10-Q 1 psx-2014930_10q.htm 10-Q PSX-2014/9/30_10Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended
September 30, 2014
 

 
 
or
 
 

[    ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from
 
to
 
 
Commission file number:
001-35349
 
Phillips 66
(Exact name of registrant as specified in its charter)
 
Delaware
 
45-3779385
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

3010 Briarpark Drive, Houston, Texas 77042
(Address of principal executive offices) (Zip Code)
281-293-6600
(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.     Yes  [X]    No  [    ]
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  [X]    No  [    ]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer   [X]        Accelerated filer  [    ]        Non-accelerated filer   [    ]        Smaller reporting company  [    ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  [    ]    No  [X]
The registrant had 553,513,402 shares of common stock, $.01 par value, outstanding as of September 30, 2014.



PHILLIPS 66

TABLE OF CONTENTS
 





PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
 
Consolidated Statement of Income
Phillips 66
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

2013

 
2014

2013

Revenues and Other Income
 
 
 
 
 
Sales and other operating revenues*
$
40,417

44,146

 
126,249

128,547

Equity in earnings of affiliates
511

647

 
2,053

2,304

Net gain on dispositions
109

8

 
125

50

Other income (loss)
11

(7
)
 
59

65

Total Revenues and Other Income
41,048

44,794

 
128,486

130,966

 
 
 
 
 
 
Costs and Expenses
 
 
 
 
 
Purchased crude oil and products
33,602

38,717

 
107,299

111,217

Operating expenses
1,104

992

 
3,271

3,002

Selling, general and administrative expenses
401

349

 
1,215

1,044

Depreciation and amortization
249

233

 
722

704

Impairments
12

1

 
16

26

Taxes other than income taxes*
3,874

3,624

 
11,344

10,449

Accretion on discounted liabilities
6

6

 
18

18

Interest and debt expense
60

68

 
194

207

Foreign currency transaction losses (gains)
13


 
23

(16
)
Total Costs and Expenses
39,321

43,990

 
124,102

126,651

Income from continuing operations before income taxes
1,727

804

 
4,384

4,315

Provision for income taxes
538

278

 
1,451

1,448

Income From Continuing Operations
1,189

526

 
2,933

2,867

Income from discontinued operations**

14

 
706

43

Net Income
1,189

540

 
3,639

2,910

Less: net income attributable to noncontrolling interests
9

5

 
24

10

Net Income Attributable to Phillips 66
$
1,180

535

 
3,615

2,900

 
 
 
 
 
 
Amounts Attributable to Phillips 66 Common Stockholders:
 
 
 
 
 
Income from continuing operations
$
1,180

521

 
2,909

2,857

Income from discontinued operations

14

 
706

43

Net Income Attributable to Phillips 66
$
1,180

535

 
3,615

2,900

 
 
 
 
 
 
Net Income Attributable to Phillips 66 Per Share of Common Stock (dollars)
 
 
 
 
 
Basic
 
 
 
 
 
Continuing operations
$
2.11

0.86

 
5.10

4.62

Discontinued operations

0.02

 
1.24

0.07

Net Income Attributable to Phillips 66 Per Share of Common Stock
$
2.11

0.88

 
6.34

4.69

Diluted
 
 
 
 
 
Continuing operations
$
2.09

0.85

 
5.05

4.58

Discontinued operations

0.02

 
1.23

0.07

Net Income Attributable to Phillips 66 Per Share of Common Stock
$
2.09

0.87

 
6.28

4.65

 
 
 
 
 
 
Dividends Paid Per Share of Common Stock (dollars)
$
0.5000

0.3125

 
1.3900

0.9375

 
 
 
 
 
 
Average Common Shares Outstanding (in thousands)
 
 
 
 
 
Basic
559,492

608,934

 
569,692

617,654

Diluted
564,958

614,519

 
575,589

623,846

* Includes excise taxes on petroleum products sales:
$
3,781

3,568

 
11,046

10,254

** Net of provision for income taxes on discontinued operations:
$

8

 
5

23

Prior period amounts have been recast to reflect discontinued operations.
 
 
 
 
 
See Notes to Consolidated Financial Statements.
 
 
 
 
 

1


Consolidated Statement of Comprehensive Income
Phillips 66
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

2013

 
2014

2013

 
 
 
 
 
 
Net Income
$
1,189

540

 
3,639

2,910

Other comprehensive income (loss)
 
 
 
 
 
Defined benefit plans
 
 
 
 
 
Actuarial gain/loss:
 
 
 
 
 
Amortization to net income of net actuarial loss
15

22

 
41

72

Plans sponsored by equity affiliates
4

6

 
10

(2
)
Income taxes on defined benefit plans
(5
)
(11
)
 
(16
)
(25
)
Defined benefit plans, net of tax
14

17

 
35

45

Foreign currency translation adjustments
(233
)
186

 
(106
)
(98
)
Income taxes on foreign currency translation adjustments
8

(4
)
 
9

(1
)
Foreign currency translation adjustments, net of tax
(225
)
182

 
(97
)
(99
)
Hedging activities by equity affiliates


 

1

Income taxes on hedging activities by equity affiliates


 


Hedging activities by equity affiliates, net of tax


 

1

Other Comprehensive Income (Loss), Net of Tax
(211
)
199

 
(62
)
(53
)
Comprehensive Income
978

739

 
3,577

2,857

Less: comprehensive income attributable to noncontrolling interests
9

5

 
24

10

Comprehensive Income Attributable to Phillips 66
$
969

734

 
3,553

2,847

See Notes to Consolidated Financial Statements.

2


Consolidated Balance Sheet
Phillips 66
 
 
Millions of Dollars
 
September 30
2014

 
December 31
2013

Assets
 
 
 
Cash and cash equivalents
$
3,108

 
5,400

Accounts and notes receivable (net of allowances of $43 million in 2014 and $47 million in 2013)
7,043

 
7,900

Accounts and notes receivable—related parties
1,723

 
1,732

Inventories
5,673

 
3,354

Prepaid expenses and other current assets
647

 
851

Total Current Assets
18,194

 
19,237

Investments and long-term receivables
10,237

 
11,220

Net properties, plants and equipment
16,951

 
15,398

Goodwill
3,275

 
3,096

Intangibles
819

 
698

Other assets
174

 
149

Total Assets
$
49,650

 
49,798

 
 
 
 
Liabilities
 
 
 
Accounts payable
$
10,381

 
9,948

Accounts payable—related parties
1,089

 
1,142

Short-term debt
35

 
24

Accrued income and other taxes
945

 
872

Employee benefit obligations
363

 
476

Other accruals
956

 
469

Total Current Liabilities
13,769

 
12,931

Long-term debt
6,178

 
6,131

Asset retirement obligations and accrued environmental costs
726

 
700

Deferred income taxes
5,632

 
6,125

Employee benefit obligations
842

 
921

Other liabilities and deferred credits
309

 
598

Total Liabilities
27,456

 
27,406

 
 
 
 
Equity
 
 
 
Common stock (2,500,000,000 shares authorized at $.01 par value)
     Issued (2014—636,940,692 shares; 2013—634,285,955 shares)
 
 
 
Par value
6

 
6

Capital in excess of par
19,028

 
18,887

Treasury stock (at cost: 2014—83,427,290 shares; 2013—44,106,380 shares)
(5,702
)
 
(2,602
)
Retained earnings
8,439

 
5,622

Accumulated other comprehensive income (loss)
(25
)
 
37

Total Stockholders’ Equity
21,746

 
21,950

Noncontrolling interests
448

 
442

Total Equity
22,194

 
22,392

Total Liabilities and Equity
$
49,650

 
49,798

See Notes to Consolidated Financial Statements.

3


Consolidated Statement of Cash Flows
Phillips 66
 
Millions of Dollars
 
Nine Months Ended
September 30
 
2014

 
2013

Cash Flows From Operating Activities
 
 
 
Net income
$
3,639

 
2,910

Adjustments to reconcile net income to net cash provided by operating activities
 
 
 
Depreciation and amortization
722

 
704

Impairments
16

 
26

Accretion on discounted liabilities
18

 
18

Deferred taxes
(527
)
 
282

Undistributed equity earnings
360

 
(76
)
Net gain on dispositions
(125
)
 
(50
)
Income from discontinued operations
(706
)
 
(43
)
Other
70

 
34

Working capital adjustments
 
 
 
Decrease (increase) in accounts and notes receivable
810

 
535

Decrease (increase) in inventories
(2,336
)
 
(1,353
)
Decrease (increase) in prepaid expenses and other current assets
(95
)
 
(90
)
Increase (decrease) in accounts payable
299

 
2,017

Increase (decrease) in taxes and other accruals
510

 
163

Net cash provided by continuing operating activities
2,655

 
5,077

Net cash provided by discontinued operations
2

 
53

Net Cash Provided by Operating Activities
2,657

 
5,130

 
 
 
 
Cash Flows From Investing Activities
 
 
 
Capital expenditures and investments
(2,647
)
 
(1,156
)
Proceeds from asset dispositions*
663

 
1,188

Advances/loans—related parties
(3
)
 
(65
)
Collection of advances/loans—related parties

 
100

Other
161

 

Net cash provided by (used in) continuing investing activities
(1,826
)
 
67

Net cash used in discontinued operations
(2
)
 
(14
)
Net Cash Provided by (Used in) Investing Activities
(1,828
)
 
53

 
 
 
 
Cash Flows From Financing Activities
 
 
 
Repayment of debt
(30
)
 
(1,015
)
Issuance of common stock
1

 
(4
)
Repurchase of common stock
(1,750
)
 
(1,602
)
Share exchange—PSPI transaction
(450
)
 

Dividends paid on common stock
(787
)
 
(575
)
Distributions to noncontrolling interests
(18
)
 
(1
)
Net proceeds from issuance of Phillips 66 Partners LP common units

 
404

Other
23

 
(4
)
Net cash used in continuing financing activities
(3,011
)
 
(2,797
)
Net cash provided by (used in) discontinued operations

 

Net Cash Used in Financing Activities
(3,011
)
 
(2,797
)
 
 
 
 
Effect of Exchange Rate Changes on Cash and Cash Equivalents
(110
)
 
82

 
 
 
 
Net Change in Cash and Cash Equivalents
(2,292
)
 
2,468

Cash and cash equivalents at beginning of period
5,400

 
3,474

Cash and Cash Equivalents at End of Period
$
3,108

 
5,942

* Includes return of investments in equity affiliates.
Prior period amounts have been recast to reflect discontinued operations.
See Notes to Consolidated Financial Statements.

4


Consolidated Statement of Changes in Equity
Phillips 66
 
 
Millions of Dollars
 
Attributable to Phillips 66
 
 
 
Common Stock
 
 
 
 
 
Par
Value

Capital in Excess of Par

Treasury Stock

Retained
Earnings

Accum. Other
Comprehensive Income (Loss)

Noncontrolling
Interests

Total

 
 
 
 
 
 
 
 
December 31, 2012
$
6

18,726

(356
)
2,713

(314
)
31

20,806

Net income



2,900


10

2,910

Other comprehensive loss




(53
)

(53
)
Cash dividends paid on common stock



(575
)


(575
)
Repurchase of common stock


(1,602
)



(1,602
)
Benefit plan activity

116


(8
)


108

Issuance of Phillips 66 Partners LP common units





404

404

Distributions to noncontrolling interests and other

(3
)



(1
)
(4
)
September 30, 2013
$
6

18,839

(1,958
)
5,030

(367
)
444

21,994

 
 
 
 
 
 
 
 
December 31, 2013
$
6

18,887

(2,602
)
5,622

37

442

22,392

Net income



3,615


24

3,639

Other comprehensive loss




(62
)

(62
)
Cash dividends paid on common stock



(787
)


(787
)
Repurchase of common stock


(1,750
)



(1,750
)
Share exchange—PSPI transaction


(1,350
)



(1,350
)
Benefit plan activity

141


(11
)


130

Distributions to noncontrolling interests and other





(18
)
(18
)
September 30, 2014
$
6

19,028

(5,702
)
8,439

(25
)
448

22,194

 

 
Shares in Thousands
 
Common Stock Issued

Treasury Stock

December 31, 2012
631,150

7,604

Repurchase of common stock

26,645

Shares issued—share-based compensation
2,635


September 30, 2013
633,785

34,249

 
 
 
December 31, 2013
634,286

44,106

Repurchase of common stock

21,898

Share exchange—PSPI transaction

17,423

Shares issued—share-based compensation
2,655


September 30, 2014
636,941

83,427

See Notes to Consolidated Financial Statements.

5


Notes to Consolidated Financial Statements
Phillips 66
 
Note 1—Interim Financial Information

The interim financial information presented in the financial statements included in this report is unaudited and includes all known accruals and adjustments necessary, in the opinion of management, for a fair presentation of the consolidated financial position of Phillips 66 and its results of operations and cash flows for the periods presented. Unless otherwise specified, all such adjustments are of a normal and recurring nature. Certain notes and other information have been condensed or omitted from the interim financial statements included in this report. Therefore, these interim financial statements should be read in conjunction with the consolidated financial statements and notes included in our 2013 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2014, are not necessarily indicative of the results to be expected for the full year.

Certain prior period financial information has been recast to reflect a change in the composition of our operating segments. See Note 21—Segment Disclosures and Related Information, for additional information.


Note 2—Changes in Accounting Principles

Effective July 1, 2014, we early adopted the Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” This ASU amends the definition of discontinued operations so that only disposals of components of an entity representing major strategic shifts that have a major effect on an entity’s operations and financial results will qualify for discontinued operations reporting. The ASU also requires additional disclosures about discontinued operations and individually material disposals that do not meet the definition of a discontinued operation. The adoption of this ASU did not have an effect on our consolidated financial statements.


Note 3—Variable Interest Entities (VIEs)

In 2013, we formed Phillips 66 Partners LP, a master limited partnership, to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and natural gas liquids pipelines and terminals, as well as other transportation and midstream assets. We consolidate Phillips 66 Partners as we determined that Phillips 66 Partners is a VIE and we are the primary beneficiary. As general partner, we have the ability to control its financial interests, as well as the ability to direct the activities of Phillips 66 Partners that most significantly impact its economic performance. See Note 23—Phillips 66 Partners LP, for additional information.

We hold significant variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary. Information on these VIEs follows:

Merey Sweeny, L.P. (MSLP) is a limited partnership that owns a delayed coker and related facilities at the Sweeny Refinery. As discussed more fully in Note 7—Investments, Loans and Long-Term Receivables, in August 2009, a call right was exercised to acquire the 50 percent ownership interest in MSLP of the co-venturer, Petróleos de Venezuela S.A. (PDVSA). That exercise was challenged, and the dispute has been arbitrated. In April 2014, the arbitral tribunal upheld the exercise of the call right and the acquisition of the 50 percent ownership interest. In July 2014, PDVSA filed a petition to vacate the tribunal’s award. Until this matter is resolved, we will continue to use the equity method of accounting for MSLP, and the VIE analysis below is based on the ownership and governance structure in place prior to the exercise of the call right. MSLP is a VIE because, in securing lender consents in connection with our separation from ConocoPhillips in 2012 (the Separation), we provided a 100 percent debt guarantee to the lender of the 8.85% senior notes issued by MSLP. PDVSA did not participate in the debt guarantee. In our VIE assessment, this disproportionate debt guarantee, plus other liquidity support provided jointly by us and PDVSA independently of equity ownership, results in MSLP not being exposed to all potential losses. We have determined we are not the primary beneficiary while our call exercise award is subject to vacatur because under the partnership agreement the co-venturers jointly direct the activities of MSLP that most significantly impact economic performance. At September 30, 2014, our maximum exposure to loss represented the outstanding debt principal balance of $203 million and our investment of $131 million.

6


We have a 50 percent ownership interest with a 50 percent governance interest in Excel Paralubes (Excel). Excel is a VIE because, in securing lender consents in connection with the Separation, ConocoPhillips provided a 50 percent debt guarantee to the lender of the 7.43% senior secured bonds issued by Excel. We provided a full indemnity to ConocoPhillips for this debt guarantee. Our co-venturer did not participate in the debt guarantee. In our assessment of the VIE, this debt guarantee, plus other liquidity support up to $60 million provided jointly by us and our co-venturer independently of equity ownership, results in Excel not being exposed to all potential losses. We have determined we are not the primary beneficiary because we and our co-venturer jointly direct the activities of Excel that most significantly impact economic performance. We use the equity method of accounting for this investment. At September 30, 2014, our maximum exposure to loss represented 50 percent of the outstanding debt principal balance of $86 million, or $43 million, plus half of the $60 million liquidity support, or $30 million. The book value of our investment in Excel at September 30, 2014, was $124 million.

In 2013, we entered into a multi-year consignment fuels agreement with a marketer who we currently support with debt guarantees. Pursuant to the consignment fuels agreement, we own the fuels inventory, control the fuel marketing at each site and pay a fixed monthly fee to the marketer. We determined the consignment fuels agreement and the debt guarantees together create a variable interest in the marketer, with the marketer not being exposed to all potential losses. We determined we are not the primary beneficiary because we do not have the power to direct the activities that most significantly impact the economic performance of the marketer or its service stations. We have no ownership interest in the marketer. At September 30, 2014, our maximum exposure to loss represented the outstanding debt balance of $190 million and the fixed annual contractual payments under the consignment fuels agreement of approximately $90 million.


Note 4—Inventories

Inventories consisted of the following:

 
Millions of Dollars
 
September 30
2014

 
December 31
2013

 
 
 
 
Crude oil and petroleum products
$
5,412

 
3,093

Materials and supplies
261

 
261

 
$
5,673

 
3,354



Inventories valued on the last-in, first-out (LIFO) basis totaled $5,252 million and $2,945 million at September 30, 2014, and December 31, 2013, respectively. The estimated excess of current replacement cost over LIFO cost of inventories amounted to approximately $7,400 million and $7,600 million at September 30, 2014, and December 31, 2013, respectively.


Note 5—Business Combinations

We completed the following acquisitions during the first nine months of 2014:

In August 2014, we acquired a 7.1 million-barrel-storage-capacity crude oil and petroleum products terminal located near Beaumont, Texas, to promote growth plans in our Midstream business.
In July 2014, we acquired Spectrum Corporation, a private label and specialty lubricants business headquartered in Memphis, Tennessee. The acquisition supports our plans to selectively grow stable-return businesses in our Marketing and Specialties (M&S) segment.
In March 2014, we acquired our co-venturer’s interest in an entity that operates a power and steam generation plant located in Texas that is included in our M&S segment. This acquisition provided us with full operational control over a key facility providing utilities and other services to one of our refineries.

7


We funded each of these acquisitions with cash on hand. Total cash consideration paid was $741 million, net of cash acquired, and this amount is included in the “Capital expenditures and investments” line of our consolidated statement of cash flows. In the aggregate, we provisionally recorded $592 million of properties, plants and equipment (PP&E), $179 million of goodwill, $110 million of intangible assets, $70 million of net working capital and $92 million of assumed long-term liabilities. The completion of our acquisition accounting for these transactions is subject to the finalization of valuations of the assets acquired and liabilities assumed.


Note 6—Assets Held for Sale or Sold

In July 2014, we entered into an agreement to sell the Bantry Bay terminal in Ireland, which is included in our Refining segment. Following regulatory review, the transaction is expected to close in the fourth quarter of 2014. As of September 30, 2014, the net assets of the terminal were classified as held for sale, which resulted in a before-tax impairment of $12 million from reducing the carrying value of the long-lived assets to estimated fair value less costs to sell. In addition, we reclassified long-lived assets of $77 million to the “Prepaid expenses and other current assets” line of our consolidated balance sheet. The long-term liabilities reclassified to the “Other accruals” line of our consolidated balance sheet were not material.

In December 2013, we entered into an agreement to exchange the stock of Phillips Specialty Products Inc. (PSPI), a flow improver business, which was included in our M&S segment, for shares of Phillips 66 common stock owned by the other party. Accordingly, as of December 31, 2013, the net assets of PSPI were classified as held for sale and the results of operations of PSPI were reported as discontinued operations. At December 31, 2013, PSPI had a net carrying value of $193 million, which primarily included $58 million of net PP&E and $117 million of allocated goodwill. The carrying amounts of PSPI’s assets and liabilities at December 31, 2013, were reported in the “Prepaid expenses and other current assets” and “Other accruals” lines of our consolidated balance sheet, respectively.

On February 25, 2014, we completed the PSPI share exchange, resulting in the receipt of approximately 17.4 million shares of Phillips 66 common stock, which are held as treasury shares, and the recognition of a before-tax gain of $696 million. At the time of the disposition, PSPI had a net carrying value of $685 million, which primarily included $481 million of cash and cash equivalents, $60 million of net PP&E and $117 million of allocated goodwill. Cash and cash equivalents of $450 million included in PSPI’s net carrying value is reflected as a financing cash outflow in the “Share exchange—PSPI transaction” line of our consolidated statement of cash flows. Revenues, income before-tax and net income from discontinued operations, excluding the recognized before-tax gain of $696 million, were not material for the nine-month periods ended September 30, 2014 and 2013.

In July 2013, we completed the sale of the Immingham Combined Heat and Power Plant (ICHP), which was included in our M&S segment. At the time of the disposition, ICHP had a net carrying value of $762 million, which primarily included $724 million of net PP&E, $110 million of allocated goodwill, and $111 million of deferred tax liabilities. A gain was deferred due to an indemnity provided to the buyer. A portion of the deferred gain is denominated in a foreign currency; accordingly, the amount of the deferred gain translated into U.S. dollars is subject to change based on currency fluctuations. Absent claims under the indemnity, the deferred gain will be recognized into earnings as our exposure under this indemnity declines. As of December 31, 2013, the deferred gain was $375 million. In the third quarter of 2014, we recognized $109 million of the previously deferred gain, which is included in the “Net gain on dispositions” line of our consolidated statement of income. As of September 30, 2014, the remaining deferred gain was $265 million.

In May 2013, we sold our E-Gas™ Technology business. The business was included in our M&S segment and at the time of disposition had a net carrying value of approximately $13 million, including a goodwill allocation. The $48 million before-tax gain is included in the “Net gain on dispositions” line of our consolidated income statement.



8


Note 7—Investments, Loans and Long-Term Receivables

Equity Investments
Summarized 100 percent financial information for WRB Refining LP (WRB) and Chevron Phillips Chemical Company LLC (CPChem) were as follows:
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

 
2013

 
2014

 
2013

 
 
 
 
 
 
 
 
Revenues
$
7,896

 
8,754

 
24,579

 
24,974

Income before income taxes
784

 
820

 
3,094

 
3,585

Net income
758

 
801

 
3,021

 
3,526




WRB
WRB is a 50-percent-owned business venture with Cenovus Energy Inc. (Cenovus). Cenovus was obligated to contribute $7.5 billion, plus accrued interest, to WRB over a 10-year period that began in 2007. In the first quarter of 2014, Cenovus prepaid its remaining balance under this obligation. As a result, WRB declared a special dividend, which was distributed to the co-venturers in March 2014. Of the $1,232 million that we received, $760 million was considered a return on our investment in WRB (an operating cash inflow), and $472 million was considered a return of our investment in WRB (an investing cash inflow). The return of investment portion of the dividend was included in the “Proceeds from assets dispositions” line in our consolidated statement of cash flows. At September 30, 2014, the book value of our investment in WRB was $1,933 million and our basis difference was $3,418 million.

Other
MSLP owns a delayed coker and related facilities at the Sweeny Refinery. MSLP processes long residue, which is produced from heavy sour crude oil, for a processing fee. Fuel-grade petroleum coke is produced as a by-product and becomes the property of MSLP. Prior to August 28, 2009, MSLP was owned 50/50 by ConocoPhillips and PDVSA. Under the agreements that govern the relationships between the partners, certain defaults by PDVSA with respect to supply of crude oil to the Sweeny Refinery triggered the right to acquire PDVSA’s 50 percent ownership interest in MSLP, which was exercised on August 28, 2009. PDVSA initiated arbitration with the International Chamber of Commerce challenging the exercise of the call right and claiming it was invalid. The arbitral tribunal held hearings on the merits of the dispute in December 2012, and post-hearing briefs were exchanged in March 2013. The arbitral tribunal issued its ruling in April 2014, which upheld the exercise of the call right and the acquisition of the 50 percent ownership interest. In July 2014, PDVSA filed a petition in U.S. district court to vacate the tribunal’s ruling.  Following the Separation, Phillips 66 generally indemnifies ConocoPhillips for liabilities, if any, arising out of the exercise of the call right or otherwise with respect to the joint venture or the refinery. Until this matter is resolved, we will continue to use the equity method of accounting for our investment in MSLP.



9


Note 8—Properties, Plants and Equipment

Our investment in PP&E, with the associated accumulated depreciation and amortization (Accum. D&A), was:

 
Millions of Dollars
 
September 30, 2014
 
December 31, 2013
 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
 
 
 
 
 
 
 
 
 
 
 
Midstream
$
4,285

 
1,160

 
3,125

 
2,865

 
1,104

 
1,761

Chemicals

 

 

 

 

 

Refining
19,699

 
7,162

 
12,537

 
19,191

 
6,718

 
12,473

Marketing and Specialties
1,493

 
744

 
749

 
1,395

 
749

 
646

Corporate and Other
1,063

 
523

 
540

 
975

 
457

 
518

Discontinued Operations*

 

 

 

 

 

 
$
26,540

 
9,589

 
16,951

 
24,426

 
9,028

 
15,398

* At December 31, 2013, net PP&E of $58 million associated with discontinued operations was classified as current assets.


Note 9—Goodwill

Effective January 1, 2014, we reallocated $52 million of goodwill from the Refining segment to the M&S segment based upon the realignment of certain assets between the reporting units. Goodwill was reassigned to the reporting units using a relative fair value approach. Goodwill impairment testing was completed and no impairment recognition was required. See Note 21—Segment Disclosures and Related Information, for additional information on this segment realignment.

See Note 5—Business Combinations, and Note 6—Assets Held for Sale or Sold, for information on goodwill assigned to business acquisitions and dispositions, respectively.

The carrying amount of goodwill was as follows:
 
Millions of Dollars
 
September 30
2014

 
December 31
2013

 
 
 
 
Midstream
$
543

 
518

Refining
1,867

 
1,867

Marketing and Specialties
865

 
711

 
$
3,275

 
3,096




10


Note 10—Impairments

The three- and nine-month periods ended September 30, 2014 and 2013, included the following before-tax impairment charges:

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

2013

 
2014

2013


 
 
 
 
 
Refining
$
12

1

 
14

2

Marketing and Specialties


 
2

15

Corporate and Other


 

9

 
$
12

1

 
16

26



During the third quarter of 2014, we recorded a $12 million held-for-sale impairment in our Refining segment related to the Bantry Bay terminal. See Note 6—Assets Held for Sale or Sold, for additional information.

During the nine-month period of 2013, we recorded a $15 million held-for-use impairment in our M&S segment, primarily related to PP&E associated with our planned exit from the composite graphite business.
  

Note 11—Earnings Per Share

The numerator of basic earnings per share (EPS) is net income attributable to Phillips 66, reduced by noncancelable dividends paid on unvested share-based employee awards during the vesting period (participating securities). The denominator of basic EPS is the sum of the daily weighted-average number of common shares outstanding during the periods presented and fully vested stock and unit awards that have not yet been issued as common stock. The numerator of diluted EPS is also based on net income attributable to Phillips 66, which is reduced only by dividend equivalents paid on participating securities for which the dividends are more dilutive than the participation of the awards in the earnings of the periods presented. To the extent unvested stock, unit or option awards and vested unexercised stock options are dilutive, they are included with the weighted-average common shares outstanding in the denominator. Treasury stock is excluded from the denominator in both basic and diluted EPS.
  

11


 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014
 
2013
 
2014
 
2013
 
Basic

Diluted

 
Basic

Diluted

 
Basic

Diluted

 
Basic

Diluted

Amounts attributed to Phillips 66 Common Stockholders (millions):
 
 
 
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Phillips 66
$
1,180

1,180

 
521

521

 
2,909

2,909

 
2,857

2,857

Income allocated to participating securities
(2
)

 
(2
)

 
(5
)

 
(4
)

Income from continuing operations available to common stockholders
1,178

1,180

 
519

521

 
2,904

2,909

 
2,853

2,857

Discontinued operations


 
14

14

 
706

706

 
43

43

Net Income available to common stockholders
$
1,178

1,180

 
533

535

 
3,610

3,615

 
2,896

2,900

 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (thousands):
555,677

559,492

 
605,176

608,934

 
565,831

569,692

 
613,896

617,654

Effect of stock-based compensation
3,815

5,466

 
3,758

5,585

 
3,861

5,897

 
3,758

6,192

Weighted-average common shares outstanding—EPS
559,492

564,958

 
608,934

614,519

 
569,692

575,589

 
617,654

623,846

 
 
 
 
 
 
 
 
 
 
 
 
Earnings Per Share of Common Stock (dollars):
 
 
 
 
 
 
 
 
 
 
 
Income from continuing operations attributable to Phillips 66
$
2.11

2.09

 
0.86

0.85

 
5.10

5.05

 
4.62

4.58

Discontinued operations


 
0.02

0.02

 
1.24

1.23

 
0.07

0.07

Earnings Per Share
$
2.11

2.09

 
0.88

0.87

 
6.34

6.28

 
4.69

4.65



12


Note 12—Debt

At both September 30, 2014, and December 31, 2013, we had no direct outstanding borrowings under our $4.5 billion revolving credit agreement, while $51 million in letters of credit had been issued that were supported by it. At September 30, 2014, and December 31, 2013, no amount had been drawn on the $250 million revolving credit agreement of Phillips 66 Partners. Accordingly, as of September 30, 2014, an aggregate $4.7 billion of total capacity was available under these facilities.

At September 30, 2014, we classified $800 million of debt due within one year as long-term debt, based on our intent to refinance the obligation on a long-term basis and our ability to do so under our revolving credit facility.

Effective September 30, 2014, we terminated our $696 million trade receivables securitization facility. No amounts were drawn against this facility throughout its duration, and at the time of termination no letters of credit were outstanding thereunder.


Note 13—Guarantees

At September 30, 2014, we were liable for certain contingent obligations under various contractual arrangements as described below. We recognize a liability, at inception, for the fair value of our obligation as a guarantor for newly issued or modified guarantees. Unless the carrying amount of the liability is noted below, we have not recognized a liability either because the guarantees were issued prior to December 31, 2002, or because the fair value of the obligation is immaterial. In addition, unless otherwise stated, we are not currently performing with any significance under the guarantee and expect future performance to be either immaterial or have only a remote chance of occurrence.

Guarantees of Joint Venture Debt
In April 2012, in connection with the Separation, we issued a guarantee for 100 percent of the 8.85% senior notes issued by MSLP in July 1999. At September 30, 2014, the maximum potential amount of future payments to third parties under the guarantee was estimated to be $203 million, which could become payable if MSLP fails to meet its obligations under the senior notes agreement. The senior notes mature in 2019.

Other Guarantees
We have residual value guarantees associated with leases with maximum future potential payments totaling $292 million. We have other guarantees with maximum future potential payment amounts totaling $310 million, which consist primarily of guarantees to fund the short-term cash liquidity deficits of certain joint ventures, guarantees of third parties related to prior asset dispositions, and guarantees of the lease payment obligations of a joint venture. These guarantees generally extend up to 10 years or life of the venture.

Indemnifications
Over the years, we have entered into various agreements to sell ownership interests in certain corporations, joint ventures and assets that gave rise to qualifying indemnifications. Agreements associated with these sales include indemnifications for taxes, litigation, environmental liabilities, permits and licenses, supply arrangements, and employee claims; and real estate indemnity against tenant defaults. The provisions of these indemnifications vary greatly. The majority of these indemnifications are related to environmental issues, the term is generally indefinite, and the maximum amount of future payments is generally unlimited. The carrying amount recorded for indemnifications at September 30, 2014, was $234 million. We amortize the indemnification liability over the relevant time period, if one exists, based on the facts and circumstances surrounding each type of indemnity. In cases where the indemnification term is indefinite, we will reverse the liability when we have information the liability is essentially relieved or amortize the liability over an appropriate time period as the fair value of our indemnification exposure declines. Although it is reasonably possible future payments may exceed amounts recorded, due to the nature of the indemnifications, it is not possible to make a reasonable estimate of the maximum potential amount of future payments. Included in the recorded carrying amount were $107 million of environmental accruals for known contamination that were included in asset retirement obligations and accrued environmental costs at September 30, 2014. For additional information about environmental liabilities, see Note 14—Contingencies and Commitments.


13


Indemnification and Release Agreement
In 2012, we entered into the Indemnification and Release Agreement with ConocoPhillips. This agreement governs the treatment between ConocoPhillips and us of matters relating to indemnification, insurance, litigation responsibility and management, and litigation document sharing and cooperation arising in connection with the Separation. Generally, the agreement provides for cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of our business with us and financial responsibility for the obligations and liabilities of ConocoPhillips’ business with ConocoPhillips. The agreement also establishes procedures for handling claims subject to indemnification and related matters.


Note 14—Contingencies and Commitments

A number of lawsuits involving a variety of claims that arose in the ordinary course of business have been filed against us or are subject to indemnifications provided by us. We also may be required to remove or mitigate the effects on the environment of the placement, storage, disposal or release of certain chemical, mineral and petroleum substances at various active and inactive sites. We regularly assess the need for accounting recognition or disclosure of these contingencies. In the case of all known contingencies (other than those related to income taxes), we accrue a liability when the loss is probable and the amount is reasonably estimable. If a range of amounts can be reasonably estimated and no amount within the range is a better estimate than any other amount, then the minimum of the range is accrued. We do not reduce these liabilities for potential insurance or third-party recoveries. If applicable, we record receivables for probable insurance or other third-party recoveries. In the case of income-tax-related contingencies, we use a cumulative probability-weighted loss accrual in cases where sustaining a tax position is less than certain.

Based on currently available information, we believe it is remote that future costs related to known contingent liability exposures will exceed current accruals by an amount that would have a material adverse impact on our consolidated financial statements. As we learn new facts concerning contingencies, we reassess our position both with respect to accrued liabilities and other potential exposures. Estimates particularly sensitive to future changes include contingent liabilities recorded for environmental remediation, tax and legal matters. Estimated future environmental remediation costs are subject to change due to such factors as the uncertain magnitude of cleanup costs, the unknown time and extent of such remedial actions that may be required, and the determination of our liability in proportion to that of other potentially responsible parties. Estimated future costs related to tax and legal matters are subject to change as events evolve and as additional information becomes available during the administrative and litigation processes.

Environmental
We are subject to international, federal, state and local environmental laws and regulations. When we prepare our consolidated financial statements, we record accruals for environmental liabilities based on management’s best estimates, using all information available at the time. We measure estimates and base liabilities on currently available facts, existing technology, and presently enacted laws and regulations, taking into account stakeholder and business considerations. When measuring environmental liabilities, we also consider our prior experience in remediation of contaminated sites, other companies’ cleanup experience, and data released by the U.S. Environmental Protection Agency (EPA) or other organizations. We consider unasserted claims in our determination of environmental liabilities, and we accrue them in the period they are both probable and reasonably estimable.

Although liability of those potentially responsible for environmental remediation costs is generally joint and several for federal sites and frequently so for state sites, we are usually only one of many companies alleged to have liability at a particular site. Due to the joint and several liabilities, we could be responsible for all cleanup costs related to any site at which we have been designated as a potentially responsible party. We have been successful to date in sharing cleanup costs with other financially sound companies. Many of the sites at which we are potentially responsible are still under investigation by the EPA or the state agencies concerned. Prior to actual cleanup, those potentially responsible normally assess the site conditions, apportion responsibility and determine the appropriate remediation. In some instances, we may have no liability or may attain a settlement of liability. Where it appears that other potentially responsible parties may be financially unable to bear their proportional share, we consider this inability in estimating our potential liability, and we adjust our accruals accordingly. As a result of various acquisitions in the past, we assumed certain environmental obligations. Some of these environmental obligations are mitigated by indemnifications made by others for our benefit and some of the indemnifications are subject to dollar and time limits.


14


We are currently participating in environmental assessments and cleanups at numerous federal Superfund and comparable state sites. After an assessment of environmental exposures for cleanup and other costs, we make accruals on an undiscounted basis (except those pertaining to sites acquired in a purchase business combination, which we record on a discounted basis) for planned investigation and remediation activities for sites where it is probable future costs will be incurred and these costs can be reasonably estimated. At September 30, 2014, our total environmental accrual was $519 million, compared with $492 million at December 31, 2013. We expect to incur a substantial amount of these expenditures within the next 30 years. We have not reduced these accruals for possible insurance recoveries. In the future, we may be involved in additional environmental assessments, cleanups and proceedings.

Legal Proceedings
Our legal organization applies its knowledge, experience and professional judgment to the specific characteristics of our cases, employing a litigation management process to manage and monitor the legal proceedings against us. Our process facilitates the early evaluation and quantification of potential exposures in individual cases. This process also enables us to track those cases that have been scheduled for trial and/or mediation. Based on professional judgment and experience in using these litigation management tools and available information about current developments in all our cases, our legal organization regularly assesses the adequacy of current accruals and determines if adjustment of existing accruals, or establishment of new accruals, is required.

Other Contingencies
We have contingent liabilities resulting from throughput agreements with pipeline and processing companies not associated with financing arrangements. Under these agreements, we may be required to provide any such company with additional funds through advances and penalties for fees related to throughput capacity not utilized.

At September 30, 2014, we had performance obligations secured by letters of credit and bank guarantees of $834 million ($51 million of which were issued under the provisions of our revolving credit facility, and the remainder were issued as direct bank letters of credit and bank guarantees) related to various purchase and other commitments incident to the ordinary conduct of business.


Note 15—Derivatives and Financial Instruments

Derivative Instruments
We use financial and commodity-based derivative contracts to manage exposures to fluctuations in foreign currency exchange rates and commodity prices or to capture market opportunities. Since we are not currently using cash-flow hedge accounting, all gains and losses, realized or unrealized, from commodity derivative contracts have been recognized in the consolidated statement of income. Gains and losses from derivative contracts held for trading not directly related to our physical business, whether realized or unrealized, have been reported net in “Other income (loss)” on our consolidated statement of income. Cash flows from all our derivative activity for the periods presented appear in the operating section of the consolidated statement of cash flows.

Purchase and sales contracts with fixed minimum notional volumes for commodities that are readily convertible to cash (e.g., crude oil and gasoline) are recorded on the balance sheet as derivatives unless the contracts are eligible for, and we elect, the normal purchases and normal sales exception (i.e., contracts to purchase or sell quantities we expect to use or sell over a reasonable period in the normal course of business). We generally apply this normal purchases and normal sales exception to eligible crude oil, refined product, natural gas and power commodity purchase and sales contracts; however, we may elect not to apply this exception (e.g., when another derivative instrument will be used to mitigate the risk of the purchase or sales contract but hedge accounting will not be applied, in which case both the purchase or sales contract and the derivative contract mitigating the resulting risk will be recorded on the balance sheet at fair value).

Our derivative instruments are held at fair value on our consolidated balance sheet. For further information on the fair value of derivatives, see Note 16—Fair Value Measurements.

Commodity Derivative Contracts—We operate in the worldwide crude oil, refined products, natural gas liquids (NGL), natural gas and electric power markets and are exposed to fluctuations in the prices for these commodities. These fluctuations can affect our revenues, as well as the cost of operating, investing and financing activities. Generally, our policy is to remain exposed to the market prices of commodities; however, we use futures, forwards, swaps and options

15


in various markets to balance physical systems, meet customer needs, manage price exposures on specific transactions, and do a limited, immaterial amount of trading not directly related to our physical business. We also use the market knowledge gained from these activities to capture market opportunities such as moving physical commodities to more profitable locations, storing commodities to capture seasonal or time premiums, and blending commodities to capture quality upgrades. Derivatives may be used to optimize these activities, which may move our risk profile away from market average prices.

The following table indicates the balance sheet line items that include the fair values of commodity derivative assets and liabilities presented net (i.e., commodity derivative assets and liabilities with the same counterparty are netted where the right of setoff exists); however, the balances in the following table are presented gross. For information on the impact of counterparty netting and collateral netting, see Note 16—Fair Value Measurements.

 
Millions of Dollars
 
September 30
2014

 
December 31
2013

Assets
 
 
 
Accounts and notes receivable
$

 
2

Prepaid expenses and other current assets
1,359

 
592

Other assets
9

 
2

Liabilities
 
 
 
Other accruals
1,151

 
633

Other liabilities and deferred credits
6

 
1

Hedge accounting has not been used for any item in the table.


The gains (losses) from commodity derivatives incurred, and the line items where they appear on our consolidated statement of income, were:
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

 
2013

 
2014

 
2013

 
 
 
 
 
 
 
 
Sales and other operating revenues
$
179

 
(44
)
 
208

 
74

Equity in earnings of affiliates
6

 
(12
)
 
4

 
(13
)
Other income (loss)
(3
)
 
(24
)
 
12

 
3

Purchased crude oil and products
71

 
(78
)
 
28

 
85

Hedge accounting has not been used for any item in the table.


The following table summarizes our material net exposures resulting from outstanding commodity derivative contracts. These financial and physical derivative contracts are primarily used to manage price exposure on our underlying operations. The underlying exposures may be from non-derivative positions such as inventory volumes. Financial derivative contracts may also offset physical derivative contracts, such as forward sales contracts. As of September 30, 2014, and December 31, 2013, the percentage of our derivative contract volume expiring within the next 12 months was over 99 percent for both periods.
 
 
Open Position
Long/(Short)
 
September 30
2014

 
December 31
2013

Commodity
 
 
 
Crude oil, refined products and NGL (millions of barrels)
(31
)
 
(9
)



16


Credit Risk
Financial instruments potentially exposed to concentrations of credit risk consist primarily of over-the-counter (OTC) derivative contracts and trade receivables.

The credit risk from our OTC derivative contracts, such as forwards and swaps, derives from the counterparty to the transaction. Individual counterparty exposure is managed within predetermined credit limits and includes the use of cash-call margins when appropriate, thereby reducing the risk of significant nonperformance. We also use futures, swaps and option contracts that have a negligible credit risk because these trades are cleared with an exchange clearinghouse and subject to mandatory margin requirements until settled; however, we are exposed to the credit risk of those exchange brokers for receivables arising from daily margin cash calls, as well as for cash deposited to meet initial margin requirements.

Our trade receivables result primarily from the sale of products from, or related to, our refinery operations and reflect a broad national and international customer base, which limits our exposure to concentrations of credit risk. The majority of these receivables have payment terms of 30 days or less. We continually monitor this exposure and the creditworthiness of the counterparties and recognize bad debt expense based on historical write-off experience or specific counterparty collectability. Generally, we do not require collateral to limit the exposure to loss; however, we will sometimes use letters of credit, prepayments, and master netting arrangements to mitigate credit risk with counterparties that both buy from and sell to us, as these agreements permit the amounts owed by us or owed to others to be offset against amounts due us.

Certain of our derivative instruments contain provisions that require us to post collateral if the derivative exposure exceeds a threshold amount. We have contracts with fixed threshold amounts and other contracts with variable threshold amounts that are contingent on our credit rating. The variable threshold amounts typically decline for lower credit ratings, while both the variable and fixed threshold amounts typically revert to zero if our credit ratings fall below investment grade. Cash is the primary collateral in all contracts; however, many contracts also permit us to post letters of credit as collateral.

The aggregate fair values of all derivative instruments with such credit-risk-related contingent features that were in a liability position were not material at September 30, 2014, or December 31, 2013.


Note 16—Fair Value Measurements

Fair Values of Financial Instruments
We used the following methods and assumptions to estimate the fair value of financial instruments:

Cash and cash equivalents: The carrying amount reported on the consolidated balance sheet approximates fair value.
Accounts and notes receivable: The carrying amount reported on the consolidated balance sheet approximates fair value.
Debt: The carrying amount of our floating-rate debt approximates fair value. The fair value of our fixed-rate debt is estimated based on quoted market prices.
Commodity swaps: Fair value is estimated based on forward market prices and approximates the exit price at period end. When forward market prices are not available, fair value is estimated using the forward prices of a similar commodity with adjustments for differences in quality or location.
Futures: Fair values are based on quoted market prices obtained from the New York Mercantile Exchange, the InterContinental Exchange Futures or other traded exchanges.
Forward-exchange contracts: Fair values are estimated by comparing the contract rate to the forward rate in effect at the end of the respective reporting periods and approximating the exit price at those dates.

17


We carry certain assets and liabilities at fair value, which we measure at the reporting date using an exit price (i.e., the price that would be received to sell an asset or paid to transfer a liability), and disclose the quality of these fair values based on the valuation inputs used in these measurements under the following hierarchy:

Level 1: Fair value measured with unadjusted quoted prices from an active market for identical assets or liabilities.
Level 2: Fair value measured with: 1) adjusted quoted prices from an active market for similar assets; or 2) other valuation inputs that are directly or indirectly observable.
Level 3: Fair value measured with unobservable inputs that are significant to the measurement.

We classify the fair value of an asset or liability based on the lowest level of input significant to its measurement; however, the fair value of an asset or liability initially reported as Level 3 will be subsequently reported as Level 2 if the unobservable inputs become inconsequential to its measurement or corroborating market data becomes available. Conversely, an asset or liability initially reported as Level 2 will be subsequently reported as Level 3 if corroborating market data becomes unavailable. We made no material transfers in or out of Level 1 during the nine-month periods ended September 30, 2014 and 2013.

Recurring Fair Value Measurements
Financial assets and liabilities recorded at fair value on a recurring basis consist primarily of investments to support nonqualified deferred compensation plans and derivative instruments. The deferred compensation investments are measured at fair value using unadjusted prices available from national securities exchanges; therefore, these assets are categorized as Level 1 in the fair value hierarchy. We value our exchange-traded commodity derivatives using closing prices provided by the exchange as of the balance sheet date, and these are also classified as Level 1 in the fair value hierarchy. When exchange-cleared contracts lack sufficient liquidity or are valued using either adjusted exchange-provided prices or non-exchange quotes, we classify those contracts as Level 2. OTC financial swaps and physical commodity forward purchase and sales contracts are generally valued using quotations provided by brokers and price index developers such as Platts and Oil Price Information Service. We corroborate these quotes with market data and classify the resulting fair values as Level 2. In certain less liquid markets or for longer-term contracts, forward prices are not as readily available. In these circumstances, OTC swaps and physical commodity purchase and sales contracts are valued using internally developed methodologies that consider historical relationships among various commodities that result in management’s best estimate of fair value. We classify these contracts as Level 3. Financial OTC and physical commodity options are valued using industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and contractual prices for the underlying instruments, as well as other relevant economic measures. The degree to which these inputs are observable in the forward markets determines whether the options are classified as Level 2 or 3. We use a mid-market pricing convention (the mid-point between bid and ask prices). When appropriate, valuations are adjusted to reflect credit considerations, generally based on available market evidence.

The following tables display the fair value hierarchy for our material financial assets and liabilities either accounted for or disclosed at fair value on a recurring basis. These values are determined by treating each contract as the fundamental unit of account; therefore, derivative assets and liabilities with the same counterparty are shown gross (i.e., without the effect of netting where the legal right of setoff exists) in the hierarchy sections of these tables. These tables also show that our Level 3 activity was not material.

We have master netting arrangements for all of our exchange-cleared derivative instruments, the majority of our OTC derivative instruments, and certain physical commodity forward contracts (primarily pipeline crude oil deliveries). The following tables show these contracts on a net basis in the column “Effect of Counterparty Netting.” We have no contracts that are subject to master netting arrangements that are reflected gross on the consolidated balance sheet.


18


The carrying values and fair values by hierarchy of our material financial instruments, either carried or disclosed at fair value, and derivative assets and liabilities, including any effects of master netting agreements or collateral, were:
 
Millions of Dollars
 
September 30, 2014
 
Fair Value Hierarchy
 
Total Fair Value of Gross Assets & Liabilities

Effect of Counterparty Netting

Effect of Collateral Netting

Difference in Carrying Value and Fair Value

Net Carrying Value Presented on the Balance Sheet

Cash Collateral Received or Paid, Not Offset on Balance Sheet

 
Level 1

 
Level 2

 
Level 3

Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
918

 
326

 

 
1,244

(1,098
)
(13
)

133

3

OTC instruments

 
55

 

 
55

(18
)


37


Physical forward contracts*

 
64

 
5

 
69

(8
)


61


Rabbi trust assets
75

 

 

 
75

N/A

N/A


75

N/A

 
$
993

 
445

 
5

 
1,443

(1,124
)
(13
)

306

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
837

 
261

 

 
1,098

(1,098
)




OTC instruments

 
21

 

 
21

(18
)


3


Physical forward contracts*

 
38

 

 
38

(8
)


30


Floating-rate debt
51

 

 

 
51

N/A

N/A


51

N/A

Fixed-rate debt, excluding capital leases**

 
6,405

 

 
6,405

N/A

N/A

(452
)
5,953

N/A

 
$
888

 
6,725

 

 
7,613

(1,124
)

(452
)
6,037


* Physical forward contracts may have a larger value on the balance sheet than disclosed in the fair value hierarchy when the remaining contract term at the reporting date is greater than 12 months and the short-term portion is an asset while the long-term portion is a liability, or vice versa.
** We carry fixed-rate debt on the balance sheet at amortized cost.


 
Millions of Dollars
 
December 31, 2013
 
Fair Value Hierarchy
 
Total Fair Value of Gross Assets & Liabilities

Effect of Counterparty Netting

Effect of Collateral Netting

Difference in Carrying Value and Fair Value

Net Carrying Value Presented on the Balance Sheet

Cash Collateral Received or Paid, Not Offset on Balance Sheet

 
Level 1

 
Level 2

 
Level 3

 
Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
227

 
332

 

 
559

(538
)


21


OTC instruments

 
10

 

 
10

(8
)


2


Physical forward contracts*

 
25

 
2

 
27




27


Rabbi trust assets
64

 

 

 
64

N/A

N/A


64

N/A

 
$
291

 
367

 
2

 
660

(546
)


114



 
 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
253

 
326

 

 
579

(538
)
(41
)



OTC instruments

 
11

 

 
11

(8
)


3


Physical forward contracts*

 
43

 
1

 
44




44


Floating-rate debt
50

 

 

 
50

N/A

N/A


50

N/A

Fixed-rate debt, excluding capital leases**

 
6,168

 

 
6,168

N/A

N/A

(262
)
5,906

N/A

 
$
303

 
6,548

 
1

 
6,852

(546
)
(41
)
(262
)
6,003


* Physical forward contracts may have a larger value on the balance sheet than disclosed in the fair value hierarchy when the remaining contract term at the reporting date is greater than 12 months and the short-term portion is an asset while the long-term portion is a liability, or vice versa.
** We carry fixed-rate debt on the balance sheet at amortized cost.

19


The values presented in the preceding tables appear on our balance sheet as follows: for commodity derivative assets and liabilities, see the first table in Note 15—Derivatives and Financial Instruments; rabbi trust assets appear in the “Investments and long-term receivables” line; and floating-rate and fixed-rate debt appear in the “Short-term debt” and “Long-term debt” lines.

Nonrecurring Fair Value Remeasurements
The following table shows the values of assets, by major category, measured at fair value on a nonrecurring basis in periods subsequent to their initial recognition during the nine-month periods ended September 30, 2014 and 2013:

 
Millions of Dollars
 
 
 
Fair Value
Measurements Using
 
 
 
Fair Value*

 
Level 1
Inputs

 
Level 2
Inputs

 
Level 3
Inputs

 
Before-
Tax Loss

September 30, 2014
 
 
 
 
 
 
 
 
 
Net asset disposal group (held for sale)
$
72

 
72

 

 

 
12

 
 
 
 
 
 
 
 
 
 
September 30, 2013
 
 
 
 
 
 
 
 
 
Net properties, plants and equipment (held for use)
$
22

 
22

 

 

 
27

* Represents the fair value at the time of the impairment.


During the nine-month period ended September 30, 2014, net assets related to the Bantry Bay terminal in our Refining segment, with a carrying amount of $84 million, primarily consisting of net PP&E, were written down to fair value less costs to sell, resulting in a before-tax loss of $12 million. This impairment was attributed to the long-lived assets in the disposal group. The fair value was determined by a negotiated selling price with a third party. See Note 6—Assets Held for Sale or Sold, for additional information.

During the nine-month period ended September 30, 2013, net PP&E held for use related to the composite graphite business in our M&S segment, with a carrying amount of $18 million, was written down to its fair value, resulting in a before-tax loss of $18 million. The fair value was based on an internal assessment of expected discounted future cash flows. During this same period, corporate net PP&E held for use, with a carrying amount of $31 million, was written down to its fair value of $22 million, resulting in a before-tax loss of $9 million. The fair value was primarily determined by a third-party valuation.



20


Note 17—Employee Benefit Plans

Pension and Postretirement Plans
The components of net periodic benefit cost for the three and nine months ended September 30, 2014 and 2013, were as follows:
 
 
Millions of Dollars
 
Pension Benefits
 
Other Benefits
 
2014
 
2013
 
2014

 
2013

 
U.S.

 
Int’l.

 
U.S.

 
Int’l.

 
 
 
 
Components of Net Periodic Benefit Cost
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
30

 
9

 
31

 
9

 
1

 
2

Interest cost
27

 
9

 
23

 
7

 
2

 
2

Expected return on plan assets
(35
)
 
(9
)
 
(30
)
 
(7
)
 

 

Amortization of prior service cost
1

 

 
1

 

 

 

Recognized net actuarial loss
10

 
3

 
21

 
4

 

 

Total net periodic benefit cost
$
33


12


46


13


3


4

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
91

 
29

 
93

 
27

 
5

 
6

Interest cost
81

 
27

 
69

 
23

 
6

 
5

Expected return on plan assets
(106
)
 
(28
)
 
(90
)
 
(22
)
 

 

Amortization of prior service cost (credit)
2

 
(1
)
 
2

 
(1
)
 
(1
)
 
(1
)
Recognized net actuarial loss (gain)
30

 
9

 
63

 
12

 
(1
)
 

Total net periodic benefit cost
$
98

 
36

 
137

 
39

 
9

 
10



During the first nine months of 2014, we contributed $166 million to our U.S. plans and $46 million to our international plans. We currently expect to make additional contributions of approximately $30 million in 2014, primarily to our international plans.


21


Note 18—Accumulated Other Comprehensive Income (Loss)

The following table depicts changes in accumulated other comprehensive income (loss) by component, as well as detail on reclassifications out of accumulated other comprehensive income (loss):
 
 
Millions of Dollars
 
Defined Benefit Plans

 
Foreign Currency Translation

 
Hedging

 
Accumulated Other Comprehensive Income (Loss)

 
 
 
 
 
 
 
 
December 31, 2012
$
(778
)
 
466

 
(2
)
 
(314
)
Other comprehensive income (loss) before reclassifications
(1
)
 
(99
)
 
1

 
(99
)
Amounts reclassified from accumulated other comprehensive income (loss)*
 
 
 
 
 
 
 
Amortization of defined benefit plan items**
 
 
 
 
 
 
 
Actuarial losses
46

 

 

 
46

Net current period other comprehensive income (loss)
45

 
(99
)
 
1

 
(53
)
September 30, 2013
$
(733
)
 
367

 
(1
)
 
(367
)
 
 
 
 
 
 
 
 
December 31, 2013
$
(404
)
 
443

 
(2
)
 
37

Other comprehensive income (loss) before reclassifications
6

 
(97
)
 

 
(91
)
Amounts reclassified from accumulated other comprehensive income (loss)*
 
 
 
 
 
 


Amortization of defined benefit plan items**
 
 
 
 
 
 
 
Actuarial losses
29

 

 

 
29

Net current period other comprehensive income (loss)
35

 
(97
)
 

 
(62
)
September 30, 2014
$
(369
)
 
346

 
(2
)
 
(25
)
* There were no significant reclassifications related to foreign currency translation or hedging.
** These accumulated other comprehensive income (loss) components are included in the computation of net periodic benefit cost (see Note 17—Employee Benefit Plans, for additional information).


Note 19—Cash Flow Information
 
 
Millions of Dollars
 
Nine Months Ended
 
September 30
 
2014

 
2013

Noncash Investing and Financing Activities
 
 
 
Increase in net PP&E and debt related to capital lease obligation
$
24

 
177

 
 
 
 
Cash Payments
 
 
 
Interest
$
131

 
146

Income taxes
1,734

 
1,001



PSPI Noncash Stock Exchange
As discussed more fully in Note 6—Assets Held for Sale or Sold, on February 25, 2014, we completed the exchange of our flow improvers business for shares of Phillips 66 common stock owned by the other party to the transaction. The noncash portion of the net assets surrendered by us in the exchange was $204 million, and we received approximately 17.4 million shares of our common stock, with a fair value at the time of the exchange of $1.35 billion.


22


Note 20—Related Party Transactions

Significant transactions with related parties were:

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2014

 
2013

 
2014

 
2013

 
 
 
 
 
 
 
 
Operating revenues and other income (a)
$
1,653

 
2,066

 
5,306

 
5,865

Purchases (b)
3,772

 
4,996

 
12,298

 
13,757

Operating expenses and selling, general and administrative expenses (c)
33

 
28

 
109

 
80

Interest expense (d)
2

 
2

 
6

 
6


(a)
We sold crude oil to the Malaysian Refining Company Sdn. Bdh. (MRC). NGL and other petrochemical feedstocks, along with solvents, were sold to CPChem, and gas oil and hydrogen feedstocks were sold to Excel. Certain feedstocks and intermediate products were sold to WRB. We also acted as agent for WRB in supplying other crude oil and feedstocks, wherein the transactional amounts did not impact operating revenues. In addition, we charged several of our affiliates, including CPChem and MSLP, for the use of common facilities, such as steam generators, waste and water treaters, and warehouse facilities.

(b)
We purchased refined products from WRB. We also acted as agent for WRB in distributing asphalt and solvents, wherein the transactional amounts did not impact purchases. We purchased natural gas and NGL from DCP Midstream, LLC (DCP Midstream) and CPChem for use in our refinery processes and other feedstocks from various affiliates. We purchased refined products from MRC. We also paid fees to various pipeline equity companies for transporting finished refined products. In addition, we paid a price upgrade to MSLP for heavy crude processing. We purchased base oils and fuel products from Excel for use in our refining and specialty businesses.

(c)
We paid utility, commission and processing fees to various affiliates.

(d)
We incurred interest expense on a note payable to MSLP.


23


Note 21—Segment Disclosures and Related Information

Our operating segments are: