Activist fund Elliott targets Phillips 66

Recent record profits by some leading US refiners have put the business models of others under scrutiny, writes Nathan Risser

Activist hedge fund Elliott Investment Management has purchased a $1bn stake in US refiner Phillips 66 and is calling for the company to refocus on its refining business and reduce operating costs.

Elliott says the company has underperformed compared with its peers Valero and Marathon Petroleum, which were better prepared to take advantage of the "refining super-cycle in 2022 and 2023". US refiners reported historically wide margins in the past year as demand recovered to pre-pandemic levels and as much as 1mn b/d of US refinery capacity closures constrained supply.

Elliott is keen for Phillips 66 to refocus on capturing the wide margins that led other companies to report record earnings in recent years. But Phillips 66's operating expense per barrel of crude — a proxy for operating efficiency at a refinery — has spiked since 2019 compared with its industry peers, Elliott says.

The refiner is planning $3bn in asset sales and said last month that it will accelerate its target for cost reductions to $1.4bn by the end of 2024, with more than 50pc in savings to come from its refining business. But US refiners have a limited appetite for acquiring or building new refineries and several plants are already on the market. Canada's 320,000 b/d Saint John refinery, owned by Irving Oil, is up for sale and a further 805,000 b/d of Citgo's US refining assets are in the process of being auctioned, with so far limited interest from major US refiners.

Phillips 66's chief executive, Mark Lashier, says the company has "engaged in discussions with Elliott Management, and we welcome their perspectives and the perspectives of other shareholders on our strategy". Elliott previously targeted Canadian integrated Suncor, pushing for board changes and divestment of its 1,500 retail stores, which ultimately it did not sell. US refiner Marathon, however, agreed to sell its 3,900-store Speedway retail network in 2019 following pressure from Elliott, which had criticised its integrated downstream business model.

Midstream vs refining

Should Phillips 66 fail to make sufficient progress towards its cost-cutting goals, Elliott says it will push for management changes and a sale of the company's stake in Chevron Phillips Chemicals (CPChem) — valued at about $15bn-20bn after taxes by the investor — and its European convenience stores and other non-operated midstream assets. But the company has said it intends to grow its midstream business to take advantage of rising production from US shale. "We are a midstream company that takes away primarily natural gas liquids from [the Permian] basin… and we intend to get bigger in that business," Lashier said last month.

Upstream mega-mergers recently announced by ExxonMobil and Chevron will double down on their ambitions to become leading US shale producers, and "we are going to make sure that we're positioned to be a great service provider for Exxon and all their peers in the Permian", Lashier said.

By owning midstream crude and refined products pipelines, refiners can avoid paying tariffs on pipelines operated by other companies and secure feedstock availability to, and product off-take from, their own facilities. In the early 2010s, some US refiners span off their midstream assets into tax-advantaged master limited partnerships (MLPs). They subsequently re-integrated them into their overall corporate structure by acquiring the outstanding share of the MLPs.

Analysts at US investment bank Piper Sandler said they broadly agree with Elliott's plan for Phillips 66, but are not convinced by its push for the refiner to sell CPChem and European retail and non-operated midstream assets. These divestments should be a last resort should Phillips 66's other cost-cutting measures fail, it suggests.