REFILE-RPT-Sell cheap fuel and profit - Delta Air Lines' refining 101

Thu May 23, 2013 10:35am EDT

* Delta's Trainer refinery could take 50,000 bpd of Bakken crude by end year

* Delta eyes chances to ship jet fuel to Midwest markets

By Matthew Robinson

NEW YORK, May 23 (Reuters) - Making money in the refining business is generally a pretty straightforward proposition: sell your fuel at the highest possible price relative to cost.

But Delta Air Lines, the first carrier to expand into the refining business, is trying to find its profits by driving down the price of fuel as much as it can. So far, the airline is seeing the first sign of success: the company's top officials point to the drop in the price of jet fuel in its New York hub.

And it expect costs will fall further as Delta ramps up supplies of cheap crude to the refinery from the Bakken play in North Dakota.

Controlling the company's $12 billion per year in jet fuel costs was the goal for Delta when it purchased the Trainer, Pennsylvania refinery in 2012, a move that jolted the rather static universe of U.S. refining participants and threw up questions marks from analysts covering several asset classes.

"We're not trying to compete over jet fuel, we're trying to drive down our margin improvement and drive our highest cost lower," Delta President Ed Bastian told Reuters in an interview, referring to the cost of jet fuel.

"We're the only operator of a refinery that wants to see gas prices come down."

BAKKEN RESCUE

One of the main costs Delta has focused on at the Trainer plant has been crude. Nearly half of the refining capacity on the East Coast was facing shutdown at the end of 2011, as well as plants in the Caribbean that supplied that market, due to the high cost of importing oil from West Africa and the North Sea.

Facing higher jet costs as its traditional suppliers dwindled, Delta bought Trainer from Phillips 66. It is now seeking to drive down costs by tapping into the cheap crude at the center of the U.S. oil boom. By the end of the year, Bastian said 50,000 barrels per day of oil from North Dakota's Bakken region could supply the 185,000 bpd plant at a substantial discount to internationally purchased oil.

Midwest and Gulf Coast refiners have enjoyed better margins over the past two years thanks to the Bakken, and other shale oil plays.

"This is going to continue to grow as we improve the logistics and distribution capabilities to get more Bakken into the refinery," said Bastian, adding cost savings could be in excess of $100 million per year.

In the medium term the plant could take up to half its crude from North Dakota, and potentially all of its feedstock in the longer term, Bastian said.

The realization that the Bakken crude, which had been helping Midwest refiners since production started to surge in 2010, did not come until after Delta had purchased the plant, according to CEO Richard Anderson. Since then, several East Coast plants have sought to bring in Bakken crude by rail to cut costs.

Delta had been looking at other ways of controlling fuel costs, bidding on a refinery on the block in Meraux, Louisiana and at one point even contemplated buying an oil company, before buying Trainer, Anderson said.

MAXIMUM JET

After restarting the refinery it had bought, Delta is set to maximize its yield of jet fuel. Output of the fuel is expected to produce about 40,000 bpd by the end of the year. Supplies on the East Coast appear to be growing, with inventories now at the highest level since October 2011, according to U.S. government data.

Having some say over the price of jet fuel in the region is particularly important for Delta, which has set out on an ambitious growth plan to increase its share of the New York City hub. Delta is the largest buyer of jet fuel in New York, as well as the country as a whole, making up 20 percent of all U.S. purchases, Anderson said.

The company took a $63 million loss from the refinery in the fourth quarter due to slower operations after Hurricane Sandy struck. Sandy's impact continued to be felt in January. But Bastian said earlier this year he expects the plant to turn a profit of $75 million to $100 million in the second quarter.

Anderson noted that since the Trainer plant restarted in September 2012, jet fuel's premium to traditionally lower priced fuels produced by refineries has inverted.

"Since we have really had our refinery up and running, we have brought the jet fuel premium well below low sulfur diesel," Anderson told Reuters, noting that the $150 million price tag was the cost of a Boeing 777.

According to Reuters data, at the start of 2012, physical jet fuel in the New York Harbor was trading at a $9 premium to ultra low sulfur diesel. In recent weeks, jet dropped to a $16.25 discount to diesel.

The company gets about 80 percent of its jet fuel needs either through the plant's production or by swapping out the gasoline and diesel it makes to BP and Phillips for jet fuel.

And while the stated aim of the airline's unusual vertical integration model is lower fuel costs for its planes, there are signs the company is thinking more like a refinery.

Anderson said the refinery, run by subsidiary Monroe Energy LLC, was exploring opportunities to ship some jet fuel to the Midwest to exploit higher prices there.

"There is a $10 crack spread opportunity," Anderson said referring to the profit the refiner could make, "The crack spread for jet is double what it is on the coast."

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