Canada

Delta Air Lines Bought an oil refinery. It didn’t go as planned.

Jet fuel is known as the steady eddy of the refinery business, a predictable profit-maker that balances the seasonal gyrations of gasoline and diesel sales. But for airlines, it is a headache — a big and unpredictable expense that confounds managers.

So Delta Air Lines tried a bold experiment: It bought an oil refinery in 2012 outside Philadelphia, the first such purchase by a major U.S. airline. When jet fuel prices were high, as they were then, Delta figured the refinery, which turns crude oil into the stuff that planes, cars and trucks burn, could offset some of its expenses and perhaps even make money.

“A lot of energy guys hate it, and I can understand why, because we’re taking money out of their pockets,” Ed Bastian, the airline’s current chief executive and then president, said at an industry conference in 2012.

But the refinery made only modest profits some years and lost money in others. This year, as the coronavirus hammered demand for air travel, it has become a liability for Delta, widely considered by analysts as one of the best-run airlines in the country.

The energy industry critics Bastian dismissed appear to have correctly identified the flaws in Delta’s strategy. Like airlines, oil refining is a cyclical enterprise that can be difficult in the best of times — refineries are expensive to run, prone to accidents, subject to environmental regulations and, yet, earn meagre profits.

Today, airlines and refineries face their biggest crises in modern times. Tens of millions of people are working from home and the number of people flying is down about 75 per cent from a year ago. Delta’s refinery, Monroe Energy, has been one of many casualties in an industry that is working well below capacity, idling plants and losing money.

Monroe, in Trainer, Pa., lost $114 million (U.S.) in the second quarter and its future appears bleak. In 2018, Delta announced it was interested in finding a partner to jointly own and operate it, but it never found any takers.

“The refinery may not even be a live albatross,” said Tom Kloza, global head of energy analysis at Oil Price Information Service. “We don’t see jet fuel becoming a marquee money-maker for refiners again until the middle of the decade, if then.”

The coronavirus cut off demand for all transportation fuels in April as the economy shut down. Consumption of gasoline and diesel has recovered somewhat, but American refiners have still had to cut their fuel production by roughly 15 per cent in recent weeks compared with last year.

Jet fuel has seen the most dramatic downturn by far, forcing refineries to slash output by nearly half, to an average of 1.1 million barrels a day for the four weeks ending July 24, compared with 1.9 million barrels a day for the same time period last year, according to the Energy Department.

Air travel recovered a little in May and June, but it stalled in July as infections surged across the country and states imposed new quarantine restrictions on visitors. International travel remains very limited. And until a vaccine is widely available, the industry recovery will be choppy at best.

Refinery executives have many long-term worries, like stricter fuel economy standards and the growth of electric vehicles. But the pandemic is their most immediate concern.

“It’s certainly not easy to see what’s coming,” said Karl Schmidt, vice-president of supply and marketing for Citgo, which has three refineries in Texas, Louisiana and Illinois. “It will be interesting to see how long it takes for people to regain comfort about getting on a plane if and when we have a vaccine.”

Marathon Petroleum, the nation’s biggest independent refiner, announced last month that it would shut down two refineries in California and New Mexico. Royal Dutch Shell is trying to sell at least four refineries. And at least three more refineries in Alaska, California and Texas are at serious risk, according to industry consultants. HollyFrontier, a Dallas-based company, plans to lay off 200 workers from an oil refinery in Cheyenne, Wyo., as it converts the plant to biodiesel production.

BP recently announced its intention to pare back refining by one-third as it shifts to renewables and other clean energy.

“Refineries are struggling right now because demand has collapsed and that has led to severe overcapacity,” said Rick Joswick, head of oil pricing, refining and trade flow analytics at S&P Global Platts.

While it is a relatively small percentage of total output, jet fuel is crucial for most refineries. While gasoline is profitable during the summer driving season and diesel is profitable in the fall and winter, jet fuel is a high-margin product year-round. When jet fuel production is down, refineries earn a lot less and operate inefficiently.

“It will be multiple years before jet fuel demand gets back to 2019 levels, probably five years,” said Kurt Barrow, a vice-president at IHS Markits, an energy consulting firm. “It’s a serious issue among other serious issues.”

Even before the virus spread, refinery profit margins were suffering.

U.S. refineries made good money in recent years exporting gasoline, diesel and jet fuel. But that trend may be coming to an end because Chinese, Indian, Nigerian and Saudi Arabian energy companies are ramping up exports.

In addition, demand for imported fuel in Latin America, a big market for many U.S. refiners, is declining sharply because of the pandemic.

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The situation is particularly dire for East Coast refineries like Monroe that tend to be less efficient than refiners along the Gulf Coast because they can only process certain grades of crude oil.

Such issues apparently did not factor into Delta’s thinking when the airline paid $150 million for the struggling Trainer refinery, which ConocoPhillips had idled six months earlier citing pressure from imports, weak demand and regulatory costs. The refinery, which started in 1912 as a wooden structure, has been rebuilt, shut down, restarted and expanded by a series of owners, including Sinclair, BP and Phillips Petroleum.

When Delta took over, global air travel was growing, refiners were exporting to Africa and Latin America, and a shale drilling boom was suddenly producing cheap domestic oil for refiners to process.

For roughly the list price of a wide-body aircraft at the time, Richard Anderson, then Delta’s chief executive officer, asserted that the refinery would reduce the company’s fuel expenses by $300 million annually, allowing it to more than recoup its investment in just a year. That math suggested other airlines would be foolish not to make similar purchases.

“Everybody was kind of content to watch what Delta did with it and if it made a whole lot of sense you might have seen others replicate it, but in this case that’s not what happened,” said Helane Becker, a managing director and senior airline analyst at Cowen, an investment bank.

While the refinery had some decent years, it never yielded the amount of jet fuel that the airline had originally hoped for relative to other fuels. Nevertheless, Delta has argued that the facility helps to blunt the effect of the volatile energy market and lowers jet fuel prices across the board by boosting supplies.

The refinery relied largely on crude shipped by rail from the Bakken Formation in North Dakota. But in late 2015, Congress lifted a decades-long ban on oil exports. That change encouraged companies to build pipelines that took Bakken crude more cheaply south for export or refining in Gulf Coast refineries.

Executives at Delta and its refinery declined requests for comment.

In a recent conference call, Paul Jacobson, the airline’s chief financial officer, said that the plant was operating “at break-even levels” after a steep April loss. In response to a question about whether the airline wanted to sell all or part of the refinery, he said nothing was out of the question.

“As with everything in the business, we’re looking at everything,” he said. “But our plans have not changed with respect to the refinery right now.”

As Delta’s demand for jet fuel has dropped, Monroe has switched to producing more diesel. But diesel inventories are growing in the Northeast, potentially limiting sales.

“It’s a refinery that could shut down if nobody wants to buy it,” said John Auers, executive vice-president of Turner Mason & Co., an energy consulting firm.

“I don’t think Delta is interested in running it longer term. It didn’t play out as they thought it would.”

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