On April 30th, Delta Airlines announced that it would be acquiring an oil refining complex in Pennsylvania for $100mm as a sort of alternative hedge on jet fuel costs. The facility needs to be retooled to focus more on Jet Fuel, but Delta CEO Richard Anderson believes that the investment could save the airline $300mm annually.
My first reaction to the news was sheer respect to Delta for the ballsiness of the move. This is in effect a bitch slap to Wall St. and the commodities futures industry for failing to come up with a product that successfully manages fuel cost inflation. However, after contemplating the move, I have doubt that this purchase will pan out successfully.
What makes Delta think that it can efficiently run a refinery that was bleeding money for years?
The oil refining business has been in decline for a while because higher crude prices actually make refining less profitable by squeezing the spread a refiner can make. Big refiners have been biting the bullet of margin compression for a while and some, like Sunoco, have exited the business altogether. Therefore, the refining venture may have actually increased Delta's risk of loss to rising crude prices.
I am sure many people remember or have learned about the German industrial firm Metallgeschaft. In the 90's Metallgeschaft attempted an elaborate crude hedging project and lost billions when the crude futures market shifted from backwardation to contango. With one hundred million dollars suck so far, Delta's investment is no Metallgeschaft; however, corporate ventures into other industries have a habit of transforming themselves into cash guzzling nightmares.
On the other hand, if this venture proves fruitful, it could have a game changing effect on how companies manage their exposure to volatile costs. This is a throw-back to the fat cat days of the late 1800's where many well-to-do 'captains of industry' owned vertically integrated railroad companies.
What do you guys think about this move? Do you see Delta's CEO as a bold visionary or as a destroyer of value? Is this a reflection of the Street's failure to innovate practical financial products?
I mean, they've really got that airliner thing down so they might as well get into refining.....
it would be more efficient for Vitol to buy an airline
The one thing that surprises me here is that Delta bought a refinery but didn't buy the oil fields for it. We saw a lot of vertical integration in the first half of the 20th century and it created a lot of economic stability and helped improve supply chain management for the companies involved.
Previously, Delta's economic equation was:
(Delta's Capital) + Labor Costs + Oil Prices+ Refining Spreads= People fly where they want.
Now, it's taken the refining spreads out of the equation. It can take Oil Prices out too, if it buys a smaller but producing E&P firm and leave itself with an equation like the overall economy:
Capital + Labor = Consumer Goods/Services
I think a bit of vertical integration is good in a volatile market. It allows companies to avoid getting distracted by uncorrelated economic risk and things beyond their control and zero in on operational risk. I think there's also some skew to be offset between two negatively correlated businesses like airlines and energy.
Not sure if it's a good move but it's pretty fucking funny
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