Corn Field
Dec 5, 2003
As DL subsidiary’s refinery starts to receive crude oil and plans to be at full operational capacity by the end of the month, many of the naysayers who panned the purchase just a few months ago are now realizing their criticism was incorrect. Others such as in the article linked below are telling us why those analysts were wrong in their assessment and why the deal makes a lot of sense – and the benefits to DL from the deal are growing, not shrinking.
I believe DL said on their investor call yesterday that they will spend even more money to expand the refinery to 200K bbl/day – but not entirely sure if I heard that correctly as I was doing other things.
There are major portions of the article that worth noting and are included:

On April 30, Delta Air Lines (DAL) bought a 185,000 barrel per day (bpd) oil refinery in Trainer, Pa. from ConocoPhillips (COP). Delta's goal for this transaction is to mitigate risk stemming from the "crack spread" (the price difference between crude oil and jet fuel) and thus generate cost savings. Delta's refinery purchase has been met with a wide range of responses. Most analysts in the airline industry have been cautiously optimistic about the decision, while most analysts in the oil/gas sector have condemned Delta's move. However, with the Trainer refinery re-start coming soon, I think the purchase looks like a smart decision. Elevated crack spreads will make it possible for the Trainer refinery to earn a sizable return on investment.
In a presentation given Thursday morning, Delta president Ed Bastian pointed to crack spreads as the fastest growing cost for Delta. There have been several recent refinery closures in the U.S., particularly on the East Coast, as well as extended downtime due to various accidents. These factors, combined with some demand growth since the Great Recession, have sent crack spreads soaring. On slide 12 of his presentation, Bastian discloses that the crack spread paid by Delta tripled from 2009 to 2011. For the month of April (when the deal to purchase the Trainer refinery was negotiated), Brent crude averaged $119.75/barrel, while Gulf Coast jet fuel averaged $3.226/gallon, which works out to $135.49/barrel (data sourced from the EIA). The April crack spread was thus $15.74, though it apparently varied quite widely over the course of the month. Delta hopes to use the Trainer refinery to produce jet fuel at a lower cost than it would otherwise pay on the market. Since the company consumes nearly 4 billion gallons of jet fuel per year, a small decrease in fuel costs could have a dramatic impact on the bottom line.
Back in April, Delta announced that it expected the Trainer refinery purchase to reduce its annual costs by $300 million. However, jet fuel crack spreads have actually widened since then. While the average spread was $15.74 in April, the crack spread between Brent crude and Gulf Coast jet fuel was up to $21.50/barrel as of Wednesday. If this additional premium of nearly $6/barrel were to remain, Delta's annual benefit from the Trainer refinery could double. (I will present some more detailed calculations below.)
Critics of the decision argue mainly that the Trainer refinery was not viable for ConocoPhillips, and that there is no reason to believe an airline could run a refinery better than an oil company could. In a very interesting piece published back in May, Gregory Millman argued that for three reasons, the logic behind Delta's refinery purchase was flawed. First, by focusing on jet fuel production, Delta would be unable to switch between different product combinations based on market conditions. Adopting a rigid production target would depress the refinery's long-term return on investment. Second, the Trainer refinery was uneconomical to begin with, which is why ConocoPhillips shuttered it last year. Third, Millman argues that Delta has not factored in $100-$200 million of necessary working capital in its estimate of the total refinery investment.
There is some merit to these arguments, but they do not capture the full logic of Delta's decision. The issue of working capital is least important: if the refinery produces a $300 million or better annual savings for Delta, it will be a good use of capital regardless of whether the investment is $250 million or $450 million. The other two points boil down to the argument that the Trainer refinery will be uneconomical for Delta, just as it was for its previous owners. However, my own analysis of the cost breakdown shows that this is not the case.
(see the article for a discussion regarding the cost-benefit of the deal)
Even if the market crack spread were $18 (as it has been for much of this summer) rather than yesterday's level of $21.50, Delta's savings would still exceed $400 million.
On Thursday, Delta also confirmed that it is looking into the possibility of switching the refinery's crude oil sourcing (at least in part) from imported seaborne crude to domestic Bakken crude. …. The possibility of alternative sourcing provides further upside for Delta, with no real downside (if it's not economical, Delta can continue buying Brent crude).
So why did the energy analysts get it wrong? Quite simply, Delta is a net consumer of oil products, whereas ConocoPhillips and now Phillips 66 are producers. This has two impacts. First, adding a refinery creates risk for a producer of oil products. If refining margins drop, operating another refinery would increase the losses of a refiner like Phillips 66. The increased risk makes oil companies err on the side of having less refining capacity. By contrast, for Delta, a drop in refining margins would hurt the refinery subsidiary, but benefit the company as a whole. The refinery thus acts as a natural hedge and de-risks the company. Therefore, it is unsurprising that Delta would be willing to operate a refinery that was marginal for an oil company.
Second, energy analysts assume that the market is in equilibrium, when this clearly is not the case for refiners. As Millman notes in the article I discussed earlier, U.S. refiners are earning more than twice the return on capital of U.S. airlines. As risky as the refining business is, the airline business is even riskier! The average returns should thus be reversed (in theory). It is always possible that Delta's entry to the market will cause the crack spread to narrow to $10, in which case Delta would be paying higher than the market price for jet fuel. Even so, the alternative would be not entering the market and buying at a higher market price (because without the Trainer refinery, there would be less supply). This would just mean that other airlines such as United (UAL) would benefit more from Delta's move into refining than Delta itself.
In short, I see no evidence to support the bear case regarding Delta's refinery…
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Are you finally taking a position on the refinery or not? You say a lot of things that sound like concrete positions (many of the naysayers who panned the purchase just a few months ago are now realizing their criticism was incorrect) but as always don't come out and honestly say your position is X, Y, or Z. Better for the ego to have it both ways I guess...

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Based on what DL is saying as the basis for the refinery, yes, I believe it will be financially positive. Given that this article and others are indicating the transaction will do what DL said it was intended to do, I think there is growing evidence it does make sense.

Given that there were a chorus of people including you who said that what DL couldn't even technically do what they said they were going to do - obtain almost 1/3 jet fuel from crude - let alone make the finances work and you also feel very strongly about people admitting they were wrong, perhaps you should be the one that not only admits you were wrong but also lead the campaign against those "analysts" who said the refinery deal couldn't work for DL.

To be clear, though, the deal won't be positive until DL has paid off the cost of the refinery but based on what DL is saying, that will probably happen by the middle of 2013.

I'm sure we can count on you to provide an update on the deal with the appropriate admission that you misread the whole deal should DL actually make money or more appropriately have fuel costs below its peers.
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Based on what DL is saying as the basis for the refinery, yes, I believe it will be financially positive. Given that this article and others are indicating the transaction will do what DL said it was intended to do, I think there is growing evidence it does make sense.

Given the use of wiggle room words like "believe" and "think", I take it you haven't taken a position although you say that I was wrong before any factual data points are established. So your charge that I was wrong is in itself a position - if DL doesn't get 32% jet fuel from the input at Trainer or save $300 million/year from Trainer jet fuel production I'll expect you to admit that you were wrong and to lead the campaign against those who label others "wrong" before the facts are in...

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I remain very skeptical that an airline can invest a mere $250 million in an old, shut-down refinery and magically save $300 million per year on its jet fuel costs.

"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 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."

So the refinery will save DL $100 million on fuel in 2012 and then save at least $200 million in 2013 and $300 million each year thereafter? If that actually happens, then good for Delta. But like I posted above, I'm skeptical that the experts in refining (the oil companies) would throw away such a profitable refinery so cheaply.

If Trainer produces fuel cost savings of $1.5 billion by September, 2017, then I'll post that I was wrong. Something tells me that I won't need to write such a post, but someone place this on their calendar to remind me.

If this works, then DL should borrow $2.5 billion, take over 10 similar refineries and, if the earnings are scalable, DL's refinery division would then produce $3 billion a year in earnings (10 refineries producing $300 million each).

The return on investment trumpeted by Richard Anderson (120% per year) is just a little optimistic for my tastes.
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that skepticism is valid, FWA. And no one should buy anything hook, line, and sinker.
But your skepticism is far different from pronouncing that something can't work.

BTW, DL has said it won't buy another refinery because one refinery will produce 80% of the fuel it uses in the US.... and it cannot market the products the refinery produces so it has to enter into swapping agreements.

Trainer was the right size for what DL is.

There are alot of people, me included, who will be watching very carefully to see if DL actually succeeds with the refinery.. and DL is held accountable for its investments as is any other publicly traded company.

Given that the crack spread has increased since the refinery deal was announced, the economics do look to be in DL's favor.

The risk, as the article notes, is that the crack spread could collapse and DL's investment might not make sense any longer. But there are structural reasons in the global production of petroleum products that indicate that won't happen.

Since threads on this forum don't ever die, we can all go back and look at what was said.
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Ya gotta admire DL's kutzpah, though:

Delta airlines had filed two complaints against the rates since 2011, one of which was resolved in March without the regulator's action, Buckeye said.

Three complaints this year...

The complaint involves all 3 major NYC airports.

Not sure if the pipeline facilities involved with the Trainer deal access the airports directly but there are pipelines leaving Trainer that are part of the deal.

"Delta Air Lines Inc, JetBlue Airways Corp, United Continental and US Airways filed the complaint with the Federal Energy Regulatory Commission alleging a Buckeye subsidiary -- Buckeye Pipe Line Co -- charges "unjust and unreasonable" rates to transport jet fuel from the Linden, New Jersey terminal to the Newark Liberty, John F. Kennedy and La Guardia airports, Buckeye said."
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It appears that DL's decision to keep Trainer running thru the refinery during Sandy while other refiners in the NE shut down is reducing the time necessary for the refinery to be profitable producing jet fuel. Ironically, the refinery was still in the rampup process and was producing more non-jet fuel products than planned but gasoline and diesel is exactly what the region needed, to DL's benefit.

"As a result, Delta is probably realizing much better-than-projected trading rates for its refined products, and will continue to do so until Northeast supplies come back into balance (probably around the end of this month). For example, according to EIA data, Gulf Coast jet fuel traded at an average premium to NY gasoline of 27.7 cents/gallon in the two weeks prior to Hurricane Sandy's arrival. That premium narrowed to 22.1 cents for the week ended 11/2, and then to 10.4 cents in the week ended 11/9. As of Wednesday (the most recent day for which data is available), the premium was a mere 3.2 cents. Indeed, Gulf Coast jet fuel was actually trading at a discount to NY gasoline for several days last week!"


Hopes of a US gov't debt/budget deal have pushed the dollar stronger and prices of crude oil down which helps the airline industry in general.
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