Delta’s Oil Refinery Purchase is Either Brilliant or Insane (or Both)

With fuel being an airline’s biggest expense, we all know that the airline and oil industries are tied together. But that tie got even closer this week when Delta announced that it would buy an oil refinery to start making its own fuel, or at least some of it. Now, I don’t understand the oil industry very well, but I’ve learned a lot more over the last couple of days. What I know now is that this move is brilliant . . . or completely insane. In other words, I really don’t know at all but it sure is interesting.

Delta Oil - Diesel and Jet A

I’ve spent time on the phone with people at Delta, I’ve read investor presentations, and I’ve even had beers with a couple of folks who work for big oil companies. In other words, I tried to really get my head around what this all means. Here’s how I understand it.

How This Works
Delta has set up a subsidiary to buy the Phillips 66 refinery in Trainer, Pennsylvania which is in the southeast corner of the state on the Delaware River right near the Delaware border, for $180 million. The actual outlay is only $150 million because the state chips in $30 million for a variety of reasons. This is really cheap.

The subsidiary, which is awesomely named Monroe Energy LLC after, I assume, Delta’s original hometown of Monroe, Louisiana, will then invest $100 million to convert the refinery so that it can make as much jet fuel as possible. From here on, I’ll just refer to the subsidiary as Delta to make things easier.

Delta has set up an agreement with BP to provide the crude oil to the refinery and then Delta will refine it, so the airline doesn’t have to source its crude needs. As part of this deal, Delta is going to own a pipeline that sends the oil up near New York City to a deepwater port. Delta can then use its existing fuel network to transport fuel to its New York hubs and via ship and truck elsewhere around the Northeast.

The problem with jet fuel, however, is that you can’t just turn crude oil into it and nothing else. The process ends up with a lot of byproducts in the form of things like gasoline, diesel, etc. In fact, after optimizing the refinery to produce as much jet fuel as possible, Delta will still only see a third of the total output come in that form. So what Delta has done is agreed with both Phillips 66 and BP to have them take all the non-jet fuel product and exchange it for jet fuel. BP and Phillips 66 will sell the gasoline, diesel, etc through their channels and then they will provide Delta with jet fuel at locations around the US for Delta’s other operations outside the northeast.

By the time everything is up and running, Delta thinks it will be able to provide 80 percent of its domestic jet fuel needs from this project. This year alone, Delta expects to save $100 million in fuel costs and that should increase to around $300 million at today’s prices.

Sounds great, right? Well sure. But where I’m still fuzzy is on how the savings will actually occur.

The Dreaded Crack Spread
Last year, Delta paid around $12 billion for fuel, so that $300 million savings is around 2.5 percent of the total. That’s not bad. Of that $12 billion, $2 billion came from the crack spread.

The Real Crack Spread

The refining process is known as “cracking.” And the crack spread is the cost of the refining process that gets baked into the price of jet fuel. (It’s not really the cost but rather market driven.) So as you can see above from this, ahem, slightly-modified Bloomberg chart, that cost can swing pretty insanely from down around $5 a barrel at its low to almost $40 a barrel. That’s big money. Last year, Delta paid just over 15 percent of its total fuel bill to pay for the cracking process. Put another way, the crack spread accounts for about ten percent of the airline’s total unit costs so it’s a massive expense.

Of course, Delta still has to operate a refinery, so it’s not like it can completely save the cost of the crack spread. But it’s brought in an industry veteran and has come to a tentative agreement with the refinery workers to put it back into production. Delta thinks this works well no matter what happens.

How This Doesn’t Work Well
To me, the obvious downside is if the crack spread on jet fuel in the market drops. What if it goes down to $5? Wouldn’t Delta lose a bunch of money because it could just get fuel cheaper elsewhere? It certainly seems that way to me, but the crack spread seems to travel with the price of oil, at least over the last few years. So if the crack spread drops a lot, that means oil dropped a lot as well. That’s why over the last five years this would have been a money-losing proposition only at the end of 2008, when fuel prices crashed. Every other year, it would have saved the airline money.

Delta's New Refinery

If that kind of crash happens again, Delta will end up paying more for fuel than it would if it bought it on the market, but jet fuel will have dropped so much that the impact will be acceptable in theory. Does this sound familiar? That’s because it’s really just another type of fuel hedge. You may lose money if fuel price drops but you win if it doesn’t.

Dwindling Supply
Part of this isn’t about price at all but rather about supply. Apparently, about half of the jet fuel refining capacity has been shuttered in the northeast over the last few years. With this, Delta can guarantee its supply. Delta shows that the Trainer refinery makes money, so why would it have been idled by its previous owner?

I have to assume that it wasn’t making money, especially on the gasoline by-product which has slim to no margins. We do know that the price of refining in the northeast is more expensive than in the south, and for some types of gas, it’s even cheaper to just buy it from Europe or Asia. So is Delta going to be paying a premium to refine in this area? Maybe.

But there is a big benefit to being in the northeast, because Delta has a lot of thirsty airplanes in the region. Some of the higher costs are offset by lower transportation costs since this is right near Delta’s New York operation. That direct pipeline that goes near the New York airports is one reason that Delta thinks this is a unique opportunity. Having that network significantly lowers transportation costs, and it dumps the fuel out right near two of Delta’s hubs.

I suppose we’ll look back on this in a few years one of two ways; it’s either an incredible move or it’s colossally stupid. Delta seems to have thought through all the different scenarios, so on paper it makes sense. But will it be the same in practice? This one is definitely way outside my knowledge, but it kind of sounds like it might be a great move. Then again, what do I know?

[Original photos via Flickr users Simon_sees, pedrosimoes7, and Wikimedia Commons user Walter Siegmund/CC 2.0]


56 Responses to Delta’s Oil Refinery Purchase is Either Brilliant or Insane (or Both)

  1. David says:

    What happens to flights that start in Atlanta, Minneapolis, Detroit, etc.. as well as long haul flights to countries outside the USA ?
    Tankering for a short flight (sub 2 hrs out of NYC) might work, but fuel for anything more than about 2 hours from NYC *has* to be supplied locally.

    How much fuel does Delta really source from the area around the refinery / NY compared to the rest of the annual airline-wide fuel bill ?

    • Well thats taken care of by Delta’s trading the non-jetfule product with Phillips 66 and BP for jet fuel elsewhere..

    • CF says:

      David – Exactly as Nick says. This refinery will produce the fuel that can be used in the Northeast. The rest of the fuel will come from BP and ConocoPhillips around the country in exchange for the gasoline and diesel products.

  2. ” Apparently, about half of the jet fuel refining capacity has been shuttered in the northeast over the last few years. With this, Delta can guarantee its supply.”

    This is a non-issue. The US still exports kerosene type jet fuel at volumes just as high as before Conoco and Sunoco shut down assets. Any extra jet fuel production coming from the Delta refinery will either A) drive down jet fuel prices in the US which means jet fuel refining margins will decline but Delta airlines will have decreased purchase costs or B) mean that somewhere else capacity will have to be shut down in the US or to one of the current export markets. Unfortunately for Delta they bought the marginal refinery so if crude prices are maintained and product prices take a nose dive Trainer is the first logical refinery to shut down. It doesn’t have nearly the capacity or complexity of the gulf coast refineries which are processing much cheaper crudes and already provide a more than adequate supply of products to the Northeast.

    Lets not even get started on how much money Delta stands to lose on gasoline, fuel oil and heating oil in the Northeast.

    The laundry list of environmental, health and safety violations attributed to Trainer should also not be overlooked as its one of the longest in the industry. Not to mention very expensive capital investments that will be needed to meet European sulfur specs…where most of the diesel is exported…which is one of the primary reasons why Conoco shut Trainer down in the first place.

    JP Morgan, Conoco and BP – winners
    Delta – loser

    • Jason H says:

      If I remember correctly the rules around diesel is more strict here in the US than it is in Europe. That is part of the reason diesel cars have been slower to gain traction here.

      I like that Delta is thinking a bit outside the box on this one. Given that the purchase is paid off with savings in such a short timeframe is an added bonus. Also, if the Dakota crude can be brought to Trainer the upside is even better as the Dakota crude is cheaper to purchase. You have admire Delta’s management for this one, even if it doesn’t work out exactly as planned they are trying to do something to secure their airline in the long term.

      • Except that Dakota crude would require a $400+ million upgrade and a new cross regional pipeline. There are over 400 varieties of crude oil and depending on the complexity of the refinery you can only economically use specific ones. Putting Dakota crude in Trainer would be like throwing diesel in your gasoline engine.

        EU sulfur standard (Euro V) – 10ppm
        US sulfur standard (ULSD) – 15ppm

    • Very interesting. Couple of follow-up questions. Why is this the “marginal” refinery? Assuming that local operating costs and the size of the facility have a lot to do with it, do those numbers change by incorporating reduced transit expense of the jet fuel to DL’s use in the NY / northeast area (as compared to bringing it from the gulf coast)?

      Also, as I mentioned below, do we not have to know the contractual terms of the agreements DL has with BP and Phillips in order to exchange the 2/3 of the refinery’s output that constitutes byproducts for jet fuel in additional locations in order to fully understand whether this can be a profitable (or at least break even) enterprise?

    • CF says:

      Southeasterner – Thanks for chiming in. This is similar to what I learned last night when I had drinks with a couple of refinery guys.

      I’m really questioning whether the stated $100 million investment will actually be enough to fix up the refinery to a passable safety standard, in addition to converting it to allow for more jet fuel to be produced. The guys I talked to thought it was laughable, but then again, they still thought the purchase price was pretty low.

      The issue around gasoline is huge… depending upon how long the agreement goes with BP and ConocoPhillips. The margin on gas is terrible, and nobody wants it, but if Delta has BP and ConocoPhillips willing to exchange gas at a fixed rate for jet fuel, then that is a non-issue. I don’t know the details of that agreement and I can’t imagine that we’ll be finding out the details publicly. But if that agreement expires, then Delta is going to be stuck with a lot of garbage that nobody will want (except for too cheap to be made profitably.) Part of me thinks that Delta got this sweetheart deal as part of another agreement with BP and ConocoPhillips to supply the rest of Delta’s fuel needs which are substantial.

      If the $100 million investment is enough and the payback is within one year as stated by Delta, then it doesn’t really matter what happens. Let’s say the BP and ConocoPhillips deal is over in 5 years. Delta will have already made a lot of money and if it can’t get a new deal for the gasoline, then it can just shutter the plant. Granted, then it owns all that liability in the refinery and on the site, but a subsidiary technically owns it. I wonder if Delta could just have that subsidiary file for bankruptcy and somehow walk away.

      Lots to consider here, and we’ll probably never know the answer until it happens.

      • Environmental liabilities stay with all previous owners, regardless of whether they have filed for bankruptcy or otherwise disappeared due to the Federal CERCLA and RCRA regulations. This is why it takes so long to clean up many “superfund” sites because liability must be aggregated and assigned among all remaining viable previous site owners, operators and contributors of waste.

  3. Dan says:

    The amateur in me doesn’t think this a colossally stupid move, but I don’t have enough background to argue with the likes of Southeasterner.

  4. If this works for Delta, I can see other airlines and other transportation companies forming joint ventures of some sort to do the same thing. The diesel can be sold to railroads and truckers. The lubricant grade product can be used by the owners, too. The gasoline, etc. can be sold to others as is being done here.

    Getting into a business with which one is unfamiliar is risky. But I have to give Delta an “A” for having guts.

    • Sanjeev M says:

      +1 Unbelieveable guts on the part of DL. For a 70,000 employee organization to be this nimble and fast-thinking is commendable. Lets hope it stays this way without impacting the consumer.

  5. Great analysis Brett, I thought you were just an airline guy! But you should really be congratulated on, despite researching and creating this analysis, knowing that you still don’t know enough to draw a conclusion.

    Southeasterner’s points are very interesting. My thought is that a lot of the success/fail of the enterprise will be tied up in the contractual agreements that DL has with BP and Phillips regarding the 2/3 of the total refinery outputs that are not jet fuel and exchange for jet fuel in other parts of the country.

    As a corporate tax expert, the only thing I can add to the analysis is that even if Monroe Energy LLC runs at a loss, that loss should offset income DL is earning elsewhere in the US so, assuming DL has an ETR of 30%, each dollar of losses only “costs” 70 cents after offsetting other income. Of course, that’s still a loss. The best case scenario for tax purposes is that the LLC runs at a near break-even level for book purposes but has a tax loss so that it doesn’t lose much in the way of actual money and also creates a small tax asset.

  6. Thanks Brett… That is much more detailed analysis than anything in the media.

  7. ScottC says:

    As I understand it, part of the problem with Northeast refineries is that they are set up to process light sweet crude, most of which was coming from the North Sea (aka Brent Crude) and parts of Africa. The price of this type of crude is currently running $20-30 a barrel higher than heavier oils (such as Bakken ND crude).

    Further, the east coast refineries are designed to maximize gasoline production. The refineries are struggling because the cost of their imput oil is much higher and the demand for gasoline has dropped. I read somewhere that Delta was looking at buying Bakken oil and transporting by train (there is no pipeline coming east from there) because Bakken oil is so cheap right now.

    As I understand Delta’s plans, part of the upgrades is to allow the refinery to process heavier crude oils (which are cheaper) and to maximize Jet-A production. Thus, they could save on buying cheaper oils and refining to Jet-A with a lower crack spread.

    Further, Jet-A is fungible. Delta will not literally fuel its planes with the Jet-A it refines at Trainer. Rather, for every gallon Delta puts in the pipeline, it will be able to draw a gallon at the other end, even though that gallon came from somewhere else.

    I also read that part of the reason Delta is doing this is to be able to better hedge fuel costs by having more detailed market data.

    • CF says:

      ScottC – That sounds right to me about the issue of the crude input. But will $100 million really be enough to fix up the refinery to where Delta wants? I don’t know, but it sounds like not a lot.

      Regarding the Jet-A, Delta actually does plan on using this Jet-A itself. It owns the pipeline now, so it will take the jet fuel right off the pipeline at its deepwater port and deliver it to NYC airports along with others in the northeast. It is staying out of the market entirely and using its own supplies in thise case.

    • Arcanum says:

      “Fungible” is my new word for today. Thanks Scott!

  8. I always wanted to be able to the point when Brett would crack under the pressure of being so publicly cranky. I guess seeing his crack will suffice.

  9. CP says:

    Fascinating analysis! It is way better than anything I’ve seen in other sources. Nice job, Cranky.

    It’s a gusty move on Delta’s part. Given that oil seems to be *the* issue in airline profitability, it’s encouraging to see an airline innovating in this area. I guess time will tell if the move pays off.

    Cranky, a future topic I’d love to see you cover: every so often, you see an item about an airline (including some US airlines) operating a flight on alternative fuel. I’d be interested in knowing more about the potential of that technology. If it is possible to fly a plane on alternative fuels, why don’t we see more of them? Cost…? Output…? I think it’s particularly interesting that Delta chose to make its big bet on good ol’ jet fuel, some some new-fangled substance.

    • CP says:

      That is, “NOT some new-fangled substance.” CP needs his coffee.

    • CF says:

      CP – My understanding of alternative fuel is that there is nothing that can produced at a remotely economical rate in large quantities at this time. All of the food-based substances end up being problematic because of what it does to food prices. The rest don’t seem to be able to be produced in large quantities economically. There’s a lot of talk about algae because it’s easily renewable and I know jatropha was the in-and-cool plant for awhile. In the end, it’s easy to make a fuel that drops into a jet engine but we’re far from a place where it can be done economically and for a large fleet.

    • Joe says:

      Shortly after Alaska Airlines did an alternative fuel demo flight, an article appeared noting that the fuel cost something like $17/gal, three to four times the going rate for Jet-A.

  10. Jeff Z says:

    I’m skeptical of Delta’s ability to make more money at this venture than just buying the fuel from other. I suspect that the real motivation of this purchase is not in the stockholders interest, but in the interest of management. With the conclusion of Northwest’s integration, Delta has a lot of attorneys, regulatory experts, and integration specialists looking for new projects. They naïvely think they can take their airline integration skills and turn these skills into refinery integration skills. Also, they assume the airlines are one of the most regulated businesses in the world, so the refining business can’t be that different?

    • CP says:

      I find this (1) highly cynical and (2) not very likely. The integration with NWA has been complete for a couple of years. If this were really Delta’s motivation, we would have seen an action like this sooner.

      Also, I speculate that a decision like this would have involved the board. I doubt that the board — which does represent the shareholders — would have approved the venture if Delta’s rationale (stated or otherwise) was “we have people in need of a new project.”

      • Jeff Z says:

        Your totally right. Corporate boards always do what is in the best interest of shareholders. :)

      • Sean S. says:

        I can’t speak to specifics of Delta’s board, but simply because Delta’s board approved it doesn’t mean its in the best interest of the shareholders. I think the past couple years in regards to institutional investors and others having fits about board selection amongst others things is a testament to the lack of responsiveness amongst board’s to shareholders wishes.

    • CF says:

      Jeff Z – I don’t think that’s the case. Delta start spending more time on fuel hedging and it recently merged its financial hedging with its fuel purchasing group. It brought people in from the outside and tried to really build this group up that way. This isn’t an issue of workers being idled or anything like that. It’s a fundamental belief that they can somehow control the price of fuel.

      It’s the exact opposite approach of US Airways, which thinks that all of these hedging strategies are too expensive and not worthwhile. It just buys fuel on the market.

  11. fredd says:

    Delta’s competitors are probably thrilled. Delta takes all the risk, maybe helps itself in the process, and drops prices for everyone else by removing a big chunk of its $12 billion of consumption from the open jet fuel market. When demand drops like that, prices usually follow. For Delta, it’s a risky move. For everyone else in the jet fuel market, nothing but upside.

  12. SAN Greg says:

    Great job explaining the business side of this issue. I think the biggest downside risk is not financial, but public image if something goes wrong such as a major mishap (i.e. refinery accident that involves worker casualties, or a major spill that goes into the Delaware River). If it is discovered that there are safety issues would that have people wondering if Delta has safety issues with airplane maintenance? Look at the damaged corporate image of Exxon and BP after being associated with major spills, and BP with refinery accidents in Texas.

  13. Joe says:

    Basically they’re just going to take profits from the refining division to fund unprofitable air routes. Questionable at best.

  14. Paul says:

    There’s an interesting article in Aviation Week that lays out the competitive advantage that Delta may get – and some of the risks.

  15. Let’s see, first you buy a refinery that had been mothballed for being old inefficient and needing huge improvements to meet the EPA restrictions. Chase takes it off their books and adds the capital cost, costs of future operations (it was previously shut down for not being a profitable entity) and gives a an interested 3rd party a seeming bargain on their future major costs in return for a whole lot of liability. What makes one think Delta which has no experience than Tilton had at United trying to hedge. Tilton came from Texaco. I want whatever Delta’s drinking!

  16. Jim says:

    Great analysis, Brett. I have a few thoughts:

    1. Why couldn’t Phillips, which is part of one of the largest oil companies in the world, make this refinery profitable? If they could, they wouldn’t be selling it. And if they couldn’t, I seriously doubt Delta can.

    2. WHY are taxpayers paying $30 million to subsidize the purchase of this refinery for Delta? Which side greased the government’s hands, the airline or the oil company?

    3. I never knew that Delta started out in Louisiana, that is pretty cool.

    • CF says:

      Jim – Great question about why Phillips couldn’t make this profitable. I think there are a couple reasons. First, Delta has different motivations. It doesn’t want to maximize profits of the refinery, but it wants to run it lean and lower fuel bills for the airline. So profit isn’t really an issue.

      I do wonder if Phillips really just didn’t want the liability. It knows where the dead bodies are, so it sold this to Delta so it could wipe its hands clean. But I’m sure there’s something in the purchase that says Phillips is responsible for anything it did. Not sure.

      On your second point, the taxpayer thing is all about jobs. The government looks like a hero because it is participating in a maneuver to save a ton of jobs that were going to disappear in the state.

      On your third point, that’s right. The Delta name is from the Mississippi Delta.

      • CF – see my point above. A company cannot transfer environmental liabilities or be held harmless in any way contractually due to the retroactive nature of how the federal CERCLA and RCRA statutes operate. All previous owners, operators and even third-party contributors of waste can be held wholly or partially liable for environmental cleanup expenses.

        • Jim says:

          Bill, two companies can still have a contract agreeing on who will pay for damages. The feds can force other potentially liable parties to pay, but if another company has agreed to pay costs, then the company forced to pay can enforce the contract (unless the other company is bankrupt or something along those lines).

          • True, I think one of the posts mentioned DL being able to put the sub in bankruptcy to avoid environmental liability and that is clearly not the case. Feds could still find a prior owner as a PRP even if that prior owner had a contractual agreement to have them pay remediation expenses (especially if the party absorbing the liability is balking at payment or remediation strategies).

    • theAVclub says:

      Firstly, Phillips66 is only 3 days old so it isn’t one of the most profitable companies, yet. It’s former company, ConocoPhillips may have been. In any case, Trainer was idled before Delta came in and that is probably why it was so cheap. This article may shed some light: http://www.tulsaworld.com/business/article.aspx?subjectid=49&articleid=20120429_49_E1_CUTLIN480302

  17. Sounds like a plan straight out of out of Airline Tycoon – man that game was addictive!

  18. I’m sure the other major airlines in the world will be watching to see what will happen. Who knows, it might work. Then again, why hasn’t an airline tried this before?

    Airlines buying hotels and car rental company’s of years past didn’t work out so hot, so who knows about this.

    • CF says:

      David SF eastbay – I wondered that too. Why hadn’t others tried this before? And my guess is that it’s only been in the last 10 years that fuel has become such an issue. Sure, it was an issue in the 70s, but the industry was regulated back then, so it was a very different dynamic.

  19. Ken says:

    If their profit will be based on the wide crack spread, the could simply sell the spread in the futures market to alleviate the risk of it falling.

  20. Well, I know a fair bit about the airline industry and I know a fair bit about the oil market, so I should be able to offer an “expert opinion” about whether Delta’s move makes sense. Unfortunately, I can’t. Frankly, the oil market tends to defy rational analysis as so many things having nothing to do with supply and demand tend to impact price — and therefore the outcome of any investment in the industry.

    My gut feeling on this though (and my gut tends to be right about 75% on the oil market) is that this move will not directly save Delta money but could materially help the industry. The reason is that the benchmark price of most oil products (gasoline, diesel) is determined at a delivery point in New York harbor. Delta is basically re-opening a refinery that isn’t needed. And not to make money, but to pump fuel into the New York market. We are already seeing the financial speculators get nervous about this outcome (I believe the refinery doesn’t restart until September), and oil product prices have been in decline since the Delta announcement was made.

    The issue is more complicated than this simple analysis (everything is complicated when it comes to price discovery in the oil market), but I have the feeling that the “winners” out of this will be the other airlines who will now see a lower fuel bill and will not have to operate what could easily be a money-losing refinery.

    • I think your spot on.

      By increasing jet fuel production in a long market Delta will decrease prices and their fuel costs but all that savings in fuel costs will now decrease revenue for their refining business. This clearly gives the advantage to United, AA and others who get the benefit of lower market rates for jet fuel while not having to deal with selling off gasoline, heating oil and fuel oil at a loss in an over-supplied market.

      In a sense Delta is cross subsidizing their direct competitors.

  21. I’ll try to be optimistic and give it 3 years before it is shut down (again).

    I honestly don’t think it’s an overly crazy idea…it’s just the wrong asset. If they want to invest in an industry invest in an asset with positive earnings potential. They should have gone after a more complex refinery in the gulf coast that is actually making money processing cheaper crude.

    Should make for a very interesting Harvard case study in the failures of vertical integration (not that we don’t have enough already).

  22. This is a great article and analysis of the purchase by Delta….I personally think they have made a great move buying this refinery. Guaranteeing fuel for a big airline is a major factor in success. I wonder if more airlines will follow them.

  23. maggie says:

    Quite an interesting discussion.
    Two thing I can add-
    Delta does own two hotels-both overseas-NWA owned them before the merger.
    The merger wasn’t completed until just this past May 1 when, at last, DAL and NWA flight attendants began flying together system-wide as one group. NOW it’s done:)

  24. FYI – a thorough crunching of the numbers (and they aren’t favorable for DL) from the travel insider:

    http://blog.thetravelinsider.info/2012/05/deltas-oil-refinery-purchase-now-confirmed-and-even-stranger-than-earlier-expected.html

    • Thanks for that link. It certainly confirms my suspicion that Delta is very unlikely to make money actually operating a Philadelphia oil refinery.

      That said, I do believe (as I argue above) that the operation of this refinery — especially with its focus on producing jet fuel which will be sent to the New York market — is likely to depress jet fuel prices. This will benefit Delta — perhaps enough to offset any losses they sustain at the refinery. But the big winners will be the airlines that operate out of NYC and don’t have to own a marginal refinery.

    • CF says:

      Oh my. This Travel Insider analysis is horrendous. The numbers couldn’t be more wrong. It seems he decided to spend more time coming up with snarky ways to make fun of other people than actually doing any sort of analysis. This is worthy of a Cranky Jackass award, but I really have no interest in giving this kind of analysis any more attention, so I’ll just address in the comments here.

      Delta says its $250+ million investment will bring it immediate savings of $300 million a year because it won?t have to pay the refinery?s ?profit margin? on its jet fuel purchases.

      Delta wants to save the crack spread, but the refinery doesn’t get the entire crack spread. The market sets that. But since Delta will be paying for the crude and doing the refining itself, it doesn’t have to deal with market pricing on the crack spread. So you can’t just assume that’s all refinery profit that it’s saving.

      Let?s express this as what the alleged profit margin on the price of each gallon of jet fuel from the Trainer refinery would have to be, which in the last year, after a 28% increase over the year before, averaged Delta $3.06/gallon.

      Why use last year’s fuel price when you can use a more recent one for the first quarter? Adjusted for hedging cost, Delta paid $3.28 a gallon. Without hedging costs, it was $3.11 a gallon. But hey let’s humor him and use $3.06 a gallon anyway just because it’s still easy to make this work using that older, lower number.

      We earlier estimated that, based on its daily capacity of 185,000 gallons of crude, the Trainer refinery is capable of producing about 700,000 gallons of jet fuel a day.

      Huh, what?! The daily capacity is 185,000 barrels, not gallons, which I assume was a typo in his writing. But where does he get 700,000 gallons of jet fuel? Delta says that the facility will produce 52,000 barrels per day of jet fuel. There are 42 gallons in a barrel, so that’s 2.184 million gallons per day. But this also fails to note that Delta will trade the non-jet fuel output for 120,000 more barrels of jet fuel. So the total amount of jet fuel coming from this transaction is over 7.2 million gallons per day, not 700,000 gallons.

      We?d also said it makes no sense that Delta should consume all this, due to the extra costs of tankering the fuel to far away locations where it would be needed (Delta?s minimal operations out of Philadelphia would consume only a tiny fraction of this).

      Another complete misunderstanding of the deal. The purchase of the facility includes a pipeline that goes right near the NYC airports. This isn’t about fulfilling feel needs in Philly (though it can). It’s about New York which is expected to be able to use this with its massive twin operations. Since the pipeline ends in a deepwater port, it can be used throughout the northeast pretty easily. But forget about that. The vast majority (70%) of the jet fuel that Delta will acquire will be delivered around the country by its trading partners BP and ConocoPhillips so it doesn’t even have to worry about that.

      Let?s also say that the $100 million investment that Delta will make in the refinery will increase the jet fuel share of the output of the refinery by 20%, up to 840,000 gallons a day. In a year, assuming say 350 days of production, that would be 294 million gallons of jet fuel.

      Using the correct output (and sticking with his 350 days if he wants), it’s 2.5 billion gallons per year. (Delta consumes a total of about 3.8 billion gallons per year, so this passes the sniff test.)

      Now if we round that guesstimate figure up to 300 million, there is an interesting coincidence. The refinery can produce about 300 million gallons of jet fuel and Delta is saying it will save $300 million. Do you think someone did the same calculation we just did, and decided to pick on a nice round $1/gallon saving.

      How realistic is it that there is a $1 profit in the $3.06 per gallon that Delta has been paying for jet fuel? Which oil company do you know of that reports a 33% profit margin?

      Just so, so wrong. Using the correct numbers, Delta would save $300 million on 2.5 billion gallons of jet fuel, which is around 12 cents per gallon. That’s effectively saving about $5 per barrel, which seems quite plausible, actually.

      I find it particularly amusing that he goes on to arbitrarily decide that ConocoPhillips makes 11 cents a gallon in profit on jet fuel. While I imagine jet fuel is much more profitable than that (and gas much less profitable), that 11 cent number isn’t far off from what we see here.

      If this is the case, the losses from the sale of everything else the refinery produces will remain in place the same as before, and Delta will have to fund such losses.

      There is a long-winded paragraph talking about how the rest of the output will result in losses for Delta. Apparently he failed to note that there is a deal in place to swap that inventory for jet fuel. So Delta doesn’t have to get rid of that inventory at all. Now, how Delta got BP and ConocoPhillips to swap on a 1:1 basis is amazing to me, since jet fuel should be worth a lot more. (And Delta did confirm that it is a 1:1 basis.)

      • wow, sorry to have caused you all that extra work but this is why novices need to read about things from multiple sources. it sounded plausible enough to me but, then again, i am not a professional in either of these fields and simply skimmed the article instead of doing an analysis. good lesson for us all! “i read it on the internet, it must be true!”

  25. Joel says:

    I wonder if anyone at Delta ever read Tom Peters’ classic In Search of Excellence, which contained the lesson “Stick to the knitting”–that is, stay with the business you know. I don’t that is the case at Delta.

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