Flint Hills Resources: Handling Headwinds

FHR had to answer an existential question: What will it take to stay in business?

Flint Hills Resources provides millions of Americans with much-needed, reliable, affordable fuels and chemical compounds for making countless essentials. Flights in and out of Dallas-Ft. Worth, Austin and Minneapolis, the roadways required for vehicles (electric or gasoline), the syringes used to give vaccinations and even the Minnesota Vikings’ football playing field all rely on refined products produced by FHR. In keeping with Koch’s Vision, FHR makes those products while using fewer resources and reducing emissions, resulting in industry-leading performance.

America’s refining industry is a low-margin, capital-intensive and cyclical business. Some of those down cycles have been brutal. Even so, in the past, the only year our refining business failed to make a profit was 1949, when both of its refineries lost money. (They were soon sold.) Fifty years later, it happened again when Corpus Christi lost tens of millions and Pine Bend was barely profitable.

Early Improvements

That deterioration in our refining business was a wake-up call. The first step was replacing the CEO of the refining group with Dave Robertson, who had previously led its sales team and was known and trusted by long-term employees. His approach was to interview the employees he felt would tell him the truth.

Those interviews revealed significant problems in all five dimensions of MBM. The people causing them were terminated and the problems were quickly corrected. Profitability greatly improved. One of the changes at Corpus that transformed its performance was reconfiguring the plant so it would be profitable even when margins were as low as they were in 1999.

As Robertson put it: “Individuals working in the business both identified the problems and came up with the solutions. The fix was a bottom-up approach recommended and implemented by team members committed to our principle-based framework.” Given this success, FHR spent the following years focused on expanding and upgrading.

What Does $8 Billion Buy?

Initially designed in 1955 to process 25,000 barrels per day, the Pine Bend refinery in Minnesota can now process 370,000 b/d. When the Corpus Christi East refinery was acquired in 1981, it had a capacity of 55,000 b/d. The expanded South Texas complex can now process more than 350,000 b/d.

As a result of the 2009 boom in shale oil production from the Eagle Ford region in South Texas, FHR realized it needed to transform how it configured and ran its Corpus complex. By developing the capability to transport and process large volumes of new domestic crude, rather than relying on imports, Corpus became much more competitive.

Improvements such as these didn’t come cheap or easy. The most recent series of upgrades and expansions at Pine Bend cost nearly $2 billion, with several thousand construction workers on-site for years. Adding and modifying equipment at Corpus Christi cost another $1.5 billion.

By 2001, FHR had expanded its vision to include acquiring other chemical process businesses. The goal was to apply its management, technical, operational, trading and commercial capabilities more broadly to create greater value. FHR spent more than $5 billion on chemical plants in Illinois, Texas and Louisiana; biodiesel and ethanol assets in Iowa, Nebraska and Georgia; and a refinery in Alaska.

Expenditures such as these were justified by assumptions about the return that could be earned during a 20-year period. Those returns were usually overestimated due to these businesses’ lower entry barriers and operating, environmental and regulatory issues. As the refining industry faced even stronger headwinds, making long-range assumptions in that industry became even more difficult.

What Are Headwinds?

Headwinds are powerful, sustained factors that can destroy demand and increase costs. Although pandemics, recessions and wars can create tough times, we don’t consider them headwinds because, despite their severity, they are usually temporary.

Headwinds are not a death sentence. Books printed on paper have not disappeared because of e-books. (In fact, they outsell e-books four-to-one.) It is also wrong to assume that the effects of headwinds will always be harmful. By scaring away new competitors, investments and innovations, headwinds can sometimes increase the profitability of existing businesses for extended periods.

Flint Hills Resources had to keep all that in mind as it figured out how to respond to headwinds affecting the prospects for fossil fuels.

What We’re Up Against

Many would like to force energy companies like FHR out of existence. In recent years we have seen an unprecedented and coordinated array of legal, regulatory, political and societal pressure intent on destroying every aspect of America’s hydrocarbon infrastructure. There have already been bans on gasoline-powered lawnmowers, prohibitions against natural gas appliances in new homes, and pressure on banks to divest any holdings in fossil fuel-related companies. Several governments are seeking to ban the sale of combustion engines no later than 2050 — and preferably by 2035.

Exacerbating this situation are costly subsidies. Electric vehicles sold in the U.S. receive tens of thousands of dollars in combined benefits. Even more costly mandates include requiring more than 10% ethanol in gasoline, low-carbon fuel standards and refinery emissions fees. Limiting energy options is just the beginning. Governments are also targeting the availability of other products, such as food, clothing and transportation, based on emissions. Even worse, they are censoring those who raise questions or challenge government policies and punishing those who exercise their First Amendment rights of free speech, association and to petition the government.

Given that Koch’s principle-based framework calls for investing solely in businesses and products with sustainable competitive advantages that can create superior long-term returns, FHR’s leadership had to answer some tough questions: What do we do in the face of all these headwinds? Can we even stay in business?

Answering Hard Questions

“Prior to 2015, our focus was about growth through expansions and acquisitions,” explained Brad Razook, FHR’s president and CEO before becoming Koch’s executive vice president and CEO of Resources. As more and more acquisitions and expansions were completed, returns began dropping while costs were escalating. At the same time, these growth and acquisition projects distracted the team from optimizing the business. As Dave Robertson put it: “They diluted our capability.”

Ultimately, FHR’s leadership faced the tough questions raised by increasingly challenging conditions: “How are we going to generate superior returns?” “What capabilities will we need to deal with the headwinds in our refining and other businesses?”

“Those challenges helped us realize that, because of our focus on growth, we were not improving our capabilities as quickly as we needed to,” Razook acknowledged. “We had to ask ourselves, why keep building more capacity in a declining market and making acquisitions in businesses with poor prospects? Because of our focus on growth, we were not improving our capabilities quickly.”

“In 2015, we started a rigorous review that took several months,” recalled Jeff Ramsey, who became FHR’s President and CEO after Razook. “There was a lot of marginal analysis and point-of-view work on where we might be headed.” FHR’s leadership looked at changing market conditions, configurations, yields, energy efficiencies, utilization and EH&S (environment, health and safety) performance. “One of the things our analysis highlighted was the need to address underperforming assets individually.”

The principles of headwinds and especially capabilities became essential guideposts for FHR’s thinking. “We had to reassess our capabilities and challenge where we could truly build lasting competitive advantages,” Ramsey said. “For years, we thought applying our existing capabilities to other businesses would be enough. But that wasn’t true.” Those realizations helped shape a new vision for FHR. “Instead of just adding businesses, products and capacity,” said Paul Houslet, FHR’s senior vice president of transformation, “we needed to focus our organization on where we could be most successful. That meant refining.”

“We wanted to be the best — the preferred — refiner in North America,” Ramsey said. “We realized we needed more focus and fewer distractions to get there. Otherwise, given all the headwinds, we couldn’t create superior returns in any of our businesses.”

Tough Choices

Realizing it needed to let go of its underperforming assets, FHR made some bold moves during the next five years, including divesting its biofuel plants. “We were one of the biggest biofuel producers in the U.S., but were we producing superior returns? No,” Ramsey admitted.

FHR also sold its Joliet intermediate chemicals and Peru polystyrene plants in Illinois, and its Port Arthur olefins plant in Texas. “We didn’t have any realistic options for improving or growing Port Arthur,” Ramsey said. “We had already put a lot into it, but because of rapid changes in the market, it needed major new investments.” FHR’s largest-ever acquisition, a $2.1 billion propylene plant in Houston, and its Longview polypropylene plant were sold to INVISTA because they better fit its vision.

The effects of these changes on FHR’s holdings and workforce were enormous. The number of operated facilities went from nearly 20 varied assets to just its exceptional Pine Bend and Corpus Christi refineries, along with their related pipelines and terminals. FHR also began revamping its investment strategies.

To be clear, FHR’s new vision was not a one-way street — only about shrinking and divesting. Phil Gaarder, FHR’s executive vice president of operations, described it this way: “Given the headwinds we were facing, we saw that we needed a tighter focus and smaller projects with a shorter path to profitability.” While continuing its longstanding commitment to stewardship, FHR changed its yardstick for new spending. “Instead of capacity growth,” Razook said, “we focused on improving the assets, costs and yields where we had and could build advantages.”

Transforming Our Teams

While rethinking what assets to own and operate, and how and where to invest, FHR also made organizational changes to help transform employees’ roles and empower everyone to self-actualize and contribute more. “When we had more than a dozen plants,” Ramsey said, “many of our people were siloed. We had to break down the barriers preventing employees from maximizing their contributions to Koch’s long-term success.”

Houslet often points to the division of labor by comparative advantage when discussing FHR’s workforce transformation. “It’s common for a refinery to have 40 or 50 engineers and for each engineer to be expected to perform a wide range of tasks. But not all engineers have the same interests or gifts. If a chemical engineer is great at math, why have her run a processing unit or fix valves and leaks? Let her do analysis!”

Gaarder, who spent several years in operations at both Pine Bend and Corpus, agrees: “Before, our chemical engineers might spend six or seven years working on a broad array of projects important to the refinery. Now they can lock in on what interests them and are good at doing, creating an advantage. Maybe it’s monitoring; maybe it’s process control.”

Houslet noted that moving employees to roles where they created an advantage and could self-actualize benefitted FHR enormously: “We got great engagement throughout our organization by making changes like that. Yes, there were some healthy challenges at first, but when you’re allowed to focus on your comparative advantages, you become better at what you do — you are energized and contribute more.”

“We expanded our Business Team concept to apply the five dimensions better,” added Houslet. It’s no accident that process engineers at both locations now have the technology and opportunity to work on problems at either site without leaving town.

Transforming Our Technology

Technology became essential for transformation at FHR. According to Houslet: “Our goal was to use technology to transform our work processes in ways that improved our competitiveness. That required embracing new technology faster than others in the industry, which is easier said than done. To get true transformation, you have to do a lot.”

In 2018, FHR fundamentally upgraded its computing power. “Before, the technology we wanted was either too expensive or didn’t exist. Our willingness to invest in new hardware and better work processes proved to be a game changer,” Houslet said. For example, all FHR sites are now equipped with Wi-Fi, which enables sensors to send real-time performance data remotely. “Wi-Fi is a huge enabler,” said Gaarder. “It facilitates monitoring, communication and troubleshooting. It can be applied to an instrument in minutes, not weeks. Ten years ago, maybe one percent of our hydrocarbon pumps had monitoring. Now they all do. It costs nearly $2,000 per pump — and we have thousands of pumps — but we didn’t argue about the cost. We did it because it improved jobs and generated good returns. We were willing to spend the money to improve things rather than just standing around talking about it.”

Thanks to investments such as these, operators are more efficient when looking for defects and maintenance techs can spot problems sooner. Both groups now work better together to diagnose problems and restore equipment performance. Safety has been improved by, among many things, automating chemical deliveries. Machine learning has created an endless loop of improvement. “We’ve installed at least 60,000 machine-learning applications on our refining equipment,” said Houslet, “and no sooner do we use technology to improve something than we discover we can improve it another 30%, over and over again.” “But it takes everybody collaborating with a sense of urgency to make those advantages real,” Gaarder added.

Over the years, FHR’s emphasis on environmental stewardship and making a positive difference in its communities also helped build better, mutually beneficial relationships, earning its status as a preferred partner. Significant investments in new technologies, paired with more fully empowered employees, led to new capabilities, contributing to major increases in NIAT and ROCC during the next three years. But then came something unexpected — something Ramsey called “a worst-case scenario that happened overnight.”

Worst-Case Scenario

The COVID pandemic brought a degree of demand destruction for transportation fuels far beyond what anyone had anticipated. “We lost 50% of our demand in just two days,” Razook said. By one estimate, Americans went from driving an average of six hours a week to just 42 minutes. The CEO of one airline admitted that “travel demand is essentially zero.”

As that pressure on the industry continued week after week, month after month, several refiners chose to shut down, never to reopen. “Many of our competitors reacted by taking on debt and laying off thousands of people,” Ramsey said. Although FHR’s profits fell by more than 70%, “we were one of the few — if not the only — American refiners to make a profit in 2020. Those were very, very tough times. They did, however, validate our strategy. COVID proved that the best organizations with the best assets can survive.”

Remember the observation about the refining industry being cyclical? Almost as quickly as demand went away, it came roaring back. As soon as COVID shutdowns and restrictions were lifted, demand boomed as hundreds of millions of Americans responded by getting out and about. Because Flint Hills Resources had positioned itself to meet this rebounding demand, 2022 became its best year ever.

Principles and Persistence

“I still read about new challenges, new headwinds, for our industry every day,” Ramsey admits. “Many of our peers, especially public ones, are not only lobbying for subsidies but also making promises or commitments they can’t keep. Those approaches directly conflict with our principle-based framework.”

The way Ramsey sees it, headwinds don’t necessarily lead to dead ends. “We see many opportunities to transform our business even more through better application of Principle Based Management. We’re doing that through technology, product innovation and stewardship, all by empowering our people. Before, we used to be all about being bigger; now, we’re focused on better and smarter. We want to do things in the most advantaged and responsible way possible.”

“Headwinds necessitated a transformation in how we operated,” said Razook, “which led to record performance. More fully applying our principles enabled us to succeed in a headwinds environment.” Razook also believes that “transformation changes your opportunities. It opens even more doors. That’s exciting not only for FHR and our employees but for all of Koch.”

After more than sixty years of leadership, Charles Koch sums up his point of view regarding refining and headwinds this way: “Some people think I no longer want to be in refining. That’s not true. I want us to be in it in a way that enables us to contribute and succeed.”