Delta Buys Refinery, To Make Own Fuel

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Published: May 1, 2012

Delta Air Lines will buy a US oil refinery from ConocoPhillips for USD$ 150 million, the most audacious move yet by an airline trying to save money on fuel costs.

Delta said the first ever purchase of a refinery by an airline would allow it to cut USD$ 300 million annually from jet fuel costs, which reached USD$ 12 billion last year. It said production at the refinery along with other agreements to exchange refined products for jet fuel would provide 80 percent of its fuel needs in the United States.

The company will bring in a management team and outsource the trading operations at the 185,000 barrel per day Trainer, Pennsylvania refinery.

Oil major BP will supply crude oil to be refined at the plant under a three-year agreement. BP and former refinery owner Phillips 66 will get a share of the diesel and refined fuel to sell, in exchange for supplying Delta with jet fuel in other locations.

The deal will ease fears that the closure of several major US East Coast refineries would cause a shortfall in fuel supplies this summer. The governor of Pennsylvania has scheduled a news conference for Tuesday at Trainer, which has been idled since last September pending a sale.

“Refining capacity we thought we weren’t going to have, it looks like we will,” said Katherine Spector, an analyst with CIBC World Markets in New York.

Atlanta-based Delta said the deal will include pipelines and other assets that will provide access to the delivery network for jet fuel reaching its Northeast operations, including its hubs at New York’s LaGuardia and JFK airports.

Delta said it expects the purchase to add to its earnings and expand margins in the first year of operations as it recovers its investment. In addition to the USD$ 150 million purchase cost, Delta will also spend USD$ 100 million to re-tool the refinery to expand jet fuel output, it said.

REFINERY PURGE

In the weeks leading up to the deal, analysts wondered how an airline could succeed at running a refinery that has produced losses for experienced energy companies. After the announcement, airline and oil industry analysts were still cautious on the purchase.

“Certainly, the East Coast will need refinery capacity to remain operable. But can Delta put together a group to run this refinery profitably,” said Mark Routt, senior staff consultant with KBC Advanced Technologies in Houston.

Fuel costs pushed major US airlines into the red for the first quarter, though oil prices have fallen in recent weeks from March peaks. US crude traded around USD$ 105 a barrel on Monday, while Brent crude was about USD$ 119 a barrel.

The Delta refinery would be run by a leadership team headed by Jeffrey Warmann, who last ran Murphy Oil USA’s Meraux, Louisiana, refinery.

East Coast refineries, among the oldest and least advanced in the country, have been hammered by a series of bad turns: the 2008 recession that cut demand; the rapid injection of ethanol into the US fuel mix; tougher environmental norms; and the rise of new, more sophisticated plants.

The final blow for many has been the surge in cheap shale oil production from North Dakota and West Texas, which has handed a bounty of cut-priced crude to Midwest and Gulf rivals who are now running their plants flat-out.

Over the last three years, six east coast refineries — plus two major plants in the Caribbean — have shut or been marked for closure, threatening to cut the region’s capacity by some 1.5 million barrels per day, reducing it to just a third of its peak in 2008. The cuts are deeper when factoring in Europe.

Robert Mann, an airline consultant, added that Delta’s statement did not address how it will handle exposure to fluctuations in energy prices or refined product costs or the actual refining process costs.

“It’s clearly a very innovative approach, but I think it will be a number of years before we know whether it actually works out,” Mann said.

Routt noted that the buy could be aimed at freezing out the competition. Delta is the world’s second-largest air carrier, behind industry leader United. United’s Northeast US hub is in Newark, New Jersey, about 90 miles north of the Trainer plant.

Fuel typically accounts for a third of an airline’s overall costs, and although owning a refinery won’t protect Delta from global crude oil costs, it will help ensure the carrier is not forced to pay even higher prices for imported jet fuel.

Delta said its Monroe Energy unit expects to close the purchase in the first half.

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