Delta’s unique strategy: Owning a refinery to contain fuel costs
Managing fuel costs
Delta manages its fuel costs (about 33% of the company’s total operating expense) through purchase agreements, fuel hedging, and operating a refinery. While purchase agreements and fuel hedging are common industry practices to tackle fuel price volatility, vertical integration through ownership of a refinery is a strategy unique to Delta.
Delta’s subsidiary, Monroe (an oil refinery), acquired the Trainer refinery in 2012, primarily to contain fuel cost increases. The refinery produces both jet fuel and non-jet fuel (diesel, gasoline). The non-jet fuel products are exchanged for jet fuel with Phillips 66 and BP under multi-year agreements. In 1Q14, Delta produced 40,000 bpd (barrels per day) of jet fuel (half of the jet fuel produced in northeastern refineries).
Components of Delta’s fuel cost
Delta’s fuel cost components include:
- Fuel purchase costs (reduced from 3.23 in 2012 to 3.09 in 2013)
- A fuel hedging strategy (reaping the benefit of a $0.12 reduction in price per gallon of fuel in 2013 and $0.08 in 1Q14)
- Refinery segment impact: Trainer had yet to recover from losses. Delta expects the refinery operations to turn profitable only from 2Q14, as it expects to save $2 or $3 per barrel when it sources domestic crude from the Bakken region instead of Brent across the North Atlantic. The estimated crude production is 70,000 barrels per day in 2014 and it has the capacity to refine 1,85,000 barrels of crude oil per day.
Delta’s fuel cost per gallon is at a discount to the industry average
According to management, Delta has indirectly benefited from the refinery, as restarting operations in the refinery led to increases in fuel supply, resulting in reduced fuel prices in the area. Investing in the refinery and hedging activities is said to have resulted in $0.10-per-gallon-lower fuel prices compared to the industry average fuel price in 1Q14. (The data in the table sourced from BTS also reflects Delta’s fuel cost per gallon at a discount to the average cost for all U.S. carriers). With a fuel consumption of almost 3,828 million gallons per year (2013), this translates to a cost reduction of $382.8 million.
In 2013, despite a 2% increase in fuel consumption, Delta’s total fuel expense decreased by 6% and the cost per gallon of fuel reduced to $3.00 in 2013 from $3.25 in 2012. However, it’s clear that Delta has also exposed itself to refinery risks that come with fluctuating crude oil prices.
Delta’s (DAL) average fuel cost per gallon, at $3.00, was the lowest for 2013 compared to United’s (UAL) $3.13, American Airlines’ (AAL) $3.09, Southwest’s (LUV) $3.30, and Jet Blue’s (JBLU) $3.14.