Delta Refinery Purchase Benefits Consumers
Erin is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Need to save money on gas? Buy your own refinery. That's what Delta Airlines (NYSE: DAL) is doing.
Delta announced plans on Monday to purchase the Trainer oil refinery from Phillips 66 (NYSE: PSX) for $150 million, after $30 million in state government assistance. (Phillips 66 officially began operating as an independent spin off of ConocoPhillips as of May 1, 2012.)
The company will have to spend a considerable amount of money (possibly $100 million) to convert the refinery processes in order to more efficiently produce jet fuel. The refinery will also produce gasoline and diesel. Delta will purchase the crude oil from BP (NYSE: BP). Delta estimates the deal will save close to 2.5% on fuel expenses ($300 million). It spent $11.8 billion on fuel last year. The refinery will cover 80% of Delta's fuel needs in the United States. The key location of Trainer, outside of Philadelphia, offers convenient access to Delta hubs La Guardia and JFK in New York.
The new Delta strategy, if successful, could have huge ramifications across the industry. From a consumer standpoint, this refinery purchase could potentially lower fares. The cost of fuel significantly effects the price of an airline ticket. If a company can save significantly on fuel, one of its largest expenses, it will be able to lower (or keep from raising) flight fares, making it far more competitive, which benefits consumers. (Read: Understanding Airfares) From an investor standpoint, a company that can save significant funds, and become more competitive to customers, is a company that can potentially see a considerable increase in profits.
It is no secret that all of the airlines have a fuel problem, and that the problem has become the consumer's problem. The airline business model to date has been designed to pass along increased fuel costs to customers. However, it is a competitive industry, and consumers have options on which airline to fly. Consumers tend to not stick with airline loyalty, and typically choose the cheapest flight option. Airlines hiked fares 10-12 times in 2011, and in February 2012, JetBlue, United, Delta, American and US Airways all raised ticket prices (on average $10) again.
Until now, only Southwest Airlines (NYSE: LUV) has operated on different business model. Southwest prices out tickets in advance, based on a projected fuel cost in the future. By doing so, it has been able to avoid raising prices on passengers like other airlines are forced to do. But in recent months, as fuel prices have spiked, the company has had to post a loss in profits, and raise fares.
Delta is buying the refinery through subsidiary Monroe Energy LLC, that will also operate the facility. Concerns that an airline may not know how to run a refinery, which operates on a very different business model, are addressed by the company. The Trainer refinery will be headed by Jeffrey Warmann, who has 25 years of experience in the industry, most recently as refinery manager for Murphy Oil USA Inc.’s plant in Meraux, Louisiana, according to Delta. The company will also preserve 5,000 jobs at the facility.
ConocoPhillips had intended to close the refinery if a purchaser could not be found by the end of May. Many refineries in the U.S. are struggling as more cheaper, heavier types of oil that come from Canada's oil sands, Saudi Arabia, and Venezuela. The facility can refine 185,000 barrels of crude per day.
ErinAnnie has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend Southwest Airlines. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. If you have questions about this post or the Fool’s blog network, click here for information.