Column - Benefits Remain Elusive From Deltas US Oil Refinery
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Wed Jan 22, 2014 11:53am EST Tweet 0 Share this 0 Email Print COLUMN-Benefits remain elusive from Delta's U.S. oil refinery: Kemp By John Kemp LONDON, Jan 22 (Reuters) - When Delta Air Lines announ ced it was buying the T rainer oil refinery from Phillips 66, in April 2012, the U.S. carrier hailed the transaction as "an innovative approach to managing our largest expense". Since then, the company says vertical integration has lowered jet f uel prices in the U.S. Northeast , its home region, and will eventually provide company-s pecific benefits as the refinery processes more cheap domestic crudes and returns to profitability. But t he jury is st ill out on Delta's strategy. T he refinery remained in the red in 2013, reporting a loss of $116 million. On Tuesday, the airline said the refinery lost $46 million in the fourth quarter. No other airline has copied Delta in buying a refiner y, ev en thoug h plenty of other refineries are up for sale in Western Europe and on the U.S. East Coast. It remains unclea r whether vertical integration is a more effect ive solution to t he problem of managing airline fuel costs t han traditional hedging using futures, options and swap contracts. RISING FUEL BILLS Fuelcosts areincreasingly crit ical to theprofitability of airlines. In 2013, Delta spent nearly $11.5 billion - a t hird of its operating costs - to buy almost 4 billion gallons of jet fuel. Jet fuel prices have risen almost five-fold since 2002, becoming the largest operating expense for airlines such as Delta (Table 1). Demand for jet is growing significan tly f aster than other refined products. But f or refiners, jet is only one relatively minor co-product fr om plants designed to maximise production of more import ant fuels like gasoline and diesel. So as refiners have closed plants on the U.S . E ast Coast and in Northwest Europe t o eliminate excess gasoline output and improve their margins, the squeeze on jet supplies has grown intense, and the fuel is becoming relatively more expensive. "Becaus e global demand for jet fuel and relat ed products is incr easing at the same time that jet fuel refining cap acity is decreasin g in the U.S. (particularly in the Northeast), the refining margin reflected in the prices we pay for jet fuel has increased," Delta complained in its 2012 annual filing with the Securities and Exchange Commission. Trainer' s closure would have thr eatened to push jet c osts even higher by t ightening fuel supplies in the greater New York region. Delta therefore "acquired the Trainer refinery and related assets located near Philadelphia, Pennsylvania in June 2012 as part of our strategy to mitigate the increasing cost of the refining margin we are paying", it explained. RISK MANAGEMENT With f uel bills accounting for s uch a high share of the airline' s cost base, managing price risks has become ever more essential. Like other airlines, Delta has sought t o protect itself t hrough active hedging using futures, options, collars and swaps. The cost s of hedging have been large at t imes, r eaching $1.4 billion in 2009, when oil prices unexpectedly collapsed, though of course most of the costs of true hedges should have been offset by reduced operating expenses elsewhere (Table 2). The quest ion is whether buying Trainer was a cheaper and more ef fect ive way of hedging price risks and guaranteeing fuel supplies than relying on tradit ional hedging programmes and importing fuel from other regions if needed. Delta paid just $150 million to acquire t he refinery and agreed to inves t a f urther $100 million in modernising the plant to maximise j et fuel production. In addition, the Commonwealth of Pennsylvania and Delaware County have provided additional financial assistance to support job retent ion, investment and economic development. Delta's investment was "modest" and "equivale nt t o the list price of (just one) new widebod y aircraft," the airline's chief executive noted at the time. Owning the refinery would allow Delta t o reduce its annual fuel expense by $300 million and ensure jet fuel availability in the Northeast. "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," the company promised in April 2012. RETIREMEN T ROADMAP How to plunge into Social Security Your choices could have huge consequences for the rest of your r etiremen t. Here’s what to consider. VideoHow to thin k about housing in retireme nt Planning for your dream trip Facebook Twitter RSS YouTube Follow Reuters Share Share 2 RECOMMENDED VIDEO Botched jobs in South Korea's plastic surgery A cruel ending for sea lion in Peru Lockheed F-35 fighter jets make smooth landi… Lava creeps further toward Haiwaii village HOME BUSINESS MARKET S WORLD POLIT ICS TECH OPINION BREAKINGVIEWS MONEY LIFE PICTURES VIDEO EDITION: U.S. Search News & Quot SIGN IN RE GI STER
