10-Q 1 psx-2017930_10q.htm 10-Q Document

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, 2017
 

 
 
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.)

2331 CityWest Blvd., 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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 Large accelerated filer  [X]     Accelerated filer  [    ]  Non-accelerated filer  [    ]    
 Smaller reporting company  [    ] Emerging growth company  [    ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [    ]    
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 506,740,487 shares of common stock, $.01 par value, outstanding as of September 30, 2017.



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
 
2017

2016

 
2017

2016

Revenues and Other Income
 
 
 
 
 
Sales and other operating revenues*
$
25,627

21,624

 
72,608

60,882

Equity in earnings of affiliates
530

391

 
1,357

1,159

Net gain on dispositions

3

 
15

9

Other income
49

24

 
519

59

Total Revenues and Other Income
26,206

22,042

 
74,499

62,109

 
 
 
 
 
 
Costs and Expenses
 
 
 
 
 
Purchased crude oil and products
19,463

15,961

 
55,495

44,089

Operating expenses
1,134

1,061

 
3,541

3,078

Selling, general and administrative expenses
435

411

 
1,258

1,218

Depreciation and amortization
337

293

 
972

863

Impairments
1

2

 
18

4

Taxes other than income taxes*
3,456

3,424

 
9,968

10,479

Accretion on discounted liabilities
5

5

 
16

15

Interest and debt expense
112

81

 
324

250

Foreign currency transaction (gains) losses
7

(9
)
 
6

(16
)
Total Costs and Expenses
24,950

21,229

 
71,598

59,980

Income before income taxes
1,256

813

 
2,901

2,129

Provision for income taxes
407

277

 
908

679

Net Income
849

536

 
1,993

1,450

Less: net income attributable to noncontrolling interests
26

25

 
85

58

Net Income Attributable to Phillips 66
$
823

511

 
1,908

1,392

 
 
 
 
 
 
Net Income Attributable to Phillips 66 Per Share of Common Stock (dollars)
 
 
 
 
 
Basic
$
1.60

0.97

 
3.68

2.62

Diluted
1.60

0.96

 
3.66

2.61

 
 
 
 
 
 
Dividends Paid Per Share of Common Stock (dollars)
$
0.70

0.63

 
2.03

1.82

 
 
 
 
 
 
Weighted-Average Common Shares Outstanding (thousands)
 
 
 
 
 
Basic
512,923

525,991

 
517,420

528,650

Diluted
515,960

528,798

 
520,516

531,650

* Includes excise taxes on petroleum products sales:
$
3,376

3,357

 
9,664

10,225

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
 
2017

2016

 
2017

2016

 
 
 
 
 
 
Net Income
$
849

536

 
1,993

1,450

Other comprehensive income (loss)
 
 
 
 
 
Defined benefit plans
 
 
 
 
 
Actuarial loss arising during the period

(28
)
 

(28
)
Amortization to net income of net actuarial loss and settlements
45

23

 
145

70

Curtailment gain

31

 

31

Plans sponsored by equity affiliates
2

2

 
8

11

Income taxes on defined benefit plans
(17
)
(9
)
 
(56
)
(29
)
Defined benefit plans, net of tax
30

19

 
97

55

Foreign currency translation adjustments
94

(61
)
 
222

(183
)
Income taxes on foreign currency translation adjustments
1

(1
)
 
(8
)
(4
)
Foreign currency translation adjustments, net of tax
95

(62
)
 
214

(187
)
Cash flow hedges

4

 

(12
)
Income taxes on hedging activities

(1
)
 

5

Hedging activities, net of tax

3

 

(7
)
Other Comprehensive Income (Loss), Net of Tax
125

(40
)
 
311

(139
)
Comprehensive Income
974

496

 
2,304

1,311

Less: comprehensive income attributable to noncontrolling interests
26

25

 
85

58

Comprehensive Income Attributable to Phillips 66
$
948

471

 
2,219

1,253

See Notes to Consolidated Financial Statements.

2


Consolidated Balance Sheet
Phillips 66
 
 
Millions of Dollars
 
September 30
2017

 
December 31
2016

Assets
 
 
 
Cash and cash equivalents
$
1,547

 
2,711

Accounts and notes receivable (net of allowances of $31 million in 2017 and $34 million in 2016)
5,421

 
5,485

Accounts and notes receivable—related parties
934

 
912

Inventories
4,455

 
3,150

Prepaid expenses and other current assets
578

 
422

Total Current Assets
12,935

 
12,680

Investments and long-term receivables
13,899

 
13,534

Net properties, plants and equipment
21,303

 
20,855

Goodwill
3,270

 
3,270

Intangibles
884

 
888

Other assets
421

 
426

Total Assets
$
52,712

 
51,653

 
 
 
 
Liabilities
 
 
 
Accounts payable
$
6,404

 
6,395

Accounts payable—related parties
867

 
666

Short-term debt
706

 
550

Accrued income and other taxes
901

 
805

Employee benefit obligations
482

 
527

Other accruals
545

 
520

Total Current Liabilities
9,905

 
9,463

Long-term debt
9,495

 
9,588

Asset retirement obligations and accrued environmental costs
629

 
655

Deferred income taxes
7,605

 
6,743

Employee benefit obligations
877

 
1,216

Other liabilities and deferred credits
242

 
263

Total Liabilities
28,753

 
27,928

 
 
 
 
Equity
 
 
 
Common stock (2,500,000,000 shares authorized at $.01 par value)
     Issued (2017—643,419,792 shares; 2016—641,593,854 shares)
 
 
 
Par value
6

 
6

Capital in excess of par
19,652

 
19,559

Treasury stock (at cost: 2017—136,679,305 shares; 2016—122,827,264 shares)
(9,915
)
 
(8,788
)
Retained earnings
13,464

 
12,608

Accumulated other comprehensive loss
(684
)
 
(995
)
Total Stockholders’ Equity
22,523

 
22,390

Noncontrolling interests
1,436

 
1,335

Total Equity
23,959

 
23,725

Total Liabilities and Equity
$
52,712

 
51,653

See Notes to Consolidated Financial Statements.

3


Consolidated Statement of Cash Flows
Phillips 66
 
Millions of Dollars
 
Nine Months Ended
September 30
 
2017

 
2016

Cash Flows From Operating Activities
 
 
 
Net income
$
1,993

 
1,450

Adjustments to reconcile net income to net cash provided by operating
activities
 
 
 
Depreciation and amortization
972

 
863

Impairments
18

 
4

Accretion on discounted liabilities
16

 
15

Deferred taxes
784

 
467

Undistributed equity earnings
(543
)
 
(772
)
Net gain on dispositions
(15
)
 
(9
)
Gain on consolidation of business
(423
)
 

Other
(234
)
 
(192
)
Working capital adjustments
 
 
 
Decrease (increase) in accounts and notes receivable
(33
)
 
185

Decrease (increase) in inventories
(1,228
)
 
(510
)
Decrease (increase) in prepaid expenses and other current assets
(106
)
 
(453
)
Increase (decrease) in accounts payable
464

 
1,025

Increase (decrease) in taxes and other accruals
52

 
223

Net Cash Provided by Operating Activities
1,717

 
2,296

 
 
 
 
Cash Flows From Investing Activities
 
 
 
Capital expenditures and investments
(1,295
)
 
(2,031
)
Proceeds from asset dispositions*
65

 
159

Advances/loans—related parties
(9
)
 
(266
)
Collection of advances/loans—related parties
325

 
107

Restricted cash received from consolidation of business
318

 

Other
(80
)
 
(132
)
Net Cash Used in Investing Activities
(676
)
 
(2,163
)
 
 
 
 
Cash Flows From Financing Activities
 
 
 
Issuance of debt
3,083

 
400

Repayment of debt
(3,161
)
 
(418
)
Issuance of common stock
23

 
14

Repurchase of common stock
(1,127
)
 
(812
)
Dividends paid on common stock
(1,042
)
 
(954
)
Distributions to noncontrolling interests
(83
)
 
(45
)
Net proceeds from issuance of Phillips 66 Partners LP common units
171

 
972

Other
(66
)
 
(38
)
Net Cash Used in Financing Activities
(2,202
)
 
(881
)
 
 
 
 
Effect of Exchange Rate Changes on Cash, Cash Equivalents and Restricted Cash
(3
)
 
11

 
 
 
 
Net Change in Cash, Cash Equivalents and Restricted Cash
(1,164
)
 
(737
)
Cash, cash equivalents and restricted cash at beginning of period
2,711

 
3,074

Cash, Cash Equivalents and Restricted Cash at End of Period
$
1,547

 
2,337

* Includes return of investments in equity affiliates and working capital true-ups on dispositions.
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, 2015
$
6

19,145

(7,746
)
12,348

(653
)
838

23,938

Net income



1,392


58

1,450

Other comprehensive loss




(139
)

(139
)
Cash dividends paid on common stock



(954
)


(954
)
Repurchase of common stock


(812
)



(812
)
Benefit plan activity

66


(11
)


55

Issuance of Phillips 66 Partners LP common units

263




555

818

Distributions to noncontrolling interests and other





(45
)
(45
)
September 30, 2016
$
6

19,474

(8,558
)
12,775

(792
)
1,406

24,311

 
 
 
 
 
 
 
 
December 31, 2016
$
6

19,559

(8,788
)
12,608

(995
)
1,335

23,725

Net income



1,908


85

1,993

Other comprehensive income




311


311

Cash dividends paid on common stock



(1,042
)


(1,042
)
Repurchase of common stock


(1,127
)



(1,127
)
Benefit plan activity

48


(10
)


38

Issuance of Phillips 66 Partners LP common units

45




99

144

Distributions to noncontrolling interests and other





(83
)
(83
)
September 30, 2017
$
6

19,652

(9,915
)
13,464

(684
)
1,436

23,959

 

 
Shares in Thousands
 
Common Stock Issued

Treasury Stock

December 31, 2015
639,336

109,926

Repurchase of common stock

10,141

Shares issued—share-based compensation
1,581


September 30, 2016
640,917

120,067

 
 
 
December 31, 2016
641,594

122,827

Repurchase of common stock

13,852

Shares issued—share-based compensation
1,826


September 30, 2017
643,420

136,679

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 2016 Annual Report on Form 10-K. The results of operations for the three- and nine-month periods ended September 30, 2017, are not necessarily indicative of the results to be expected for the full year. Certain prior period financial information has been recast to reflect the current year’s presentation.


Note 2—Changes in Accounting Principles

Effective January 1, 2017, we early adopted Financial Accounting Standards Board (FASB) Accounting Standards Update (ASU) No. 2017-04, “Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment,” which eliminates the second step from the goodwill impairment test. Under the revised test, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. This ASU is applied prospectively to goodwill impairment tests performed on or after January 1, 2017.

Effective January 1, 2017, we early adopted ASU No. 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash.” The new update clarifies the classification and presentation of changes in restricted cash. The amendment requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash and restricted cash equivalents. Adoption of this ASU on a retrospective basis did not have a material impact on our financial statements. See Note 17—Restricted Cash for more information.

Effective January 1, 2017, we early adopted ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” The new update clarifies how certain cash receipts and cash payments should be presented and classified in the statement of cash flows. In addition, ASU No. 2016-15 clarifies that when cash receipts and cash payments have aspects of more than one class of cash flows and cannot be separated, classification will depend on the predominant source or use. Adoption of this ASU on a retrospective basis did not have a material impact on our financial statements.

Effective January 1, 2017, we adopted ASU 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for share-based payment award transactions, including accounting for income taxes and classification of excess tax benefits on the statement of cash flows, forfeitures and minimum statutory tax withholding requirements. Adoption of this ASU on a prospective basis did not materially impact our financial position, results of operations, or cash flows. We account for forfeitures of awards when they occur and excess tax benefits, which were previously reported in cash flows from financing activities, are now reported in cash flows from operating activities on a prospective basis.



6


Note 3—Variable Interest Entities (VIEs)

Consolidated 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 (NGL) pipelines and terminals, as well as other 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 of Phillips 66 Partners, we have the ability to control its financial interests, as well as the ability to direct the activities that most significantly impact its economic performance. See Note 21—Phillips 66 Partners LP, for additional information.

The most significant assets of Phillips 66 Partners that are available to settle only its obligations, along with its most significant liabilities for which its creditors do not have recourse to Phillips 66’s general credit, were:

 
Millions of Dollars
 
September 30
2017

 
December 31
2016

 
 
 
 
Equity investments*
$
1,265

 
1,142

Net properties, plants and equipment
2,675

 
2,675

Long-term debt
2,273

 
2,396

* Included in “Investments and long-term receivables” on the Phillips 66 consolidated balance sheet.


Non-consolidated VIEs
We hold variable interests in VIEs that have not been consolidated because we are not considered the primary beneficiary.

Merey Sweeny, L.P. (MSLP) is a limited partnership that owns a delayed coker and related facilities at the Sweeny Refinery. Under the agreements that governed the relationships between the former co-venturers in MSLP, certain defaults by Petróleos de Venezuela S.A. (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. The call right was exercised in August 2009. The exercise of the call right was challenged, and the dispute was arbitrated in our favor and subsequently litigated. Through February 7, 2017, we determined MSLP was a VIE and used the equity method of accounting because the exercise of the call right remained subject to legal challenge. As discussed more fully in Note 5—Business Combinations, the exercise of the call right ceased to be subject to legal challenge in February 2017. At that point, we no longer considered MSLP a VIE and began consolidating the entity as a wholly owned subsidiary.

We have a 25 percent ownership interest in both Dakota Access, LLC (DAPL) and Energy Transfer Crude Oil Company, LLC (ETCO), which collectively own the Bakken Pipeline. These entities did not have sufficient equity at risk to fully fund the construction of all assets required for principal operations, and thus represented VIEs until operations commenced. On June 1, 2017, these entities commenced operations and were no longer considered VIEs. We use the equity method of accounting for these investments.




7


Note 4—Inventories

Inventories consisted of the following:

 
Millions of Dollars
 
September 30
2017

 
December 31
2016

 
 
 
 
Crude oil and petroleum products
$
4,172

 
2,883

Materials and supplies
283

 
267

 
$
4,455

 
3,150



Inventories valued on the last-in, first-out (LIFO) basis totaled $4,059 million and $2,772 million at September 30, 2017, and December 31, 2016, respectively. The estimated excess of current replacement cost over LIFO cost of inventories amounted to approximately $3.8 billion and $3.3 billion at September 30, 2017, and December 31, 2016, respectively.

Certain planned reductions in inventory that are not expected to be replaced by the end of the year cause liquidations of LIFO inventory values. LIFO inventory liquidations during the three- and nine-month periods ended September 30, 2017, were not material. Excluding the disposition of the Whitegate Refinery, LIFO liquidations during the three- and nine-month periods ended September 30, 2016, decreased net income by approximately $13 million and $71 million, respectively.

In conjunction with the Whitegate Refinery disposition, the refinery’s LIFO inventory values were liquidated causing a decrease in net income of $62 million during the three- and nine-month periods ended September 30, 2016. This LIFO liquidation impact was included in the gain recognized on the disposition.


Note 5—Business Combinations

MSLP owns a delayed coker and related facilities at the Sweeny Refinery, and its results are included in our Refining segment.  Prior to August 28, 2009, MSLP was owned 50/50 by ConocoPhillips and PDVSA.  Under the agreements that governed the relationships between the partners, certain defaults by PDVSA with respect to supply of crude oil to the Sweeny Refinery triggered the right, exercised in August 2009, to acquire its 50 percent ownership interest in MSLP for a purchase price determined by a contractual formula.  As the distributions PDVSA received from MSLP exceeded the amounts it contributed to MSLP, the contractual formula required no cash consideration for the acquisition. The exercise was challenged, and the dispute was arbitrated in our favor and subsequently litigated.  While the dispute was being arbitrated and litigated, we continued to use the equity method of accounting for our 50 percent interest in MSLP.  When the exercise of the call right ceased to be subject to legal challenge on February 7, 2017, we deemed that the acquisition was complete and began accounting for MSLP as a wholly owned consolidated subsidiary.

Based on a third-party appraisal of the fair value of MSLP’s net assets, utilizing discounted cash flows and replacement costs, the acquisition of PDVSA’s 50 percent interest resulted in our recording a pre-tax gain of $423 million in the first quarter of 2017.  This gain was included in the “Other income” line on our consolidated statement of income. The fair value of our original equity interest in MSLP immediately prior to the deemed acquisition was $145 million. As a result of the transaction, we recorded $318 million of restricted cash, $250 million of properties, plants and equipment (PP&E) and $238 million of debt, as well as a net $93 million for the elimination of our equity investment in MSLP and net intercompany payables. Our acquisition accounting was finalized during the first quarter of 2017.


8


In November 2016, Phillips 66 Partners acquired NGL logistics assets located in southeast Louisiana, consisting of approximately 500 miles of pipelines and storage caverns connecting multiple fractionation facilities, refineries and a petrochemical facility. The acquisition provided an opportunity for fee-based growth in the Louisiana market within our Midstream segment. The acquisition was included in the “Capital expenditures and investments” line on our consolidated statement of cash flows. At the acquisition date, we recorded $183 million of PP&E and $3 million of goodwill. Our acquisition accounting was finalized during the first quarter of 2017, with no change to the provisional amounts recorded in 2016.


Note 6—Assets Held for Sale or Sold

In June 2017, we entered into an agreement to sell vacant land. In our segment disclosures, the property is included in Corporate and Other. We classified the property as held for sale and transferred $50 million of PP&E to the “Prepaid expenses and other current assets” line on our consolidated balance sheet. We expect to close the sale in the first quarter of 2018, following a contractual inspection period. The net sales proceeds are expected to approximate the carrying value of the land.

In September 2016, we completed the sale of the Whitegate Refinery and related marketing assets, which were included primarily in our Refining segment. The net carrying value of the assets at the time of their disposition was $135 million, which consisted of $127 million of inventory, other working capital, and PP&E; and $8 million of allocated goodwill. An immaterial gain was recognized in 2016 on the disposition.


Note 7—Investments, Loans and Long-Term Receivables

Equity Investments
Summarized 100 percent financial information for Chevron Phillips Chemical Company LLC (CPChem) was as follows:
 
 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2017

2016

 
2017

2016

 
 
 
 
 
 
Revenues
$
2,287

2,186

 
7,196

6,526

Income before income taxes
345

372

 
1,469

1,400

Net income
331

355

 
1,424

1,343



Related Party Loans and Advances
In the first quarter of 2017, we received payment of the $250 million outstanding principal balance at December 31, 2016, of our sponsor loans to the DAPL and ETCO joint ventures. We also received payment of the $75 million outstanding principal balance of the partner loan to WRB Refining LP (WRB). These cash inflows, totaling $325 million, are included in the “Collections of advances/loans—related parties” line on our consolidated statement of cash flows.



9


Note 8—Properties, Plants and Equipment

Our gross investment in PP&E and the associated accumulated depreciation and amortization (Accum. D&A) balances were as follows:

 
Millions of Dollars
 
September 30, 2017
 
December 31, 2016
 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
Gross
PP&E

 
Accum.
D&A

 
Net
PP&E

 
 
 
 
 
 
 
 
 
 
 
 
Midstream
$
8,491

 
1,775

 
6,716

 
8,179

 
1,579

 
6,600

Chemicals

 

 

 

 

 

Refining
22,143

 
8,805

 
13,338

 
21,152

 
8,197

 
12,955

Marketing and Specialties
1,610

 
889

 
721

 
1,451

 
776

 
675

Corporate and Other
1,104

 
576

 
528

 
1,207

 
582

 
625

 
$
33,348

 
12,045

 
21,303

 
31,989

 
11,134

 
20,855



Note 9—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.
  
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2017
 
2016
 
2017
 
2016
 
Basic

Diluted

 
Basic

Diluted

 
Basic

Diluted

 
Basic

Diluted

Amounts attributed to Phillips 66 Common
Stockholders (millions):
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to Phillips 66
$
823

823

 
511

511

 
1,908

1,908

 
1,392

1,392

Income allocated to participating securities
(1
)

 
(2
)
(1
)
 
(4
)
(1
)
 
(5
)
(3
)
Net income available to common stockholders
$
822

823


509

510

 
1,904

1,907


1,387

1,389

 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding (thousands):
509,147

512,923

 
521,815

525,991

 
513,583

517,420

 
524,365

528,650

Effect of stock-based compensation
3,776

3,037

 
4,176

2,807

 
3,837

3,096

 
4,285

3,000

Weighted-average common shares outstanding—EPS
512,923

515,960

 
525,991

528,798

 
517,420

520,516

 
528,650

531,650

 
 
 
 
 
 
 
 
 
 
 
 
Earnings Per Share of Common Stock (dollars)
$
1.60

1.60

 
0.97

0.96

 
3.68

3.66

 
2.62

2.61




10


Note 10—Debt

At September 30, 2017, no amount had been directly drawn under our $5 billion revolving credit facility; however, we had $200 million of short-term commercial paper outstanding and $51 million of issued letters of credit that were supported by this facility. In addition, at September 30, 2017, there was $87 million outstanding under Phillips 66 Partners’ $750 million revolving credit facility. As a result, we had $5.4 billion of total committed capacity available under our credit facilities at September 30, 2017.

Debt Repayments
In May 2017, we repaid $1,500 million of 2.95% Senior Notes upon maturity with the funding from the April 2017 debt issuances discussed below.

Also in May 2017, we repaid $135 million of MSLP 8.85% Senior Notes due in 2019. This debt was recorded as a result of the consolidation of MSLP in February 2017. See Note 5—Business Combinations for additional information regarding MSLP.

Debt Issuances
In April 2017, Phillips 66 completed a private offering of $600 million aggregate principal amount of unsecured notes, consisting of $300 million of Notes due 2019 and $300 million of Notes due 2020. Interest on these notes is a floating rate equal to three-month LIBOR plus 0.65% per annum for the 2019 Notes and three-month LIBOR plus 0.75% per annum for the 2020 Notes. Interest on both series of notes is payable quarterly in arrears on January 15, April 15, July 15 and October 15, commencing in July 2017. The 2019 Notes mature on April 15, 2019, and the 2020 Notes mature on April 15, 2020. The notes are guaranteed by Phillips 66 Company, a wholly owned subsidiary.

Also in April 2017, Phillips 66 entered into term loan facilities with an aggregate borrowing amount of $900 million, consisting of a $450 million 364-day facility and a $450 million three-year facility. Interest on the term loans is a floating rate based on either the Eurodollar rate or the reference rate, plus a margin determined by our long-term credit ratings.

Phillips 66 used the net proceeds from the issuance of the notes, together with the proceeds from the term loans, and cash on-hand to repay its outstanding 2.95% Senior Notes upon maturity in May 2017, for capital expenditures and for general corporate purposes.

Subsequent Events
In October 2017, as part of a contribution of assets to Phillips 66 Partners, Phillips 66 Partners assumed the $450 million of term loans outstanding under the 364-day facility originally issued in April 2017, and repaid those loans shortly thereafter. In addition, Phillips 66 Partners issued $500 million aggregate principal amount of 3.75% Senior Notes due 2028 and $150 million aggregate principal amount of 4.68% Senior Notes due 2045. Interest on the 3.75% Senior Notes due 2028 is payable semiannually in arrears on March 1 and September 1 of each year, commencing on March 1, 2018. The 4.68% Senior Notes due 2045 are an additional issuance of existing Phillips 66 Partners’ 4.68% Senior Notes, and interest is payable semiannually in arrears on February 15 and August 15 of each year.

Also in October 2017, we repaid the $200 million of short-term commercial paper outstanding at September 30, 2017.


Note 11—Guarantees

At September 30, 2017, 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 was 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.


11


Guarantees of Joint Venture Debt
In December 2016, as part of the restructuring within DCP Midstream, LLC (DCP Midstream), we issued a guarantee, effective January 1, 2017, in support of DCP Midstream’s debt issued in the first quarter of 2017. At September 30, 2017, the maximum potential amount of future payments to third parties under the guarantee was estimated to be $175 million.  Payment would be required if DCP Midstream defaults on this debt obligation, which matures in 2019.

At September 30, 2017, we had other guarantees outstanding for our portion of certain joint venture debt obligations,
which have remaining terms of up to 8 years. The maximum potential amount of future payments to third parties under these guarantees is approximately $135 million. Payment would be required if a joint venture defaults on its debt obligations.

Other Guarantees
In 2016, the operating lease commenced on our headquarters facility in Houston, Texas. Under this lease agreement, we have a residual value guarantee with a maximum future exposure of $554 million. The operating lease has a term of five years and provides us the option, at the end of the lease term, to request to renew the lease, purchase the facility or assist the lessor in marketing it for resale.

We also have residual value guarantees associated with railcar and airplane leases with maximum future exposures totaling $349 million. At year-end 2016, based on an outside appraisal of the railcars’ fair value at the end of their lease terms, we estimated a total residual value deficiency of $94 million and recognized $28 million as expense in 2016.  During the first nine months of 2017, we recognized an additional $35 million of expense related to the residual value deficiency.  At September 30, 2017, the remaining residual value deficiency was $31 million. This deficiency will be recognized on a straight-line basis through May 2019. 

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 indemnification. Agreements associated with these sales include indemnifications for taxes, litigation, environmental liabilities, permits and licenses and employee claims, as well as real estate indemnity against tenant defaults. The provisions of these indemnifications vary greatly. The majority of these indemnifications are related to environmental issues, which generally have indefinite terms, and the maximum amount of future payments is generally unlimited. The carrying amount recorded for indemnifications at September 30, 2017, was $201 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 to support that the liability was 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 $109 million of environmental accruals for known contamination that were primarily included in the “Asset retirement obligations and accrued environmental costs” line on our consolidated balance sheet at September 30, 2017. For additional information about environmental liabilities, see Note 12—Contingencies and Commitments.

Indemnification and Release Agreement
In 2012, in connection with our separation from ConocoPhillips (the Separation), we entered into the Indemnification and Release Agreement. 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.



12


Note 12—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 financial 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 accrue 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 contingent liabilities on currently available facts, existing technology and presently enacted laws and regulations, taking into account stakeholder and business considerations. When measuring contingent 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 such 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, although some of the indemnifications are subject to dollar and time limits.

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 the costs can be reasonably estimated. At September 30, 2017, our total environmental accrual was $458 million, compared with $496 million at December 31, 2016. 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.



13


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 and enables the tracking of 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, 2017, we had performance obligations secured by letters of credit and bank guarantees of $574 million (of which $51 million was issued under the provisions of our revolving credit facility, and the remainder was 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 13—Derivatives and Financial Instruments

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

Purchase and sales contracts with firm minimum notional volumes for commodities that are readily convertible to cash are recorded on the consolidated balance sheet as derivatives unless the contracts are eligible for, and we elect, the normal purchases and normal sales exception, whereby the contracts are recorded on an accrual basis. We generally apply the normal purchases and normal sales exception to eligible crude oil, refined product, NGL, natural gas and power commodity contracts to purchase or sell quantities we expect to use or sell in the normal course of business. All other derivative instruments are recorded at fair value on our consolidated balance sheet. For further information on the fair value of derivatives, see Note 14—Fair Value Measurements.

Commodity Derivative Contracts—We sell into or receive supply from the worldwide crude oil, refined products, NGL, natural gas and electric power markets, exposing our revenues, purchases, cost of operating activities and cash flows to fluctuations in the prices for these commodities. Generally, our policy is to remain exposed to the market prices of commodities; however, we use futures, forwards, swaps and options 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, all of which may reduce our exposure to fluctuations in market prices. 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.

14


The following table indicates the consolidated balance sheet line items that include the fair values of commodity derivative assets and liabilities. The balances in the following table are presented on a gross basis, before the effects of counterparty and collateral netting. However, we have elected to present our commodity derivative assets and liabilities with the same counterparty on a net basis on the consolidated balance sheet when the right of setoff exists.

 
Millions of Dollars
 
September 30, 2017
 
Commodity Derivatives
 
Effect of Collateral Netting

Net Carrying Value Presented on the Balance Sheet

 
Assets

 
Liabilities

 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
Prepaid expenses and other current assets
$
30

 

 

30

Other assets
5

 
(3
)
 

2

Liabilities


 


 


Other accruals
933

 
(1,141
)
 
168

(40
)
Other liabilities and deferred credits
2

 
(4
)
 

(2
)
Total
$
970

 
(1,148
)
 
168

(10
)
 

 
Millions of Dollars
 
December 31, 2016
 
Commodity Derivatives
 
Effect of Collateral Netting

Net Carrying Value Presented on the Balance Sheet

 
Assets

 
Liabilities

 
 
 
 
 
 
 
Assets
 
 
 
 
 
 
Prepaid expenses and other current assets
$
267

 
(154
)
 

113

Other assets
5

 
(1
)
 

4

Liabilities


 


 


Other accruals
474

 
(612
)
 
73

(65
)
Other liabilities and deferred credits

 
(1
)
 

(1
)
Total
$
746

 
(768
)
 
73

51



At September 30, 2017, and December 31, 2016, there was no material cash collateral received or paid that was not offset on the consolidated balance sheet.


15


The gains (losses) incurred from commodity derivatives, 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
 
2017

2016

 
2017

2016

 
 
 
 
 
 
Sales and other operating revenues
$
(256
)
(6
)
 
(101
)
(274
)
Other income
33

8

 
46

24

Purchased crude oil and products
(111
)
36

 
16

(89
)
Net gain (loss) from commodity derivative activity
$
(334
)
38

 
(39
)
(339
)


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. The percentage of our derivative contract volumes expiring within the next 12 months was approximately 98 percent at September 30, 2017, and December 31, 2016.

 
Open Position
Long/(Short)
 
September 30
2017

 
December 31
2016

Commodity
 
 
 
Crude oil, refined products and NGL (millions of barrels)
(35
)
 
(18
)


Interest Rate Derivative Contracts—In 2016, we entered into interest rate swaps to hedge the variability of anticipated lease payments on our new headquarters. These monthly lease payments will vary based on monthly changes in the one-month LIBOR and changes, if any, in the Company’s credit rating over the five-year term of the lease. The pay-fixed, receive-floating interest rate swaps have an aggregate notional value of $650 million and end on April 25, 2021. They qualify for, and are designated as, cash-flow hedges.

The aggregate net fair value of these swaps, which is included in the “Other accruals” and “Other assets” lines on our consolidated balance sheet, amounted to $8 million at both September 30, 2017, and December 31, 2016.

We report the effective portion of the mark-to-market gain or loss on our interest rate swaps designated and qualifying as a cash flow hedging instrument as a component of other comprehensive income (loss) and reclassify such gains and losses into earnings in the same period during which the hedged forecasted transaction affects earnings. Gains and losses due to ineffectiveness are recognized in general and administrative expenses. We did not recognize any material hedge ineffectiveness gain or loss in the consolidated income statement for the three- and nine-month periods ended September 30, 2017 and 2016. Net realized losses from settlements of the swaps were immaterial for the three- and nine-month periods ended September 30, 2017 and 2016.

We currently estimate that pre-tax gains of less than $1 million will be reclassified from accumulated other comprehensive income (loss) into general and administrative expenses during the next twelve months as the hedged transactions settle; however, the actual amounts that will be reclassified will vary based on changes in interest rates.


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 or 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 to 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, 2017, or December 31, 2016.


Note 14—Fair Value Measurements

Recurring Fair Values Measurements
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 either with: (1) adjusted quoted prices from an active market for similar assets or liabilities; 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. For the nine-month period ended September 30, 2017, derivative assets with an aggregate value of $110 million and derivative liabilities with an aggregate value of $112 million were transferred into Level 1 from Level 2, as measured from the beginning of the reporting period. The measurements were reclassified within the fair value hierarchy due to the availability of unadjusted quoted prices from an active market.



17


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.
Derivative instruments—We fair value our exchange-traded contracts based on quoted market prices obtained from the New York Mercantile Exchange, the Intercontinental Exchange or other exchanges, and classify them 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 forward quotes 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. When forward market prices are not available, we estimate fair value using the forward price of a similar commodity, adjusted for the difference in quality or location. 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.
We determine the fair value of our interest rate swaps based on observed market valuations for interest rate swaps that have notionals, terms and pay and reset frequencies similar to ours.
Rabbi trust assets—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.
Debt—The carrying amount of our floating-rate debt approximates fair value. The fair value of our fixed-rate debt is estimated based on observable quotes.

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 on a gross basis in the hierarchy sections of these tables, before the effects of counterparty and collateral netting. These tables also show that our Level 3 activity was not material.

We have master netting agreements 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 the impact of these contracts in the column “Effect of Counterparty Netting.”

The carrying values and fair values by hierarchy of our material financial instruments and commodity forward contracts, either carried or disclosed at fair value, including any effects of netting derivative assets with liabilities and netting collateral due to right of setoff or master netting agreements, were:


18


 
Millions of Dollars
 
September 30, 2017
 
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

 
Level 1

 
Level 2

 
Level 3

Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
487

 
452

 

 
939

(938
)


1

OTC instruments

 
1

 

 
1




1

Physical forward contracts

 
30

 

 
30




30

Interest rate derivatives

 
8

 

 
8




8

Rabbi trust assets
111

 

 

 
111

N/A

N/A


111

 
$
598

 
491

 

 
1,089

(938
)


151

 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
630

 
476

 

 
1,106

(938
)
(168
)


OTC instruments

 
1

 

 
1




1

Physical forward contracts

 
30

 
11

 
41




41

Floating-rate debt
100

 
1,587

 

 
1,687

N/A

N/A


1,687

Fixed-rate debt, excluding capital leases

 
9,110

 

 
9,110

N/A

N/A

(787
)
8,323

 
$
730

 
11,204

 
11

 
11,945

(938
)
(168
)
(787
)
10,052




 
Millions of Dollars
 
December 31, 2016
 
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

 
Level 1

 
Level 2

 
Level 3

 
Commodity Derivative Assets
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
273

 
371

 

 
644

(628
)


16

OTC instruments

 
6

 

 
6

(1
)


5

Physical forward contracts

 
94

 
2

 
96




96

Interest rate derivatives

 
8

 

 
8




8

Rabbi trust assets
97

 

 

 
97

N/A

N/A


97

 
$
370

 
479

 
2

 
851

(629
)


222

 
 
 
 
 
 
 
 
 
 
 
 
Commodity Derivative Liabilities
 
 
 
 
 
 
 
 
 
 
 
Exchange-cleared instruments
$
249

 
452

 

 
701

(628
)
(73
)


OTC instruments

 
1

 

 
1

(1
)



Physical forward contracts

 
61

 
5

 
66




66

Floating-rate debt
50

 
210

 

 
260

N/A

N/A


260

Fixed-rate debt, excluding capital leases

 
10,260

 

 
10,260

N/A

N/A

(570
)
9,690

 
$
299

 
10,984

 
5

 
11,288

(629
)
(73
)
(570
)
10,016



The rabbi trust assets appear on our consolidated balance sheet in the “Investments and long-term receivables” line, while the floating-rate and fixed-rate debt appear in the “Short-term debt” and “Long-term debt” lines. For information

19


regarding the location of our commodity derivative assets and liabilities on our consolidated balance sheet, see the first table in Note 13—Derivatives and Financial Instruments.

Nonrecurring Fair Value Measurements
See Note 5—Business Combinations for remeasurement of our investment in MSLP to fair value. During the nine months ended September 30, 2017 and 2016, there were no other material nonrecurring fair value remeasurements of assets subsequent to their initial recognition.


Note 15—Employee Benefit Plans

Pension and Postretirement Plans
The components of net periodic benefit cost for the three- and nine-month periods ended September 30, 2017 and 2016, were as follows:
 
Millions of Dollars
 
Pension Benefits
 
Other Benefits
 
2017
 
2016
 
2017

 
2016

 
U.S.

 
Int’l.

 
U.S.

 
Int’l.

 
 
 
 
Components of Net Periodic Benefit Cost
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
33

 
8

 
32

 
8

 
1

 
1

Interest cost
27

 
7

 
29

 
7

 
2

 
2

Expected return on plan assets
(37
)
 
(11
)
 
(32
)
 
(9
)
 

 

Amortization of prior service cost
1

 

 
1

 

 

 

Recognized net actuarial loss
17

 
6

 
18

 
4

 

 

Settlements
21

 

 
2

 

 

 

Net periodic benefit cost
$
62


10


50


10


3


3

 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30
 
 
 
 
 
 
 
 
 
 
 
Service cost
$
99

 
25

 
96

 
26

 
4

 
5

Interest cost
81

 
20

 
87

 
22

 
6

 
6

Expected return on plan assets
(110
)
 
(30
)
 
(96
)
 
(29
)
 

 

Amortization of prior service cost (credit)
2

 
(1
)
 
2

 
(1
)
 
(1
)
 
(1
)
Recognized net actuarial loss
52

 
18

 
54

 
11

 

 

Settlements
76

 

 
5

 

 

 

Net periodic benefit cost
$
200

 
32

 
148

 
29

 
9

 
10



During the first nine months of 2017, we contributed $432 million to our U.S. employee benefit plans and $26 million to our international employee benefit plans. The contributions were included in the “Other” line within the operating activities section on our consolidated statement of cash flows. We currently expect to make additional contributions of approximately $6 million to our U.S. employee benefit plans and $9 million to our international employee benefit plans during the remainder of 2017.

For our U.S. pension plans, lump-sum benefit payments have exceeded the sum of service and interest costs for the year. As a result, we have recognized a proportionate share of prior actuarial losses, or pension settlement expense, totaling $76 million for the nine months ended September 30, 2017.

In conjunction with the Whitegate Refinery disposition, the fair market value of plan assets was updated and the pension benefit obligation was remeasured for the Ireland Pension Plan at August 31, 2016. At the measurement date, the pension liability had a net decrease of $3 million, which resulted in an increase to other comprehensive income, due to the

20


following two components: 1) a curtailment gain (decrease in projected benefit obligation) of $31 million, as all future benefit accruals were eliminated from projected benefit obligation, and 2) an actuarial loss (increase in projected benefit obligation) of $28 million, which was primarily related to a decline in the discount rate from 2.3 percent at December 31, 2015, to 1.3 percent at August 31, 2016.


Note 16—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, 2015
$
(662
)
 
11

 
(2
)
 
(653
)
Other comprehensive income (loss) before reclassifications
10

 
(187
)
 
(7
)
 
(184
)
Amounts reclassified from accumulated other comprehensive income (loss)*
 
 
 
 
 
 
 
Amortization of defined benefit plan items**
 
 
 
 
 
 
 
Actuarial losses and settlements
45

 

 

 
45

Net current period other comprehensive income (loss)
55

 
(187
)
 
(7
)
 
(139
)
September 30, 2016
$
(607
)
 
(176
)
 
(9
)
 
(792
)
 
 
 
 
 
 
 
 
December 31, 2016
$
(713
)
 
(285
)
 
3

 
(995
)
Other comprehensive income before reclassifications
5

 
214

 

 
219

Amounts reclassified from accumulated other comprehensive income (loss)*
 
 
 
 
 
 


Amortization of defined benefit plan items**
 
 
 
 
 
 
 
Actuarial losses and settlements
92

 

 

 
92

Net current period other comprehensive income
97

 
214

 

 
311

September 30, 2017
$
(616
)
 
(71
)
 
3

 
(684
)
* 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 15—Employee Benefit Plans, for additional information).


Note 17— Restricted Cash

At September 30, 2017, and December 31, 2016, the company did not have any restricted cash. The restrictions on the cash acquired in February 2017, as a result of the consolidation of MSLP, were fully removed in the second quarter of 2017 when MSLP’s outstanding debt that contained lender restrictions on the use of cash was paid in full. See Note 5—Business Combinations and Note 10—Debt for additional information regarding MSLP.

21


Note 18—Related Party Transactions

Significant transactions with related parties were:

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2017

2016

 
2017

2016

 
 
 
 
 
 
Operating revenues and other income (a)
$
638

588

 
1,778

1,544

Purchases (b)
2,557

2,118

 
6,932

5,769

Operating expenses and selling, general and administrative expenses (c)
13

31

 
52

92



As discussed more fully in Note 5—Business Combinations, in February 2017, we began accounting for MSLP as a wholly owned consolidated subsidiary. Accordingly, the table above only includes processing fees paid to MSLP through the consolidation date.
(a)
We sold NGL and other petrochemical feedstocks, along with solvents, to CPChem, and we sold gas oil and hydrogen feedstocks to Excel Paralubes (Excel). We sold refined products to our OnCue Holdings, LLC joint venture. We also sold certain feedstocks and intermediate products to WRB and also acted as agent for WRB in supplying crude oil and other feedstocks for a fee. In addition, we charged several of our affiliates, including CPChem, for the use of common facilities, such as steam generators, waste and water treaters, and warehouse facilities.

(b)
We purchased crude oil and refined products from WRB. We also acted as agent for WRB in distributing asphalt and solvents for a fee. We purchased natural gas and NGL from DCP Midstream and CPChem, as well as other feedstocks from various affiliates, for use in our refinery and fractionation processes. We paid NGL fractionation fees to CPChem. We also paid fees to various pipeline equity companies for transporting crude oil, finished refined products and NGL. We purchased base oils and fuel products from Excel for use in our refining and specialty businesses.
 
(c)
We paid utility and processing fees to various affiliates.



22


Note 19—Segment Disclosures and Related Information

Our operating segments are:

1)
Midstream—Gathers, processes, transports and markets natural gas; and transports, stores, fractionates and markets NGL in the United States. In addition, this segment transports crude oil and other feedstocks to our refineries and other locations, delivers refined and specialty products to market, and provides terminaling and storage services for crude oil and petroleum products. The segment also stores, refrigerates and exports liquefied petroleum gas primarily to Asia. The Midstream segment includes our master limited partnership, Phillips 66 Partners LP, as well as our 50 percent equity investment in DCP Midstream.

2)
Chemicals—Consists of our 50 percent equity investment in CPChem, which manufactures and markets petrochemicals and plastics on a worldwide basis.

3)
Refining—Purchases, sells and refines crude oil and other feedstocks at 13 refineries, mainly in the United States and Europe.

4)
Marketing and Specialties—Purchases for resale and markets refined products (such as gasolines, distillates and aviation fuels), mainly in the United States and Europe. In addition, this segment includes the manufacturing and marketing of specialty products (such as base oils and lubricants), as well as power generation operations.

Corporate and Other includes general corporate overhead, interest expense, our investments in new technologies and various other corporate activities. Corporate assets include all cash and cash equivalents.

We evaluate segment performance based on net income attributable to Phillips 66. Intersegment sales are at prices that approximate market.




23


Analysis of Results by Operating Segment

 
Millions of Dollars
 
Three Months Ended
September 30
 
Nine Months Ended
September 30
 
2017

2016

 
2017

2016

Sales and Other Operating Revenues
 
 
 
 
 
Midstream
 
 
 
 
 
Total sales
$
1,433

934

 
4,467

2,784

Intersegment eliminations
(433
)
(296
)
 
(1,260
)
(866
)
Total Midstream
1,000

638

 
3,207

1,918

Chemicals
2

1

 
4

3

Refining
 
 
 
 
 
Total sales
16,499

13,465

 
46,014

37,242

Intersegment eliminations
(10,461
)
(9,035
)
 
(28,641
)
(24,840
)
Total Refining
6,038

4,430

 
17,373

12,402

Marketing and Specialties
 
 
 
 
 
Total sales
18,887

16,799

 
52,903

47,327

Intersegment eliminations
(306
)
(252
)
 
(900
)
(792
)
Total Marketing and Specialties
18,581

16,547

 
52,003

46,535

Corporate and Other
6

8

 
21

24

Consolidated sales and other operating revenues
$
25,627

21,624

 
72,608

60,882

 
 
 
 
 
 
Net Income (Loss) Attributable to Phillips 66
 
 
 
 
 
Midstream
$
85

75

 
221

179

Chemicals
121

101

 
498

447

Refining
550

177

 
1,033

412

Marketing and Specialties
208

267

 
563

701

Corporate and Other
(141
)
(109
)
 
(407
)
(347
)
Consolidated net income attributable to Phillips 66
$
823

511

 
1,908

1,392



 
Millions of Dollars
 
September 30
2017

 
December 31
2016

Total Assets
 
 
 
Midstream
$
12,904

 
12,832

Chemicals
6,211

 
5,802

Refining
23,949

 
22,825

Marketing and Specialties
7,118

 
6,227

Corporate and Other
2,530

 
3,967

Consolidated total assets
$
52,712

 
51,653




24


Note 20—Income Taxes

Our effective tax rates for the third quarter and the first nine months of 2017 were 32 percent and 31 percent, respectively, compared with 34 percent and 32 percent for the corresponding periods of 2016.

The decrease in the effective tax rate for the third quarter of 2017 was primarily attributable to the relative impact of foreign operations that are subject to a lower income tax rate and excess tax benefits associated with share-based compensation.

The effective tax rate varies from the federal statutory tax rate of 35 percent primarily as a result of foreign operations, excess tax benefits associated with share-based compensation, and the impact of income attributable to noncontrolling interests, partially offset by state tax expense.


Note 21—Phillips 66 Partners LP

Phillips 66 Partners is a publicly traded master limited partnership formed to own, operate, develop and acquire primarily fee-based crude oil, refined petroleum product and NGL pipelines and terminals, as well as other midstream assets. Headquartered in Houston, Texas, Phillips 66 Partners’ assets currently consist of crude oil, refined petroleum products and NGL transportation, terminaling and storage systems, as well as crude oil and NGL processing facilities. Phillips 66 Partners conducts its operations through both wholly owned and joint-venture operations. The majority of Phillips 66 Partners’ wholly owned assets are associated with, and integral to the operation of, nine of Phillips 66’s owned or joint-venture refineries.

We consolidate Phillips 66 Partners as a variable interest entity for financial reporting purposes. See Note 3—Variable Interest Entities (VIEs) for additional information on why we consolidate the partnership. As a result of this consolidation, the public unitholders’ ownership interest in Phillips 66 Partners is reflected as a noncontrolling interest in our financial statements. At September 30, 2017, we owned a 57 percent limited partner interest and a 2 percent general partner interest in Phillips 66 Partners, while the public owned a 41 percent limited partner interest.

In June 2016, Phillips 66 Partners began issuing common units under a continuous offering program, which allows for the issuance of up to an aggregate of $250 million of Phillips 66 Partners’ common units, in amounts, at prices and on terms to be determined by market conditions and other factors at the time of the offerings (such continuous offering program, or at-the-market program, is referred to as the ATM program). For the nine months ended September 30, 2017, on a settlement-date basis, Phillips 66 Partners has issued 3,323,576 common units under the ATM program, which generated net proceeds of $171 million. From inception through September 30, 2017, Phillips 66 Partners has issued an aggregate of 3,669,728 common units under the ATM program, which generated net proceeds of $190 million.

Subsequent Events
On September 19, 2017, we entered into an agreement to contribute to Phillips 66 Partners our 25 percent interests in DAPL and ETCO and our 100 percent interest in MSLP. The transaction closed on October 6, 2017. Total consideration paid to us by Phillips 66 Partners was $1.65 billion