Delta Air Lines Inc. (DAL) is bringing some jet-fuel production in house, breaking with U.S. carriers’ reliance on outside providers, by acquiring a refinery that Phillips 66 had targeted for shutdown.
The world’s second-biggest airline will pay $180 million for the complex in suburban Philadelphia, according to a statement yesterday. Pennsylvania’s state government is putting up $30 million in assistance to defray the expense.
An airline-owned refinery is an experiment in the U.S. industry, said Ray Neidl, an airline analyst at Maxim Group LLC in New York. Atlanta-based Delta estimated the accord will save $300 million on its annual fuel bill, which was $11.8 billion last year, or about $32 million a day.
“Nothing ventured, nothing gained,” said Neidl, who has a buy rating on Delta shares. “Delta likes to try new things and I’m sure they studied this for months and ran the calculations. Nobody has done something quite like this before.”
Delta is buying the refinery in Trainer, Pennsylvania, through a subsidiary called Monroe Energy LLC, a nod to the airline’s original headquarters in Monroe, Louisiana. Trainer will add to earnings, boost margins and allow the airline to recoup its upfront investment in the first year, Chief Financial Officer Paul Jacobson said in the statement.
Delta fell 1.5 percent to $10.80 late yesterday in extended trading. Phillips 66 (PSX-W) begins trading today after the pipeline- and-refining company’s spinoff from Houston-based ConocoPhillips. The new company also will be based in Houston.
$100 Million Upgrade
Trainer can refine 185,000 barrels of crude per day, and Delta said it will spend $100 million to convert the refinery to maximize production of jet fuel, of which the airline consumed 3.86 billion gallons last year.
The plant had been idled for months, and without a buyer it would have been closed by the end of May because tighter profit margins are squeezing East Coast refineries. Sunoco Inc. (SUN) and Valero Energy Corp. (VLO) are among companies also shutting or planning to sell refineries along the U.S. East Coast, in Europe and the U.S. Virgin Islands as oil prices rise and demand wanes.
BP Plc (BP/) will supply crude oil to be refined at the Trainer refinery, and Delta said it will exchange gasoline and other refined products for more jet fuel through multiyear agreements with BP and Phillips 66.
Delta estimates that refining costs account for $2.2 billion of its fuel bill, and those production-related expenses are the fastest growing at the airline, Chief Executive Officer Richard Anderson told reporters yesterday on a conference call.
Delta Fuel Access
The deal also will help ensure jet-fuel availability at important Delta hubs, including New York’s John F. Kennedy International and LaGuardia airports, Anderson said.
“We have had this matter under study for the better part of the year,” Anderson said. “It was clear we needed to exert much more control over the supply chain.”
Delta’s purchase was also “driven somewhat by the alarming rate of shutdowns” of refineries in the northeastern U.S., President Ed Bastian said.
Fuel accounted for 36 percent of Delta’s operating costs last year. Delta has hedged 70 percent of this quarter’s fuel needs pegged to prices at $3.05 to $3.40 a gallon, according to data compiled by Bloomberg.
Jet fuel for immediate delivery in New York Harbor rose 0.2 percent to $3.30 a gallon yesterday. The average price in 2012 before today was $3.23 a gallon, 6 percent more than for the same period a year earlier.
One challenge for Delta may be showing that it can operate the Trainer refinery more profitably than its previous owner did.
“You do have to question a little bit Delta management’s thought that they can run it better than ConocoPhillips,” said Kyle Cooper, director of research at Houston-based consultant IAF Advisors. “They’ve hopefully done their work and their analysis that says that this hedging cost is going to be lower than their current hedging cost.”
Cory Garcia, an analyst at Raymond James & Associates Inc. in Houston, said letting the Trainer plant close might have been a better outcome for the oil industry, which is adding refining capacity outside the U.S.
“What you need to see is these less-profitable refineries come out of the market, shut down in order to rationalize or balance the overall supply-demand equation,” said Garcia, who rates ConocoPhillips (COP) as market perform.
Trainer will be run by Jeffrey Warmann, who has 25 years of experience in the industry, most recently as refinery manager for Murphy Oil USA Inc.’s plant in Meraux, Louisiana, Delta said.
Delta’s longer-term commitment is to invest $350 million at the facility, including acquisition costs, and keeping at least 402 full-time workers for five years from the date of occupancy, Steven Kratz, a spokesman for the Pennsylvania Department of Community and Economic Development, wrote in an e-mail message.