In buying an oil refinery, Delta Air Lines is giving up the tricky business of playing the New York jet fuel market in exchange for four just-as-difficult businesses: buying crude on the East Coast and refining gasoline, diesel and residual fuel, airline analysts said Tuesday.
"Delta traded a volatile instrument that was important to the success of their company to now having four volatile instruments that are important to the success of this business model," said John Armbrust, chairman of Armbrust Aviation. "In the old days they just had to worry about the availability and the price of jet in New York harbor."
Delta will now have to figure out how to source crude oil that drove integrated oil companies out of the challenging Northeast refining market at the same time it looks for takers for 120,000 b/d of diesel, gasoline and other petroleum products made at the refinery.
After the markets closed on Monday, Delta said it plans to buy the 185,000 b/d refinery in Trainer, Pennsylvania, from Phillips 66 -- the refining and marketing arm spun off effective Tuesday from ConocoPhillips. The airline wants to produce 52,000 b/d of jet fuel for its own planes at New York airports, plus 120,000 b/d of other products that it would trade to Phillips 66 and BP in exchange for jet fuel at airports in other regions of the country.
"If it were just making all jet fuel, that would be one thing," Armbrust said. "But the problem is that feedstock of crude oil is extremely volatile. The offtake agreement they have whereby their partners are trying to sell gasoline and diesel -- and by the way residual fuel oil -- to get jet fuel in other markets is also fraught with extreme volatility."
While that set of four distinct businesses comes with huge challenges, Armbrust does not dismiss the idea that Delta could pull it off.
"They're either going to look like the smartest kid in the class, or they're going to look pretty foolish," he said.
Armbrust said a key will be to find access to cheaper crude than today's Brent prices.
To that end, analysts said Delta might be looking at ways to build a supply chain to carry light sweet oil from the US Midcontinent or Canada to the East Coast. Or it might be hoping for major pipeline reversals like this month's move by Enbridge and Enterprise Product Partners to change the direction of the Seaway pipeline to flow from Cushing, Oklahoma, to Freeport, Texas.
Analysts also questioned whether Delta would be able to follow through with its plan to reconfigure the plant to pump out 32% jet fuel, up from 14% of output when ConocoPhillips ran it.
Armbrust said that would depend on upgrades and on the quality of feedstock.
Kevin Waguespack, vice president of Baker & O'Brien, said the 32% figure leads him to believe Delta wants to modify the plant's hydrocracker and possibly crack gasoline to more than double the jet fuel yield.
"You have an airline backward integrating into crude oil refining for a product that's typically only 10% or 12% of the slate," he said, adding that the Northeast region has the most expensive inputs. "They're entering the refining business at the high point of the cost curve. That's probably one of the highest-cost fuel producers."
Waguespack said that even though Delta has complained of out-of-control fuel costs, the jet market is a large one, and large airlines can do pretty well buying upstream of wholesale.
"The synergistic value between a jet fuel producer and an airline is just lost on me," he said. "I'm still scratching my head."
