Done Deal -- $120M for Refinery

[eolesen]

http://www.foxnews.com/us/2012/04/30/delta-air-buys-pa-refinery-from-conoco/

Delta Air Lines Inc. says it will buy a refinery near Philadelphia as part of an unprecedented deal that it hopes will cut its jet fuel bill.
Delta is buying the Trainer, Pa. refinery from Phillips 66, a refining company being spun off from ConocoPhillips. Delta says a subsidiary will pay $150 million, including $30 million in job-creation assistance it is getting from the state of Pennsylvania.
Delta estimates the deal will cut its fuel bill by $300 million a year. Fuel has become the airline industry's biggest expense over the past few years

 

[eolesen]

From the DL Press Release:

Delta Subsidiary to Acquire Trainer Refinery Complex

Delta partners with leaders in the energy industry to drive fuel savings

ATLANTA, April 30, 2012 /PRNewswire/ -- Delta Air Lines (NYSE: DAL) wholly-owned subsidiary, Monroe Energy LLC, has reached agreement with Phillips 66 (NYSE: PSX-WI) to acquire the Trainer refinery complex south of Philadelphia. As part of the transaction, Monroe will enter into strategic sourcing and marketing agreements with BP (NYSE: BP) and Phillips 66. The acquisition includes pipelines and transportation assets that will provide access to the delivery network for jet fuel reaching Delta's operations throughout the Northeast, including its hubs at LaGuardia and JFK.

After receipt of $30 million in state government assistance for job creation and infrastructure improvement from the Commonwealth of Pennsylvania, Monroe's investment to acquire the refinery will be $150 million, and Monroe will spend $100 million to convert the existing infrastructure to maximize jet fuel production. Production at the refinery combined with multi-year agreements to exchange gasoline, diesel, and other refined products from the refinery for jet fuel will provide 80 percent of Delta's jet fuel needs in the United States.

"Acquiring the Trainer refinery is an innovative approach to managing our largest expense," said Richard Anderson, Delta's chief executive officer. "This modest investment, the equivalent of the list price of a new widebody aircraft, will allow Delta to reduce its fuel expense by $300 million annually and ensure jet fuel availability in the Northeast. This strategy is aligned with the moves we have made to build a stronger airline for our shareholders, employees and customers."

Monroe is partnering with leading energy companies to supply crude oil and receive jet fuel in exchange for Trainer's non-jet fuel outputs. Under a three-year agreement, BP will supply the crude oil to be refined at the facility. Monroe Energy will exchange gasoline and other refined products from Trainer for jet fuel from Phillips 66 and BP elsewhere in the country through multi-year agreements.

The Commonwealth of Pennsylvania and Delaware County have agreed to provide assistance to ensure the refinery continues its economic contribution to the region.

"By working with world class partners like BP and Phillips 66, we can benefit from their expertise in energy sourcing and product distribution," said Ed Bastian, Delta's president. "We are also pleased to partner with Governor Corbett and the Commonwealth of Pennsylvania, the Pennsylvania Congressional delegation, and Delaware County to create jobs and economic growth for the region while generating substantial fuel savings for Delta."

"This supply and off-take agreement demonstrates BP's continued commitment to supply U.S. customers with the feedstock and products they need. We are delighted to bring BP's global scale and access to the world's energy markets to this strategic agreement with Delta," said Paul Reed, CEO, Integrated Supply and Trading, BP.

Trainer will be run by a seasoned leadership team headed by 25-year refinery veteran Jeffrey Warmann. In his last position as refinery manager for Murphy Oil USA, Inc.'s Meraux, La. refinery, Warmann led Meraux's restructuring efforts, increasing refinery output by more than 30 percent and significantly improving Meraux's profitability.

Monroe expects to close on the acquisition in the first half of 2012. Jet fuel production is expected to begin during the third quarter, and changes to the plant infrastructure to increase jet fuel production would be complete by the end of the third quarter, resulting in expected 2012 fuel savings of more than $100 million.

"We expect the Trainer acquisition to be accretive to Delta's earnings, expand our margins, and to fully recover our investment in the first year of operations," said Paul Jacobson, Delta's chief financial officer. "We look forward to closing this transaction and moving quickly to begin capturing its benefits."

 

[FWAAA]

Delta saved $45 million (five cents per gallon) in the first quarter alone due to its fuel hedging activities.

Now, DL will invest about $250 million in a refinery in hopes of driving down the crack spread? Color me skeptical.

Something about "core competencies" . . .

We're supposed to believe that a $250 million investment will yield annual savings of $300 million? Wonder why ConocoPhillips was unwilling to make such a winning investment?

 

[WorldTraveler]

Skepticism is natural esp. when non-traditional approaches are taken to solving tough problems.... DL is a public company and there will be all kinds of people scrutinizing the deal for quite some time. No one should fail to ask the tough questions about whether the refinery is delivering for DL what it said it would. There will clearly be other airlines deciding if it makes sense to do the same thing ... we will see.

but note that DL says that it will save $300M per year in fuel costs which means they will recover the acquisition cost in less than a year.
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Note that the other article I cited earlier today says the source of the fuel stock will be shifted from current sources in Africa.
Also, the refinery will be retuned for maximum jet fuel production... it will be interesting to see what the maximum amount they can obtain will be.

They also rec'd gov't assistance from the state of PA which I expected they might.
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Note that BP and Phillips 66 are both part of the deal.... and it also includes pipelines and transportation assets. No investment bank is part of the deal, apparently.
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It appears that DL returned to its roots in naming the new subsidiary.

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DL has a powerpoint presentation as part of its SEC filing on the deal... a couple notes from it:
DL says the refinery will eventually produce 52K bbls of jet fuel per day or about 32% of total output.
DL says the combination of the deals to swap the excess products plus the jet fuel refined at Trainer will provide 80% of DL's domestic jet fuel needs.
DL says that part of the motivation to do the deal is because gasoline consumption is declining in developed countries while diesel and jet fuel production is growing worldwide due to higher percentages of diesel consumption in developing countries.
Trainer will be the 3rd largest operating refinery on the east coast.
DL's acquisition cost is $150M after assistance from PA and local gov'ts.
Savings estimates are based on using Brent crude but domestic sources could reduce input costs - and increase savings.
Output from the refinery will be used by DL in the NE US; trades will supply DL's fuel needs elsewhere.
DL says markup and marketing costs add amount to about 20% of the cost of jet fuel and that is where they expect their profit to come from - net of their own refinery costs - (slide 12)
DL notes they could have obtained the same fuel cost benefit by spending $2.5B on new jets or $250M on the refinery.

 

[tech2101]

I hope they are succesful. Maybe they can offer us who still have pensions some cheap gas at "Widget Quick Stop"!

Seriously. I do hope they do well. This could be a model for others...

or that maybe the US government should buy old refineries and sell fuel to US based airlines at a regulated price. (go ahead and tear me up for that comment )

 

[ChockJockey]

That's pretty neat-o. I'll be interested to see how this works out for them. In the future airlines might own their own algae-based biofuel refineries as the prices of JetA go up on biofuel extraction down. Who knows?

 

[WorldTraveler]

I hope they are succesful. Maybe they can offer us who still have pensions some cheap gas at "Widget Quick Stop"!

Seriously. I do hope they do well. This could be a model for others...

Interestingly, $300M amounts to about 5% of DL's total employee expenses last year... or about 25% of its profit.

 

[QA4Jet-A]

Interestingly, $300M amounts to about 5% of DL's total employee expenses last year... or about 25% of its profit.

I like this part... will provide 80 percent of Delta's jet fuel needs in the United States. Really? What is the projected daily output of Jet-A at the Refinery, after it has been 'stoked', and what does DL burn per day in the US? Does this include the trade offs for Gasoline etc.?

 

[BoeingBoy]

Does this include the trade offs for Gasoline etc.?

Apparently it does. While you read figures about how much of the jet fuel refined in the NE comes (or came) from the Trainer refinery, that's primarily because there's so little refining capacity in the NE. There are single refineries that produce more product than all the NE refineries are capable of producing. I also find it very hard to believe that Trainer can be converted to produce as high a percentage of jet fuel as is being claimed - the distilling process just doesn't work that way. Much is also made of the capacity of the Trainer refinery - 185,000 barrels/day. That's what is call the per stream day capacity - the capacity at full production for 24 hours. However, all refineries need periodic shutdown for maintenance/upkeep so there aren't 365 stream days per year. There are more like 330 or fewer stream days/year since you just can't switch off the process in mid-stream and then turn it back on at full capacity - production is tapered off leading up to shutdown and then brought back up to speed when restarting. A refinery that averages 90% of full production capacity over time is really operating at full useful capacity.

Jim

 

[WorldTraveler]

QA4,
DL's filing with the SEC says the refinery will be tweaked to produce 52k bbl per day of jet fuel and with the trades DL has w/ BP and P66, they will obtain access to 80% or 210K bbl/day of jet fuel.

Jim,
I thought it would be worth while to go back to the other thread (since a new one was started for the announcement of the refinery purchase) and look at the arguments that were made by members of the forum compared to what DL said in its SEC filing.

Just a few comments...

1 - don't be too swayed by crack spreads. It isn't the difference between the cost of crude going in and finished product coming out of the refinery. It's the difference between the cost of crude at a terminal (Cushing OK for WTI crude, Saudia Arabia for ARAMCO crude) and the cost of finished product at the delivery terminal (NY harbor, for example). As transportation costs increase, the crack spread increases.

2 - refineries can tweak the amount of jet fuel produced but can't produce only jet fuel. So DL would be getting into the petroleum business, not the jet fuel business, with all the headaches/problems that that entails. Anyone ever wonder why there aren't small scale producers in the refining business any longer?

3 - owning a refinery doesn't magically reduce the price of jet fuel dramatically. Besides all the costs of running/maintaining a refinery, there's still the transportation and distrubution costs. A refinery in Delaware county doesn't put fuel in an airplanes tanks in LAX, ORD, DFW, MIA, etc. It'd probably be significantly cheaper to buy fuel in those locations than transport fuel from a refinery on the east coast. The cheapest transportation would be the pipeline, but only to the northeast from Delaware county since the pipeline from the Gulf is a one-way system.

4 - If Conoco/Phillips shut down the refinery, maybe they had a good reason.

Jim

I've not said that the amount of jet fuel produced from each barrel of crude can't be tweaked - I've said it can. But major changes - trying to produce 20-30% jet fuel from each barrel of crude is out.

Jim,
just look at the DOT stats for fuel usage by US airlines and the capacity of this refinery - which is published.
It isn't terribly unreasonable to think one refinery could produce 5% of the jet fuel used by US airlines; remember that foreign airlines come to the US and buy fuel here...so the amount is probably pretty close to the total amount of civilian jet fuel used in the US.
I have no idea how much jet fuel the military uses - but they clearly buy some of it from the same refineries that sell to commercial aviation.
Given that DL has about 20% of the capacity among US airlines, this refinery would at best provide a minority of the fuel even DL uses.
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It is an interesting concept but the refinery is still a small part of the total production of US jet fuel - and for now represents no capacity since it is not operating... and that may be part of what makes the deal attractive to DL - a mothballed plant that hasn't sold but has the potential to increase jet fuel supplies.

Obviously C-P wanted out of this refinery for very good reasons to them... it doesn't mean the reasons are the same for someone else.
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DL has made no statement about its interest in this refinery- it was leaked information from a petroleum industry source. It may or may not come to fruition and the negotiations and DL's analysis are undoubtedly going on right now.
DL is undoubtedly consulting refinery experts and consultants to help decide the viability of the project since this is clearly not in DL's core area of competence. Any company that embarked on an acquisition of this nature outside of their core area would probably face stockholder lawsuits if something goes wrong in the future and they can't demonstrate they either had inhouse experts or hired advisers during the evaluation process.
Even if DL buys the refinery, it is very likely they will contract for someone to run it - perhaps C-P, esp. since C-P said that refinery worked in tandem w/ the other refinery they are keeping.
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None of us will ever be able to judge whether this will be a good idea - and it may well be that DL will never provide enough information even IF it owns the refinery to know if it has worked out well.
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This whole topic is an interesting development and it will be worth watching.....

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Let's once again keep this whole thing in perspective...... DL spends over $10B a year on fuel. The cost of acquiring and getting the refinery up and running might require an investment equal to 3% of DL's annual fuel expenses - probably less.
....

In the best case, DL will build on its very favorable cost position to have 3-5% better costs than its peers, an amount that is more than enough to provide a competitive advantage - on top of the other cost control moves DL is taking.
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We also haven't heard if DL could obtain any government incentives to reopen the closed refinery which would offset some of its costs.
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"A 185,000 barrels per day refinery like Trainer necessarily produces far more gasoline and diesel than it does jet."

People might not see that even this serves it's purpose. Delta doesn't necessarily have to use the products on aircraft. Selling gas and diesel on the open market can generate revenue. Even though the refinery was a loss, rising fuel prices and not many refineries may make it a future investment.

The shipping tangent started with a question about whether DL could just use the jet fuel from Trainer if the purchase is made. We've both agreed that the obvious action would be for DL to in effect trade discounts with suppliers in other parts of the country, itself not an easy proposition since there's a supply chain to deal with instead of just refinery operators.



The input cost disadvantage is not easy to get around. It's either accept that disadvantage or update the refinery to handle lower grades of crude, which would make the money to get it up and running look cheap. Trainer has little refining capacity downstream of distillation, which is needed to turn lower grades of crude into as much usable product as a refinery built to use lower grades of crude. Since distillation is the most basic form of refining, changing Trainer to use lower grades of crude effectively involves building from scratch the capability to do the downstream refining processes.



Jim

In short, yes,
-the refinery can be tuned to produce 30% jet fuel,
-DL is hiring a team of petroleum experts who will run the refinery,
-they do have partnerships w/ petroleum companies who obviously believe it is also in their interests to partner with DL,
-the difference between the jet fuel crack spread and gasoline crack spreads are large reason why DL is entering into this deal and they believe there are structural reasons why it will not change, -
-DL is addressing supply issues, although the refinery will produce a minority of DL's petroleum needs, with swaps DL is assuring the supply of 80% of its domestic needs (which is probably 60-70% of its global needs)
-DL is obtaining the transportation assets necessary to distribute the fuel to its operations in the NE
- DL could obtain a 3% cost advantage relative to its competitors for jet fuel in an industry where the best margins in the past year was that much.

tech,
I also find it interesting to see what posts I write solicit negative feedback..... not surprisingly, some people don't like the idea that DL could generate fuel cost savings that amount to 5% of what it spends on employee costs per year.
In a highly cmopetitive industry with a lot of labor turmoil, it isn't terribly far fetched to believe that DL might use its cost advantage in part to provide the pay raises to its employees that it has promised while other airlines are working through messy labor integrations as part of mergers - or BKs.
Thus, it isn't surprisingly that many of the participants in this discussion on this forum really don't want to see DL obtain a cost advantage via fuel that they could use in the marketplace.

And interestingly, one columnist has already said the DL deal is targeted at WN.... while I'm not so sure, the perspective is worth considering in light of the fact that the domestic market is the backbone for every US airline and not a single US airline has ever survived w/o being able to compete in the US domestic market.
http://seekingalpha.com/article/545881-delta-refinery-deal-all-about-southwest?source=yahoo
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To those people I say, welcome to the highly competitive airline industry.

 

[wings396]

I'm seeing a golden job opportunity for you WT......

 

[BoeingBoy]

We'll see WT, but some of those claims are extremely difficult to accept. Expecting to get over 30% jet fuel from each barrel of crude input is basically impossible given how the distillation process works and Trainer has very little capacity using methods other than simple distillation to produce products. Trainer would basically have to take most of the raw gasoline production and "un-distill" it back into jet fuel. If DL had said that they could get jet fuel equivalent to 30% of the capacity of Trainer after swapping the other products produced for jet fuel, it could have been believable. It's like the "capacity" of Trainer being 185,000 barrels/day - slanted to sound better than it really is. As I said somewhere, the 185 barrels/day "capacity" is per stream day - 24 hours running at full capacity. But there aren't 365 stream days per year because of periodic maintenance/upkeep. So per calendar day the capacity is about 10% less than absolute capacity per stream day. While it's not something I check daily or even weekly, the only time U.S. refineries have run over 90% of stream day capacity was after Katrina destroyed/damaged so much refinery capacity in the Gulf and every operable refinery was producing all it could.

It all sounds good in a press release - especially to analysts that specialize in the airline business but know little about refining other than how to fill their car - but putting it into practice is a lot harder than writing a press release. So I'd recommend caution before claiming this as a victory for DL. Let's wait and see how it plays out...

Jim

 

[eolesen]

T. Boone Pickens... "Keep your wallet handy."

Texas oil and gas investor T. Boone Pickens has a warning for Pennsylvania now that it is subsidizing Delta Air Lines's purchase of a gas refinery: Keep your wallet handy.

Delta Air Lines is getting a $30 million subsidy from the Keystone State as part of a $180 million deal to buy a Phillips 66 refinery south of Philadelphia.

"The state better get ready because other refineries are going to want subsidies for them, too," he told CNBC's Closing Bell. "How they gonna handle that one?"

For Delta, "buying a refinery is like me buying an airline. Someone's going to scratch their head on that," he joked.

 

[WorldTraveler]

Yep, E,
governments have and will continue to provide incentives to bring jobs to their regions... the fact that airlines are now venturing into a business area that has previously been the domain of petroleum companies who are closing refineries is precisely the formula that stimulates governments to act.
Understandabaly Mr. Pickens isn't interested in seeing a consumer move into the producer realm, esp. w/ government help.

Jim,
your skepticism is not unexpected but I don't think anyone realistically doubts that DL will be able to deliver 52K bbl per day of jet fuel after the modifications. They didn't say in the filing with the SEC that they hope to produce 52K - they said the plant WILL deliver 52K. Don't you think there are contractual issues affecting a quote of that kind of number, including all of the contracts surrounding BP and P66 who will be swapping fuel w/ DL? Do you really think that the current owner of the refinery and one of the other largest oil companies in the world don't have a little interest in making sure that DL's expectations are accurate?

The analysts who write about the airline industry aren't even specialists in the airline industry.... and they, like you and me, certainly have no expertise at a refinery south of Philly and knowing what the facility can or can't do.

It is interesting to note that since the announcement came out, there has been more than one "on second look" the deal might make sense.

We of course will all know in less than a year - but one thing I am pretty certain will not be an issue is the basic facts of what the refinery is capable of producing. That is more predictable than the economics behind the move - or even what kind of RASM increase an airline can expect.

There may be other airlines that will act or not - but I doubt very seriously they will see the same results that DL will. There just aren't that many idled refineries located that close to key airline hubs and not every airline has the financial resources to do something like this.
I have a feeling we will see not too far down the road that DL has made a major strategic move that many here failed to believe was possible and which DL will be able to use to its advantage in its core business - not unlike what AA did when it created Sabre or what WN did with its hedge advantages about 10 years ago.

 

[BoeingBoy]

Jim,
your skepticism is not unexpected but I don't think anyone realistically doubts that DL will be able to deliver 52K bbl per day of jet fuel after the modifications. They didn't say in the filing with the SEC that they hope to produce 52K - they said the plant WILL deliver 52K.

And they also included the standard "forward looking statements" disclaimer so DL can't be held responsible for the accuracy of that statement...which was a really just a press release.

Don't you think there are contractual issues affecting a quote of that kind of number, including all of the contracts surrounding BP and P66 who will be swapping fuel w/ DL? Do you really think that the current owner of the refinery and one of the other largest oil companies in the world don't have a little interest in making sure that DL's expectations are accurate?

Depends on how the contracts are structured. Do you know for a fact that DL is promising X amount of product A and Y amount of product B in exchange for specific amounts of jet fuel? Or are the contracts just "we'll swap 1 gallon of jet fuel for X gallons of product A or Y gallons of product B"? To me it would make sense for the oil companies and even DL to keep the contracts based on exchange ratios rather than absolute quantities.

Like I said, don't be in too much of a hurry to declare victory - supposedly we'll know by the end of the year if DL is right or wrong - Trainer should be producing a $75 million per quarter return by then. Assuming that DL breaks out the refinery performance numbers...

Jim