and the price of refined products made from that oil. When that crack spread is wide, Phillips 66 makes a lot of money. However, it was much narrower last year, causing Phillips 66 and its refining peers to make much less money turning oil into refined products.
Will refining continue to lead the way?
While its refining business struggled last year, it remains Phillips 66's largest potential profit source when market conditions normalize. That's because its other businesses aren't anywhere near the size and scale of its refining business just yet. Phillips 66, however, is working to expand two of those businesses and reduce its exposure to the volatile refining segment.
The largest expansion is at the company's chemical's business, which it co-owns with Chevron (NYSE:CVX). The Chevron-Phillips 66 venture is investing $6 billion in building a large-scale ethane cracker and two polyethylene plastics units to expand production capacity. The companies expect to complete the polyethylene units by the middle of this year, followed by the ethane cracker at the end of the year. Once complete, these projects will boost the business' production capacity by one-third, which would enhance its earnings potential.
In addition, Phillips 66 along with its two master limited partnerships, Phillips 66 Partners (NYSE:PSXP) and DCP Midstream (NYSE:DCP), are investing $1.5 billion in several midstream expansion projects this year. Phillips 66 will spend more than $900 million from its own balance sheet on projects, including finishing the expansion of its Beaumont Terminal and completing a pipeline project in the Bakken. Meanwhile, Phillips 66 Partners has nearly $400 million of growth projects underway, including the Bayou Bridge Pipeline, which will connect the Beaumont Terminal with another hub. Finally, DCP Midstream recently launched a new multiyear expansion phase to expand its processing and pipeline capacity.
But even with these investments, neither of those segments will have as much moneymaking ability as the refining business does in a strong market. For example, 2014 was the best year for Phillips 66's chemicals and midstream businesses when they generated $1.2 billion and $500 million in earnings, respectively. However, even if those earnings were to double due to the recent expansions and a robust market, they'd still trail the $3.8 billion that Phillips 66's refining business produced in 2012 and the $2.5 billion it pulled in last year. Needless to say, when things are going well, Phillips 66's refining business will make it a boatload of money.