Brutal Market Conditions Torpedoed This Refining Stock's Second-Quarter Earnings

Government shutdowns to help slow the spread of COVID-19 caused demand for refined petroleum products to fall off a cliff during the second quarter. Because of that, refiners like Phillips 66 (PSX -0.35%) had to reduce production to avoid filling the country's dwindling storage capacity to the brim. These headwinds had a significant impact on its financial results during the second quarter.

Drilling down into Phillips 66's second-quarter earnings

Data source: Phillips 66.

While Phillips 66 reported a steep loss during the second quarter, its diversified operations helped cushion that blow:

Data source: Phillips 66. Chart by the author.

The headliner was the refining segment, where its loss more than doubled from the first quarter when it started feeling the effects of pandemic-related shutdowns. With those closures in full force during the early part of the second quarter, demand for refined petroleum products tumbled, taking refining volumes and margins down with them. Phillips 66 only realized $2.60 per barrel, down 63% from the first quarter. Meanwhile, refinery utilization fell from 83% in the first quarter to 75% during the second.

Midstream earnings tumbled 46.7% sequentially due to pressure on all its revenue sources. Transportation income declined by 35% because of lower pipeline and terminal volumes resulting from reduced refinery utilization. Those weak results came even though the company's MLP, Phillips 66 Partners (PSXP), started up its Gray Oak pipeline during the quarter. Meanwhile, earnings from its other MLP, DCP Midstream, plummeted more than 60% due to weaker commodity prices.

Earnings from the company's chemicals joint venture with Chevron plunged more than 50% from the first quarter. The main issue was that margins were lower for certain products because of lower prices and higher input costs.

Marketing and specialties earnings tumbled 40% from last quarter. The main issue there was that volumes were lower because of reduced refined product demand as a result of COVID-19.

Image source: Getty Images.

A look at what's ahead for Phillips 66

While oil market conditions were brutal during the second quarter, Phillips 66 had two notable highlights. First, Phillips 66 Partners started full commercial operations on its Gray Oak pipeline, which can transport 900,000 barrels of oil per day from fields in Texas to refineries and export facilities along the Gulf Coast. Meanwhile, that company and its partners finished the first export dock at their South Texas Gateway Terminal in July, which will help export oil from Gray Oak. These projects will help fuel growth as market conditions improve.

Another notable accomplishment during the quarter was that Phillips 66 shored up its liquidity. The company issued $2 billion of notes and increased its term loan capacity by $1 billion. As a result, it ended with $1.9 billion in cash while maintaining a conservative net debt-to-capital ratio of 30%.

That strong balance sheet and liquidity provide Phillips 66 with the financial flexibility to navigate the currently challenging market period. It has the funding to maintain its dividend while continuing to invest in expanding its operations. Those growth projects, which include expanding a natural gas liquids hub and its export capacity, position the company to generate higher cash flows once market conditions improve.

At the moment, there's a lot of debate as to when demand will recover. Fellow refiner Valero (VLO 0.08%) noted that demand for gasoline and diesel reached 85% to 90% of normal levels toward the end of the second quarter after bottoming out at 50% and 70% of their historical averages in April. However, with lots of excess supply, Valero doesn't expect demand and inventory levels to match their pre-pandemic averages until sometime next year. Because of that, Valero plans to operate its 15 refineries at about 79% capacity during the third quarter, up from 74% in the second quarter. Refiner PBF Energy (PBF 0.56%) said something similar, noting that gasoline and diesel demand has rebounded to about 80% of pre-pandemic levels, though jet fuel consumption has lagged. It expects further demand recovery to be uneven, given how regions are responding differently to the pandemic.   

Well-positioned for the tough road ahead

While market conditions have improved from their bottom, it will likely take a while before they're back to more normalized levels. Because of that, Phillips 66's earnings will likely remain under pressure for the next few quarters. However, it has the balance sheet strength to endure. Meanwhile, its expansion projects position it to generate improved results when market conditions do improve. But it will likely be a bumpy road for the company and its stock price.