This Thursday, April 19, 2012 file photo shows the ConocoPhillips
refinery in Trainer, Pa., near Philadelphia. Delta Air Lines Inc. bought
the refinery as part of an unprecedented deal that it hopes will cut
its jet fuel bill. A Delta subsidiary paid $150 million, including $30
million in job-creation assistance it is getting from the state of
Pennsylvania. (AP Photo/Alex Brandon)
https://fuelfix.com/blog/2015/07/06/as-delta-refinery-snaps-up-nigerian-crude-u-s-producers-ask-congress-for-freedom-to-export/
Delta Airlines has done a lot of things
right since its 2008 acquisition of, and merger with Northwest Airlines,
but buying a mothballed, dilapidated, small-ish and costly-to-operate
oil refinery outside Philadelphia in 2012 most definitely is not one of
them.
Plenty of experts in both the airline and the oil industries said at
the time that Delta’s purchase from ConocoPhillips of what is now known
as the Monroe Energy refinery in Trainer, PA, was a bad idea, and have
continued to say so ever since. But only now are Delta’s own executives,
who steadfastly have kept on defending the six-year-old mistake,
beginning to admit it. And they’re only doing it now in a grudging,
indirect way. But that can’t obscure the fact that Delta, the nation’s
most profitable airline thanks mostly to its leaders over the last
decade, likely would be even more profitable had they just stuck to
their airline knitting instead of wading into the murky swamp of the oil
business.
Last week Delta officials said publicly that they’ve hired Barclays
Investment Bank and Jefferies Financial Group to look for a joint
venture partner to buy a presumably large share of the airline’s Monroe
Energy subsidiary. That – also presumably – is because Delta’s leaders
know full well that they’ve got no realistic hope of finding a sucker
crazy enough to take the whole thing off their hands.
In fact, University of Houston energy economics professor Ed Hirs, a
long-time critic of Delta’s foray into the oil business, last week told
Reuters that Delta’ quest to sell some of Monroe Energy could come up
empty. That would put the Atlanta-based carrier - the world’s
second-largest in passengers, capacity and revenue behind the
less-profitable American Airlines - in a difficult position. It would
have to decide between continuing to sustain large (but far from fatal)
losses on its refinery or shutting it down entirely, much to their great
embarrassment.
“It was a boneheaded decision” six years ago to buy it, Hirs said.
“And they are still paying for it. It is going to be tough to sell a
refinery that has faced closure several times due to bad economics.”
MORE FROM FORBES
Delta, then led by now-retired CEO Richard Anderson, bought the
Trainer refinery for just $150 million. But the plant, which had been
dormant for a while before the purchase, needed about $120 million in
immediate investment at the time to bring it back online in a way that
would meet new, tougher environmental rules. But Anderson, with the
strong backing of his top lieutenants, including his eventual successor
Ed Bastian, broadly proclaimed that the refinery soon would be producing
$300 million annually in pre-tax profits.
But just as both airline and oil industry experts said at the time
would be the case, Delta’s refinery, which initially produced mostly jet
fuel – essentially kerosene – only came close to achieving such results
one time.
Monroe Energy lost $63 million in the less than one quarter of 2012
in which it was owned by Delta. It then lost another $115 in 2013 as
Delta struggled through the oil industry learning curve.
The refinery operation turned modestly profitable in 2014, earning
$96 million before taxes, then reached its high water mark of $291 in
profits in 2015. But as the price of oil and – more importantly refined
fuels – fell sharply in 2016 so did Monroe Energy’s performance. The
refinery had to quit producing about 40% of its product as jet fuel, on
which profits were non-existent, and to increase its production of
gasoline and diesel fuel, better-selling products that allowed it to
lose less money per barrel of production and to collect on government
incentives paid to refineries that mix corn-based ethanol into auto
fuels. Thanks to a yawning imbalance between the supply – and the price -
of crude reaching the plant and the price for its finished products
Monroe Energy lost about $125 million that year.
In 2016 Delta called in consultants to help it sort out its oil
refinery’s economic issues. They’re the ones who convinced Delta
management to have the refinery shift production toward more gasoline
and diesel and away from jet fuel. That helped slow the losses, but only
a bit. The refinery’s financial results from 2017 and thus far in 2018
(which Delta has not made public) certainly have not been good enough to
stop management from seeking a partner – preferably one with real oil
industry investing and operational savvy – who might be able to solve
the refinery’s problems (or at least provide Delta with some cushion
against the refinery’s losses).
Luckily for Delta, their up-front investment in the refinery was
relatively low. And compared with the airline’s $40.5 billion in 2017
revenues and $6.1 billion in profits, its Monroe Energy predicament
remains something of a bothersome sideshow.
Still, Delta’s foray into the oil industry serves as another sobering
lesson to airlines, which historically have done quite poorly whenever
they’ve tried various types of vertical integration strategies.
Pan Am, TWA, Northwest, United and American are big U.S. airlines
that did not do so well as owners and operators of big hotel chains.
American in the 1980s, apparently thinking its base in Texas somehow
gave it special insight into the oil business, also wasted time, and a
little money, on an oil trading subsidiary. Most carriers also used to
own at least a portion of the computerized reservations systems used to
sell their tickets via travel agencies in the days before online
selling. Those drew lots of attention from regulators but never created
the kind of profits that they likely would have made had they been
independent companies instead of captives providing their services to
their owner-airlines at deeply discounted prices.
The biggest, ugliest example of failed airline efforts at vertical
integration was the attempt in 1969 and 1970s of former United Chairman
Richard Ferris to create a one-stop shop travel company called Allegis.
It included not only United but also the Hilton and Westin hotel chains,
Hertz rental cars and other, smaller travel companies. Ferris’ plan was
so unpopular with employees and investors alike that it got him booted
out of the company less than six months after he unveiled the Allegis
mega-brand. All the Allegis subsidiaries except United then were sold
off within a year. And United escaped being forced into bankruptcy only
by agreeing to be acquired in an union-sponsored Employee Stock
Ownership Plan deal that hamstrung the company for years thereafter.
In Delta’s case, despite Anderson’s hyped prediction of $300 million
in annual pre-tax profits from the refinery business, the real reason
Delta wanted to own a refinery was to use it as a physical hedge against
fluctuating and potentially devastatingly high oil prices. The
airline’s thinking was that by producing itself a sizeable percentage of
the jet fuel the airline would be buying on the market, it could shield
itself from the violent up and down swings in the per gallon price and
from the periodic kerosene supply shortages that tended to drive big
price spikes.
But, as many academics have argued over the years, when a
commoditized business like the airline business buys other commoditized
businesses like hotels and oil companies – companies whose products are
highly sensitive to swings in demand and low price competition – the
discounts at which one of those companies is forced to sell its products
or services to its sister company typically fails to increase total
corporate profits. Instead, researchers have argued effectively it
usually has just the opposite of the intend impact by retarding total
corporate profit growth.
In Delta’s case not only was that true, its ownership of Monroe
Energy actually helped bring down the price of jet fuel for ALL airlines
even though only Delta committed corporate capital and management time
to producing those savings.
As a result, Delta never has been able to close the gap between its
unit cost for fuel and the price its primary competitors, American,
United and Delta, pay per unit of capacity. In 2011 Delta paid, on
average $3.10 per gallon of fuel vs. American’s price of $2.93, and
United’s $2.87. Even Southwest managed to pay slightly less than Delta,
$3.09 a gallon, that year even as its fabled fuel hedging position
collapsed amidst an unpredicted big drop in the market price of fuel.
More to the point, it cost Delta 4.8 cents for the fuel it required
to fly one seat one mile in 2011. American paid 4.6 cents while United
and Southwest paid 4.5 cents each. The purchase of Monroe Energy was
supposed to push Delta from the bottom to the top of that list, but last
year it still ranked fourth among that quartet of carriers in price
paid for the fuel required to fly one seat one mile: 2.5 cents vs. 2.4
for all three of its big rivals. That tiny, one-tenth of a penny
difference actually means a lot given that Delta flew 228.4 billion
available seat miles in 2017. Had it simply paid the same price for fuel
per available seat mile as its competitors paid last year Delta would
have saved about $228.4 million in total fuel expense.
In short, Delta’s purchase of, and continued investment of capital in
the Trainer refinery has produced none of the desired results for the
airline. Thus last year’s switch from heavy production of jet fuel to
producing more gasoline and diesel was a quiet but clear – and painfully
delayed - recognition of reality. So is this year’s decision to find
another company on which Delta potentially can lay off some of the risk
and responsibility for that refinery.
Thus Delta, which has done many, many things rights over the last 10
years, is facing up, however reluctantly and belatedly, to its one big
mistake. And in the big picture, even that mistake isn’t all that big.
Still, it is a black mark on Delta managements’ reputation, and one that
investors don’t like. Right now they’ll put up with it, given the
other, overwhelmingly positive results coming from Delta. But will they
be so indulgent if Delta can’t find a partner with which it can share
ownership of that old, struggling refinery in Pennsylvania?
Contributor
Dan Reed
I write about airlines, the travel biz, and related industries
I
wrote my first airline-related news story in May 1982 – about the first
bankruptcy filing of Braniff International Airways. That led to 26
years covering airlines and related subjects at the Fort Worth
Star-Telegram and USA TODAY. I followed the industry through the entire
arch of deregulation: expansion, disruption, and consolidation. I’ve
also written two books on the subject: American Eagle: The Ascent of Bob
Crandall and American Airlines, published in 1993, and (with co-author
Ted Reed) American Airlines, US Airways and the Creation of the World’s
Largest Airline, published in 2014. Today, I operate my own consulting
firm and work as a freelance journalist covering aviation, faith,
travel, business, IT, education, and sports. I’m a graduate of the
University of Arkansas (Woo Pig Sooie!) and Southwestern Baptist
Theological Seminary.
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