In an odd move, Delta Air Lines Inc. (DAL.N) will buy a Pennsylvania oil refinery from ConocoPhillips for $150 million. In a throwback to the 1920s Ford Motor company vertical integration strategy, Delta says that the first ever purchase of a refinery by an airline will allow it to cut $300 million annually from jet fuel costs. Delta said production at the refinery, along with other agreements to exchange refined products for jet fuel, will provide up to 80 percent of its fuel needs in the United States.
The refinery purchase is for a shuttered 185,000 barrel-per-day refinery in Pennsylvania. While Delta will still remain subject to fluctuating crude oil costs, the facility will enable Delta to save on the cost of refining a barrel of jet fuel, which is currently more than $2 billion a year for Delta and has been rising due to U.S. refinery shutdowns, said Delta Chief Executive Richard Anderson.
“What we’re tackling here today is the jet crack spread, which you cannot hedge in the marketplace effectively,” Anderson told reporters during a phone briefing. “It’s the fastest single growing cost in our book of expense at Delta.”
Unfortunately for Delta, this plant was shuttered for a reason- poor access to cheap crude. Now Delta is saddled with a multi-million dollar asset locked into a geographical handicap. Other handicaps for Delta include running a functionally and managerially disparate business unit, EPA headaches, and additional union with which to negotiate.
In the accounting department and on paper, this deal makes sense. Attack the excessive processing cost for jet fuel. However, why stop there? Perhaps Delta should buy an old GE engine plant or an ex-Boeing airframe facility? Think of all the money they could save on airframe and engine purchases. Better yet, attack the biggest cost – people. Vertical integration into robotics could eliminate the biggest cost of all, flight attendants and pilots.
In case you cannot tell, I don’t like this version of the vertical integration business model. Oil refining is a far cry from running an airline. Airlines are already a pretty tough business to run without additional headaches. Frankly, if Delta wants to control rising oil costs and/or participate in oil profits, why not invest in the oil in the ground? By controlling the raw product, Delta would have more upside potential with no more headaches than a refinery. This type of investment could be done much more passively than running a refinery. The only scenario where investing in oil in the ground would be a worse idea is if oil prices fell drastically, which is not likely. If this were to happen, the profit from refining jet fuel would stay fairly constant while the profits from oil drilling would plummet. Probably the best move is for Delta to leave the oil business to the oil people and focus on innovation in the airline arena.
What’s the bottom line? I think this one falls under “Everyone thinks they know how to run a restaurant because they know how to eat.” Just because you buy lots of fuel does not mean you know how to make it.
