By Svea Herbst-Bayliss

(Reuters) -Elliott Investment Management has taken a $1 billion stake in Phillips 66 and is urging the U.S. oil refiner and pipeline operator to revamp its board to boost lagging performance.

The activist investment firm, in a letter to the Houston energy company's board on Wednesday, said Phillips 66's stock, recently trading at about $118 per share, could hit $200 with improvements. It said management had laid out sensible performance targets but could use help achieving its full potential.

Phillips 66 has lagged its U.S. refining rivals at a time when fuel demand and margins have soared for the industry. Its second-quarter earnings missed Wall Street estimates, and executives laid out a plan to boost returns by cutting costs and assets. It may sell or spin off $3 billion in assets next year, executives promised.

Chief Executive Mark Lashier acknowledged discussions with Elliott but did not say whether the company was open to adding two Elliott-recommended directors to its board.

Phillips 66 welcomes "their perspectives and the perspectives of other shareholders on our strategy and actions we are taking to drive long-term sustainable growth and value creation," Lashier said in a statement. "We remain committed to acting in the best interests of our shareholders."

Shares of the refiner, which has a market value of $52 billion, rose 3% to $121.51 in early trading on news one of the industry's most prominent activist investors had gotten involved.

Prior to the letter's release, Phillips 66 stock was up 8.3% from a year ago, compared to a 21.5% gain at larger rival Marathon Petroleum during the same period.

INVESTORS 'LOST CONFIDENCE'

"Given the company's history of failed execution, we believe shareholders would welcome the appointment to the board of two new directors with refining-operating experience," Elliott partner John Pike and portfolio manager Mike Tomkins wrote in the letter, which was made public.

Elliott criticized Phillips 66's refining operations, writing that management had taken its "eye off the ball" by letting operating expenses soar.

Investors have lost confidence amid "underperformance in refining, as well as poor execution on its cost-reduction efforts," the letter said.

The hedge fund said it had found director candidates who could enhance a board "that has limited refining-operations expertise." It did not identify the candidates.

Phillips 66 currently has 13 board members.

Elliott, which earlier this week signaled that it was ready to push out a majority of directors and top executives at cell tower and fiber provider Crown Castle International, offered some support for the Phillips team, including Lashier who became CEO last year.

"Lashier and the rest of the management team deserve investor support so long as they demonstrate meaningful progress against these targets," the letter said, adding that it also understood market skepticism.

(Reporting by Svea Herbst-Bayliss in Providence, Gary McWilliams in Houston and Tanay Dhumal in Bengaluru; Editing by Anil D'Silva, Varun H K and Bernadette Baum)