Delta Cuts Out Pesky Fuel Middleman, Buys Itself An Oil Refinery

Delta Air Lines has been battling rising jet fuel prices with all the other airlines, trying to institute prices hikes — some successful, some not — and do what it can to cope. And now that everything else hasn’t worked, it’s decided hey, why not just cut to the heart of the problem and buy an oil refinery?

In a move that seems a bit like buying a dairy farm because you want to save on milk, Delta is purchasing a Pennsylvania oil refinery from ConocoPhillips for $150 million. It’s the first airline to ever do such a thing, reports Reuters.

Delta hopes to save money on fuel costs with the move, saying it will cut $300 million annual from the cost of jet fuel, which last year was $12 billion. Beyond the oil produced at its own refinery, there are agreements to exchange refined products for jet fuel that will bring in 80% of its U.S. fuel needs.

You aren’t the only one confused — analysts have been apparently furrowing their brows over the deal since it hit news last month. Some politicians and officials are relieved, however, as the refinery had been in danger of being shut down, which would have cost jobs and perhaps a spike in summer fuel costs.

What delta will really be saving on is the cost of refining a barrel of jet fuel. It will still have to pay whatever the market price is for a barrel of crude oil, but this deal will help allay some costs.

“What we’re tackling here today is the jet crack spread, which you cannot hedge in the marketplace effectively,” Delta Chief Executive Richard Anderson told reporters during a phone briefing. “It’s the fastest single growing cost in our book of expense at Delta.”

Somehow this whole thing sounds like the premise for some kind of wacky romantic comedy. Did Ashton Kutcher actually buy Delta and the oil refinery to save his best friend’s job and impress Mandy Moore?

Delta buys refinery, becoming first airline to make own fuel [Reuters]

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  1. MrGutts says:

    Never fear consumers, you will see a charge on every ticket for the buy out of the company. They will call it a convenience fee!! Yeah yeah that’s the ticket!

    • vastrightwing says:

      Print your own ticket at home? There’s a fee for that. Want to use your own headphones? Yep, there’s a fee. Oh and there’s an overhead bin fee and an under your seat fee. Don’t forget my favorite fee, the use your electronic device fee. The use while taking off fee is $99, but the in mid flight fee is only $6. And last but not least is the let your child annoy other passengers fee of only $100/minute.

  2. MutantMonkey says:

    Anyone want to wager on this having zero impact on their ticket costs, but they still manage to rake in billions in profits?

    • TheMansfieldMauler says:

      If you think that’s what’s going to happen, the thing for you to do is start buying Delta stock.

    • winstonthorne says:

      Edit:

      “Anyone want to wager on this having zero impact on their ticket costs, but they still manage to rake in billions in LOSSES?”

      There, I fixed it!

      • MutantMonkey says:

        How did you get there? They are buying it for $150 million which is going to cut a lot of overhead.

        They may not pull in billions, but how do you think they are going to lose billions?

    • wackydan says:

      Airlines are a losing bet for long term investments…Which means pretty much anyone who isn’t an investment banker or fund manager should not be buying airline stock.

    • aerodawg says:

      The net impact impact to Delta is likely to be zero for a variety of reasons. Vertical integration simply doesn’t have a history of having the intended effects.

      Think about it. If Delta is buying fuel from itself at the cost to refine, which is a discount to the market price of fuel, then they are foregoing the revenue/profit of selling the fuel itself to other users. In effect the differential itself is a cost to Delta albeit not an overt cost.

      If you’re using that mechanism to subsidize un-profitable flights, in general you would probably be better off simply cancelling the unprofitable flights and selling the fuel to other people because you eliminate the other maintenance and personell costs of operating that flight…

      • MutantMonkey says:

        What constitutes an “un-profitable flight”? Planes don’t take off anymore unless they are at something like 97% capacity.

        • aerodawg says:

          Based on my recent experience I can tell you that’s certainly not true. Mainline hub to hub flights it probably is due to a lot better capacity discipline, but there are still a lot of flights, both regional and mainline that are

          Additionally, fully capacity doesn’t necessarily mean a flight will be profitable. Depending on aircraft type, average fare and cabin configuration, even a full flight can be unprofitable.

          A seat on a flight is a 100% perishable good. Once the plane pulls back from the gate, you’ll never sell that seat on that flight, so airlines will do anything to get some revenue out of the seat, even selling it below the cost to fly the empty seat. Based on that, some routes are simply not profitable to operate, but they have to be maintained to help feed traffic into the hubs.

          In aggregate, the entire operations are getting profitable, but a lot of the individual flights are not…

        • aerodawg says:

          Additionally, I like to point out from your initial post, making “billions in profits” isn’t as great as it sounds. Delta flew just under 164 million passengers last year for $1.3 billion in profit.

          That’s an average of around $8/passenger including the high margin first class products. The chances of anything they do making a signficant impact to average price for a coach ticket are VERY small….

        • fs2k2isfun says:

          This is 100% false. Flights are very rarely canceled for low loads.

          • MutantMonkey says:

            I never said anything about flights being canceled for low loads, though it does happen occasionally.

            I was more referring to the reduction of available flights on hot routes to fill up existing ones.

          • Nobody can say "Teehee" with a straight face says:

            Correct, they aren’t cancelled for “low loads”. They are cancelled under the guise of “mechanical/maintenance issues” or “weather issues” somewhere along the way. Cancelling for load issues would make people mad, after all.

    • Jawaka says:

      The net impact will probably be that we may not see prices go up as quickly and as much as it otherwise would have.

  3. DAA says:

    They can’t run an airline how can they run a refinery?

  4. Loias supports harsher punishments against corporations says:

    Surprised it took this long – why rent the cow when you can buy the cow and get millk at cost?

  5. There's room to move as a fry cook says:

    How are they going to get fuel from the refinery to every airport that they service in America – or at least to every nearby northeast airport? Suddenly they are in the trucking business managing and scheduling a fleet of trucks – and needing their own separate fuel storage facilities at each airport.

    • j2.718ff says:

      Trucks? But they already have airplanes. They can just fly the fuel to wherever it’s needed!

      In all seriousness, though, I wonder how much the distribution problem can be solved/mitigated by creative routing of flights. Even if they can’t get 100% if their fuel from their new refinery, they might be able to get a high enough percentage for it to be worth while. Or, perhaps they could work some sort of trade agreement with another airline. (eg: You cover the cost of us fueling on the west coast, and in trade, you can use our refinery’s fuel for free)

    • MrEvil says:

      Doesn’t have to be trucked. That oil refinery is going to have a rail yard. They could easily rail tanker cars of jet fuel, that’s how most jet fuel ends up at airports all over the US. Railed to intermodal facilties closest to airports and trucked for the last mile.

      However, my bet is Delta’s plans are to rather sell all the refined products (including the jet fuel) from their refinery at market price and use the profits to offset the cost of jet fuel they actually end up buying.

    • Southern says:

      Eastern Seaboard will probably be their only problem.. The rest of the country is pretty much covered by 95,000 miles of Refined Product Pipelines, which can transport refined product from, say, Houston Texas to a terminal (Storage Tank) in New York with no problem.

      Eastern Seaboard doesn’t have much in the way of Refined Product Pipelines though. So they would probably just continue buying from whatever source(s) they have there already.

      • Southern says:

        Sorry, meant WESTERN Seaboard, not Eastern. Eastern is completely covered by pipleline.

        • huadpe says:

          Curious if you know since you apparently have some knowledge of the field, what’s the rough breakeven mileage for putting it on a train, if we take it as a given that airports lack rail links, and so that last mile still has to be done by truck?

          • Southern says:

            Sorry, no clue on that one. I doubt that there are many airports that AREN’T fed by pipeline though, since your standard 737 can hold about 45,000 gallons of jet fuel, and a tanker truck can only carry just under 9,000 gallons — meaning it would take 5 tanker trucks just to (completely) fill ONE 737. There would be a constant stream of tanker trucks going in/out of every airport. :-)

            • huadpe says:

              Good point. Large numbers are involved here. Maybe buying a refinery makes sense at this kind of scale.

    • MrObvious says:

      I’m pretty sure they could just fly it around.

    • jimbobjoe says:

      From my recollection on an article I read, the production will be going go JFK, LaGuardia, Newark and Philadelphia via pipeline. It’s more than enough for Delta, so they will be selling the production to other airlines at those airports.

  6. zmoney1978 says:

    You know Regal Theaters owns its own corn fields so when you buy that popcorn for $8.00/bag the markup is like 2000%. That’s I think what delta are thinking. Also if they sell the extra for profit why not.

    • scoosdad says:

      Really? I googled ‘Regal Theaters’ and ‘cornfield’, and all I found were stories about how they buy cornfields to build movie theaters on, but nothing on how they grow their own popcorn.

  7. There's room to move as a fry cook says:

    Zero impact on ticket costs. $300 million/$12 billion = 2.5% ‘projected’ savings that will easily be camouflaged by other factors.

    • crispyduck13 says:

      Plus they can write off the purchase as a “business expense” and pay even less corporate tax this year!

      • huadpe says:

        How is the purchase not a business expense?

        I mean, yeah, people and companies take flaky expenses often, but this seems to be quite clearly a legitimate business expense.

      • wrjohnston91283 says:

        Actually, they can’t. Depending on the legal structure, this is probably going to be its own entity, could be held on Delta’s book as an investment; it could be a separate but consolidated company; but its not going to be a one time $150m deduction for 2012. They may be able to depreciate/amortize some of it each year.

  8. GMFish says:

    The rest of the story….

    Delta Cuts Out Pesky Fuel Middleman, Buys Itself An Oil Refinery… immediately it fires everyone at the oil refinery and shudders it. After taking a huge tax break, it outsources all of the work to a refinery in Mexico. It then starts paying bribes to local officials to ignore all environmental laws.

    • wrjohnston91283 says:

      At least in your scenario; Mexico gets a shiny new refinery; India only gets our rejects:
      ttp://www.platts.com/RSSFeedDetailedNews/RSSFeed/Oil/6718250

  9. Lyn Torden says:

    “What delta will really be saving on is the cost of refining a barrel of jet fuel.”

    No … the refining process costs will be the same. What they are REALLY cutting out is some middle-man company making a profit on the process. Delta makes that profit, instead, and rolls that into the cost of operation.

    • Southern says:

      But a refinery makes a LOT more stuff than just Jet-A fuel.

      Which they’ll resell at their own profit, even further offsetting the cost of the refining process.

      In fact, from a standard 42 gallon barrel of oil, they ONLY get 4 gallons of Jet Fuel from the refining process. They get almost 20 gallons of (car) gasoline, and about 10 gallons of diesel/heating oil (plus a ton of other stuff.. kerosene, asphalt, etc.)

      • who? says:

        The other thing is that fuel is expensive to transport, so Delta will probably use what they can in the area near the refinery, sell what they can’t use locally, and still be a net buyer in the marketplace.

        If they can manage the refinery efficiently (big *if*), they might do okay on this. One of the main things that causes volatility in fuel prices is that refinery capacity is a limited resource. The amount of money it costs to refine a barrel of oil is relatively constant, but the price of fuel varies a lot based on supply and demand relative to what the refineries can produce. I would guess they’re doing this mostly to hedge the fuel price volatility.

        I still wouldn’t invest in Delta or any other airline, but I don’t see this as being a particularly stupid move.

      • Firethorn says:

        That’s due to need. With cracking, they could probably turn half the barrel into jet fuel.

  10. crispyduck13 says:

    I’m confused at why so many people are (apparently) confused at this strategy. It’s pretty simple logic really, buying a dairy farm because you want to save on milk is a reasonable decision if you go through a metric shit ton of it every year.

    • DAA says:

      Confused, not at all. It is not their core competancy Some are confused to think an airline can run a refinery.

  11. Santas Little Helper says:

    I actually think this is a great idea. I hope it works for them.

  12. Actionable Mango says:

    “Did Ashton Kutcher actually buy Delta and the oil refinery to save his best friend’s job and impress Mandy Moore?”

    That speaks volumes about the types of movies you watch!

  13. scoosdad says:

    Will they buy a kennel next so they can easily replace dead or missing animals?

    35 Pets Died On Airplanes Last Year, Over Half On Delta

  14. prosumer1 says:

    Makes total economic sense. I don’t know how much it would cost to run an oil refinery, but the initial investment can be recovered in 6 months.

  15. StevePierce says:

    I decided to cut out pesky airline middleman and I bought a plane.

  16. hikari07 says:

    Looks like consumerist is confused too… they bought the refinery from Phillips 66. ConocoPhillips legally spun off Phillips 66 on May 1st, so this is one of the first things the new company did. Please check your facts a bit closer next time.