Energy stocks are facing significant headwinds. With unprecedented restrictions on travel and movement across most countries, the demand for gasoline and other fuels has decreased dramatically. This is a severe blow for energy companies that were already grappling with a supply glut and low commodity prices. While the outlook for oil stocks looks bleak, it may not be really all that bad. The International Energy Agency expects oil demand to start recovering gradually in the second-half of 2020.
In the meantime, refining stocks may benefit from the lower crude prices. While lower gasoline demand affects refiners negatively, lower input costs are advantageous for them. Further, widened differentials between Brent and American crudes benefit refiners, as their output prices are generally benchmarked against the stronger Brent prices. Still, things will be challenging for refiners with global oil demand estimated to be down by around 25% in the first half of 2020. However, there are reasons why top refiner Phillips 66 (PSX 1.19%) may emerge stronger at the end of the coronavirus crisis.
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Phillips 66's operations
By the end of March's third week, Phillips 66 witnessed a 20% to 30% drop in gasoline demand in the U.S. That is, of course, bad. And there is no guarantee that it can't get worse. I'll come to what may happen if it gets worse in a moment. But based on the current scenario, Phillips 66 expects an EBITDA of nearly $3 billion to $4 billion for 2020, which is a little lower than the approximately $4 billion that the company generated in 2016.
Notably, with the huge deterioration in global COVID-19 situation, things have worsened dramatically since Phillips 66 made this estimate. So, the EBITDA number could be far lower than this estimate. On the positive side, if President Trump's plan to reopen the economy in a phased manner works out well, oil demand may recover gradually in the second-half of the year. If the COVID-19 cases in the US are indeed peaking, as some experts are suggesting, it would be a positive sign for oil products' demand.
Phillips 66 is protected to a certain extent from a fall in jet fuel demand. That's because its refineries can switch roughly half of their jet fuel output to gasoline or distillate. Besides, Phillips 66's jet fuel production forms a very small percentage of its total output.
Overall, from an operational viewpoint, Phillips 66 had a challenging first quarter and may see this trend continue in the next couple of quarters as well. However, as the coronavirus pandemic gets under control, the company may see rising demand for its products. One year from now, Phillips 66's refining utilization rates could probably be returning back to their normal levels.
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Diversification advantage
One of Phillips 66's key advantage is its diversified operations in midstream, downstream, and chemicals segments. Margins and volumes for the company's petrochemicals business were quite robust as late as the third week of March.
Similarly, around 80% to 85% of Phillips 66's midstream revenues from Phillips 66 Partners (PSXP) are protected under minimum volume commitments. Additionally, around 85% of Phillips 66 Partners' customers are investment-grade. This protects Phillips 66's midstream operations from counterparty risk to a significant extent. While contributions from PSXP look protected to a certain extent, the same can't be said about DCP Midstream (DCP), which has slashed its Q1 distributions by 50%. However, DCP's contribution to Phillips 66's earnings is relatively much less. For the year 2019, DCP accounted for just 2% of Phillips 66's total earnings.
Are dividends safe?
Phillips 66 is trading at an attractive yield, and the company would like to keep its dividends safe. That is a likely scenario if the effects of coronavirus subside and the demand for refined products begins to rise. On the other hand, a dividend cut to keep credit ratings investment-grade might be better option for the long-term, if things worsen. As things stand today, both the scenarios are likely.
With a debt-to-capital ratio of around 32%, the company has decent wiggle room to handle a short-term dip in earnings while maintaining its payouts, as well as its investment-grade rating. Phillips 66 has also entered into a new $1 billion loan facility that adds to its existing $5 billion revolving credit facility. So, while the balance sheet may be stretched for a while, the company may bring it back to normal over time.
If the gasoline demand remains depressed for long, the company may have a more challenging time in defending its payouts. But Phillips 66 seems to be in the camp of companies that can survive in the rough patch longest.
