Delta Adds Oil Refinery to Cut Cost - Analyst Blog

Zacks Investment Research
Posted: May 02, 2012 2:40 PM
Delta Adds Oil Refinery to Cut Cost - Analyst Blog

The second largest U.S. airline Delta Air Lines Inc. (DAL) will buy an oil refinery in Pennsylvania from Phillips 66 (PSX), the downstream business spin-off of ConocoPhillips (COP), for $150 million.

The company made a strategic move to cut fuel costs in the backdrop of surging fuel prices and lingering economic concerns. Delta spent an average of $2.86 per gallon for jet fuel prices last year, up 37% from $2.09 in 2007, according to statistics from the Bureau of Transportation. Based on this data, the company’s fuel expenses accounted for 36% of total operating expenses last year.

Though Delta is making continued efforts to reduce its fuel costs through fare hikes, hedging strategies and capacity cuts, the purchase of the oil refinery business will save $300 million of fuel costs annually and ensure the availability of jet fuel in the Northeast.

The Pennsylvania facility can currently refine about 185,000 barrels per day. Delta intends to spend $100 million to upgrade the facility that would boost jet fuel production of about 52,000 barrels per day.

Additionally, Delta inked a three-year contract with BP plc. (BP) to supply crude oil to the refinery. The company will exchange gasoline, diesel and other petroleum products for more jet fuel from other sources like BP and Phillips 66.

As a result, the transaction, which is expected to close by the third quarter, would provide about 80% of domestic jet fuel needs to the company. With the completion of the transaction, Delta will be the first carrier to buy an oil refinery business.

Coming to oil refineries companies, many of them are struggling to generate profitable business given rising crude prices, which are weighing on their margins. As a result, selling or closing refineries have become a trend in the U.S. to boost profitability and improve margins. ConocoPhillips is one of them. Last September, Conoco announced plans to either close down or sell its Pennsylvania based refinery business.

Last year, one of the biggest oil refining companies in the U.S., Sunoco Inc. (SUN), also disclosed its plans to shut down its refineries in Marcus Hook and South Philadelphia should it fail to find buyers by July this year.

We are currently maintaining our long-term Neutral recommendation on Delta Air Lines. For the short term, the stock retains a Zacks #3 (Hold) Rank.

BP PLC (BP): Free Stock Analysis Report
CONOCOPHILLIPS (COP): Free Stock Analysis Report
DELTA AIR LINES (DAL): Free Stock Analysis Report
SUNOCO INC (SUN): Free Stock Analysis Report
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