The unaudited interim financial information presented in the financial statements included in this report is prepared in accordance with generally accepted accounting principles in the United States (GAAP) 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 20182019 Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2019,2020, 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.

 

Inventories consisted of the following:

Inventories valued on the last-in, first-out (LIFO) basis totaled $4,931$4,879 million and $3,123$3,331 million at March 31, 2019,2020, and December 31, 2018,2019, respectively. The estimated excess of current replacement cost over LIFO cost of inventories amounted to approximately $5.1 billionWe performed a lower-of-cost-or-market evaluation for our crude oil and $2.9 billionpetroleum products inventory at March 31, 2019,2020, and December 31, 2018, respectively.determined that a write-down was not required based on forward prices. Should crude oil and petroleum product forward prices have a sustained decline, a future lower-of-cost-or-market write‑down may be required.

The fair value of our investment in DCP Midstream depends on the market value of DCP Midstream, LP (DCP Partners) common units. The market value of DCP Partners common units declined by approximately 85% in the first quarter of 2020.  As a result, at March 31, 2020, the fair value of our investment in DCP Midstream was significantly lower than its book value. We concluded the difference between its fair value and book value was not temporary primarily due to its magnitude. Accordingly, we recorded a $1,161 million before-tax impairment of our investment in the first quarter of 2020. This charge is included in the “Impairments” line item on our consolidated statement of operations. Following the impairment, our investment in DCP Midstream had a book value of $245 million at March 31, 2020. The impairment increased the basis difference for our investment in DCP Midstream, which indicates the carrying value of our investment is lower than our share of DCP Midstream’s recorded net assets. The basis difference of $1,795 million is expected to be amortized and recognized as a benefit to equity earnings over a period of 22 years, which was the estimated remaining useful life of DCP Midstream’s properties, plants and equipment (PP&E) at March 31, 2020. See Note 13—Fair Value Measurements, for additional information on the techniques used to determine the fair value of our investment in DCP Midstream.

Gray Oak Pipeline, LLC is considered a variable interest entity (VIE) because it does not have sufficient equity at risk to fully fund the construction of all assets required for Chevronprincipal operations. We have determined we are not the primary beneficiary because we and our co-venturers jointly direct the activities of Gray Oak Pipeline, LLC that most significantly impact economic performance. On April 1, 2020, the Gray Oak Pipeline commenced full operations from West Texas to Texas Gulf Coast destinations. The Eagle Ford segment of the pipeline commenced operations later in April. At March 31, 2020, Phillips Chemical Company66 Partners’ effective ownership interest in the Gray Oak Pipeline was 42.25%, and Phillips 66 Partners’ maximum exposure to loss was $1,382 million, which represented the book value of the investment in Gray Oak Pipeline, LLC (CPChem)of $799 million and WRB Refiningthe term loan guarantee of $583 million. See Note 19—Phillips 66 Partners LP, (WRB) was as follows:for additional information regarding Phillips 66 Partners’ ownership in Gray Oak Pipeline, LLC.

Liberty is a 50%-owned joint venture formed to develop and construct the Liberty Pipeline system which, upon completion, will transport crude oil from the Rockies and Bakken production areas to Cushing, Oklahoma. Liberty is considered a VIE because it does not have sufficient equity at risk to fully fund the construction of all assets required for principal operations. Phillips 66 Partners hasWe have determined it iswe are not the primary beneficiary because itwe and its co-venturersour co-venturer jointly direct the activities of Gray OakLiberty that most significantly impact economic performance. On March 2, 2020, Phillips 66 Partners closed a transaction to acquire our 50% interest in Liberty for $75 million. Phillips 66 Partners and its co-venturer subsequently deferred the development and construction of the Liberty Pipeline system as a result of the current challenging business environment. At March 31, 2019, Phillips 66 Partners’2020, our maximum exposure to loss was $771$216 million, which represented the book value of the investment in Gray Oak of $741 million and guaranteed purchase obligations of $30 million.

We hold a 50% interest in OnCue, a joint venture that owns and operates retail convenience stores. We fully guaranteed various debt agreements of OnCue and our co-venturer did not participate in the guarantees. This entity is considered a VIE because our debt guarantees resulted in OnCue not being exposed to all potential losses. We have determined we are not the primary beneficiary because we do not have the power to direct the activities that most significantly impact OnCue’s economic performance. At March 31, 2019,2020, our maximum exposure to loss was $124$148 million, which represented the book value of our investment in OnCue of $70$79 million and guaranteed debt obligations of $54$69 million.

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

On March 22, 2019,19, 2020, Phillips 66 Partners entered into a senior unsecured$1 billion 364-day delayed draw term loan facilityagreement (the Facility) and borrowed $1 billion under the Facility shortly thereafter. On April 6, 2020, Phillips 66 increased the size of the Facility to $2 billion, with a borrowing$1 billion of capacity of $400 million that matures on March 20, 2020. At March 31, 2019, term loans totaling $250 million were outstanding under this facility.remaining undrawn. Borrowings under this facilitythe Facility bear interest at a floating rate based on either the Eurodollar rate or the reference rate, plus a margin determined by the credit rating of Phillips 66’s senior unsecured long‑term debt. Phillips 66 Partners’ credit ratings. Proceedsis using the proceeds from term loans made under this facility were usedthe debt issuance for general partnership purposes, including repaymentcorporate purposes.

At March 31, 2020, borrowings of amounts borrowed$200 million were outstanding under Phillips 66’s uncommitted $5 billion commercial paper program, compared with 0 borrowings outstanding under the commercial paper program at December 31, 2019. At March 31, 2020, and December 31, 2019, 0 amount had been directly drawn under Phillips 66 Partners’ $750 million revolving credit facility. Atfacility; however, $3 million and $1 million in letters of credit had been issued under this facility at March 31, 2020, and December 31, 2019, borrowings of $15 million were outstanding underrespectively.

At March 31, 2019, $550 million of Phillips 66 Partners’ debt due within a year was classified as long-term debt based on Phillips 66 Partners’ intent to refinance these obligations on a long-term basis and ability to do so under its revolving credit facility.

In addition, at March 31, 2020, we had other guarantees outstanding for our portion of certain joint venture debt obligations and purchase obligations, which have remaining terms of up to fiveeight years. The maximum potential amount of future payments to third parties under these guarantees was approximately $331 million. Payment would be required if a joint venture defaults on its obligations.

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 potentially unlimited exposure. At March 31, 2019,2020, and December 31, 2018,2019, the carrying amount of recorded indemnifications was $173$159 million and $171$153 million, respectively.

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.reversal. 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. At March 31, 2019,2020, and December 31, 2018,2019, environmental accruals for known contamination of $104$111 million and $101$105 million, respectively, were included in the carrying amount of recorded indemnifications.indemnifications noted above. These environmental accruals were primarily included in the “Asset retirement obligations and accrued environmental costs” line item on our consolidated balance sheet. For additional information about environmental liabilities, see Note 11—Contingencies and Commitments.

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.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.

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-relatedincome 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.

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 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 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 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 March 31, 2019,2020, our total environmental accrual was $446accruals were $442 million, compared with $447$441 million at December 31, 2018.2019. 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.

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.

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 March 31, 2019,2020, we had performance obligations secured by letters of credit and bank guarantees of $553$463 million related to various purchase and other commitments incident to the ordinary conduct of business.

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 and unrealized gains and losses from commodity derivative contracts are recognized in our consolidated statement of income.operations. Gains and losses from derivative contracts held for trading not directly related to our physical business are reported net in the “Other income” line item on our consolidated statement of income.operations. Cash flows from all our derivative activity for the periods presented appear in the operating section on our consolidated statement of cash flows.

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 our consolidated balance sheet when the legal right of offset exists.

The realized and unrealized gains (losses) incurred from commodity derivatives, and the line items where they appear on our consolidated statement of income,operations, were:

 

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-derivativenonderivative positions such as inventory volumes. Financial derivative contracts may also offset physical derivative contracts, such as forward purchase and sales contracts. The percentage of our derivative contract volumes expiring within the next 12 months was at least 98% at March 31, 2019,2020, and December 31, 2018.2019.

The aggregate net fair value of these swaps which is included in the “Prepaid expenses and other current assets” and “Other assets” lines on our consolidated balance sheet, totaled $11 million and $15 millionwas immaterial at March 31, 2019,2020, and December 31, 2018, respectively.

We currently estimate that pre-tax gainsbefore-tax losses of $6$7 million will be reclassified from accumulated other comprehensive loss into general and administrative expenses during the next 12 months as the hedged transactions settle; however, the actual amounts that will be reclassified will vary based on changes in interest rates.

The credit risk from our 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, typically on a daily basis, until settled.

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 immaterial at March 31, 2019,2020, and December 31, 2018.2019.