Delta Airlines Got an Oil Refinery: The Math Does Not Work

EconMatters's picture

By EconMatters

Exxon Mobil Corp. (XOM), the world’s biggest energy company by market cap, said its 4Q profit rose to a five-year high boosted by its refining arm from growing supplies of cheap U.S. oil.  However, Delta Airlines (DAL) can’t tell a similar success story with its newly acquired refinery.  


Delta paid $150 million fora Phillips 66 refinery in Trainer PA last May aiming to save $300 million a year in future fuel costs.  At the time, many analysts see this acquisition as a smart fuel hedge move by Delta.  However, as I previously discussed, the actual implementation of this potential fuel cost savings could be quite problematic.  



Chart Source: IATA



During a time when most refiners are reporting good earning numbers as price gain of petroleum  products have outpaced stagnant WTI crude prices, Delta reported loss of $63 million at the Trainer refinery in 4Q, and expects more losses of up to $100 million in 1Q 2013. Delta chalked it up to Sandy, the super storm.  However, as Plattsreportedthat in a Dec. 2012 investor call, Delta executives said Trainer plant relies on crudes at about $4/b above Brent (The plant is old and relies on expensive imported crude feedstock mostly from Nigeria.)  Platts concluded that Delta is most likely selling gasoline and fuel oil (distillate) at a loss based on the current crack spread (to Brent).  Gasoline and fuel oil accounts for more than half of Trainer’s production.


Furthermore, according to Platts, 

“Refining experts who have done computer simulations tell JFI that Trainer economics theoretically only work using a crude slate of distillate-rich crudes such as Nigerian Forcados, which typically trade at a large premium to Brent crude.”

Also, there seems to be another indication of troubles in Delta’s vertical-integration strategy of purchasing a refinery as a fuel hedge.  The ex-oil-trader-turned-Delta-VP-of-Fuel, Jon Ruggles, left the company quite abruptly late last year.  Ruggles, a key person behind the Trainer refinery deal, was hired away from Merrill Lynch less than a year ago to head Delta’s trading operation.  Rumor has it that Ruggles' exit from Delta was somehow related to losses at the Trainer plant. 


The latest from Delta executives is that they now expected Trainer to have $280 million in savings in 2013 and refine 80% if the airline's domestic jet fuel requirement.  And there could still be hope for Trainer yet as Delta indicated in a recent SEC filing that the company is considering getting the cheaper Bakken crude by railcar.  Given that transporting crude by railcar adds about $22 a barrel to the cost of oil, it is hard to imagine the economics could improve much at Trainer with the current Brent premium  over WTI at only around $19 a barrel. 


To put it another way, if it were as easy as shipping Bakken oil via railcars, wouldn’t you think ConocoPhillips, who’s only been in the oil business dating back to 1875, would have figured it out long before dumping the Trainer asset?  


Now thinking the worst is over after extensive restructuring and consolidation in the airline sector, most Wall Street analysts have turned optimistic towards the airline industry.  Delta Airlines stock has climbed 25% in the past year outperforming the broader Bloomberg United States Airline Index, which includes Delta Airlines.  Investment houses like J.P. Morgan already raised Delta’s 1Q 2013 profit estimate, citing lower fuel prices and strong travel demand.



Chart Source: Bloomberg




However, the fact remains that flying is a commodity, and crude oil prices are expected to remain flat at least in the next two years due to subdued economic growth and demand.  That means the same major factors that’s been negatively impacting the airline sector -- weak world GDP, high fuel prices and fierce competition– will still be there, at least in 2013 and 2014, with many down side risks such as the euro zone, and Iran.   So in general, any increase in airline profitability would be hard-earned from things like efficiency gain and capacity reduction. 



Chart Source: IATA


On top of the tough macroeconomics, Delta has one more down side risk than peers – Trainer Refinery.  And as if that’s not bad enough already, Delta management projects nonfuel unit costs will increase 6% to 8% for the March quarter and 4% to 6% for fiscal 2013 due to salary increases and Capex.    


IATA, which represents about 80% of global carriers, forecast the average global airline industry profit margins will improve but remain thin at 2.9% in 2013.  So it is hard for me to share the same optimism as JPM regarding Delta or even the airline sector as a whole. 


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dark pools of soros's picture

Can't they just blame the workers while increasing their bonuses as long as sugerdaddy Ben's ZIRP heroin continues??

Executive management has no desire for going concerns anymore. They can suck these dry like all the vampire shows... You think those shows are for teenage girls? Nope

JuicedGamma's picture

Airlines have enough trouble running the business they are already in.  Who's goofy idea is it that running a refinery will be easy.  

This has got to be one of the stupidest management decisions ever.  


madcuban's picture

Econmatters is correct that this will go very poorly for Delta.  An airline, who is used to such high fixed costs when building out plane fleets, will not be enjoying life so much when cyclical margins are negative at various times.  It might be a stretch to assume that Conoco, who has surely been around for a long time but is one of the poorer refiners on record (Phillips isn't much better in recents years/decades) could have done more with this plant.  For instance they are just now (in the past 6-9 months) figuring out they should be running bakken via rail cars.  Others figured that out long ago and have gone several times further in making it happen.  Conoco/Phillips inherited Trainer when they bought Tosco and they've never truly understood how to run an east coast refinery, especially one in the philly area where its not so easy to makret bbls via rack into the new york market at premiums.  But the fact remains, this will go poorly for Delta who still cant figure out hwo to supply the plant properly and have deals with majors who are reaping the benefits and leaving the husk behind.

Birdman's picture

wasn't the plan to lose less with the refinery than it was losing in derivatives trades?

By closing all derivatives trades, the price of oil has dropped since Delta lowered its derivatives trades.

Since Delta's primary goal is airline ticket revenue, not making money through oil profits, I think the author of this article is clueless.

dark pools of soros's picture

A dude got the boot, so looks like it didn't go as planned

mess nonster's picture

Vertical integration does not always mean lower prices. I have chickens and estimate the eggs cost me at least 1.00 each.

dark pools of soros's picture

If you let them hatch just think of all the cute stock baby chick pictures you could put on Instagram that Facebook can sell royalty free?

SKY85hawk's picture

Why isn't a bailout on THIS bad investment being offered by Washington?


NoDebt's picture

What makes you think the government and it's "deal sweeteners" weren't involved?

otto skorzeny's picture

this should be great for the unions at the refinery-airlines have a long history of caving in to them. "Don't like airlines-lousy unions"-G Gekko

ceilidh_trail's picture

Actually, delta (not worthy of capital d) is a long history of screwing its workers. I never worked for them, but have friends who did. Layoffs and rehires and layoffs not unusual. I owned a position in Comair and made enough to purchase my home. Not long after, Comair stock dropped a ton with all the other airlines. I still had some, was going to buy more when delta bought them out at a lowball price. It cost me and others that I had gotten into it some money- it happens, life goes on. delta then began the process of slowly killing off the airline that it bought. In the end, Comair was closed, thousands lost their jobs and the pensions they had worked for after having relinquished them in a bargain to save Comair. A pilot friend spent 20+ years building the company to have it yanked away and no retirement on top. Too old for anyone else to want to hire him except for the odd commuter that pays just above minimum wage. Greater Cincinnati regional airport spent tens of millions of dollars on new terminals and runways only to have delta leave and be stuck with paying off bonds on unused facilities. Guess who really pays for this? Us. Oil refinery? I and many others kinda hope delta chokes on it.

Seize Mars's picture

Pension? Retirement? Sorry, am I supposed to feel sorry for you or something?

You were the one you believed the promise of "pension" or "retirement." Some asshole liar promised it and you believed it. Your fault.

Of course they are liar scumbags, ripping you off and jamming the taxpayer with their losses. What exactly did you expect?

JuicedGamma's picture

I dinged you for poor reading comprehension.

Seize Mars's picture

I upped you for dinging me. (It's kind of erotic)

Seize Mars's picture

Yeah, I've got to say, buying a refinery when ConocoPhilips is selling it is like going long EURJPY because Stolper says so. Not a good idea!

Hmm, it's almost like there's a whole different angle to this whole oil thing. Like a concomitant printing of money. Nah, that would be tinfoil hat fringe blog bullshit, right?


NoDebt's picture

Right in my back yard, just about.  Know plenty of guys who work there or did (including my father-in-law who retired from there just before the shut-down, having put in his ~40 years as the 3rd most senior guy in the whole place).  We were all scratching our heads over that deal when it started being talked about, but the job loss (good paying jobs, by and large) were just not something that PA politicians could tolerate with an election coming up.  For sure, it will end up as a study in Econ textbooks one day, win or lose.

It wasn't so much the unions that did them in when they announced the shut-down (the union was rather weak with the refinery changing hands several times in a short period of years), it was the EPA and the dated facilities.

Airlines have been long term investment disasters since forever.  Why not add a failed refinery to their path of wreckage?


RichardP's picture

I thought the loss probably came from Delta selling itself fuel from the refinery at below cost.  Helps Delta's bottom line to get fuel that cheaply.