Fuel costs are by far, the single biggest expense in any airline’s value chain. In 2012, Supply Chain Matters began a series of commentaries concerning Delta Airlines, specifically its bold supply chain vertical integration move in acquiring its own oil refinery to secure more cost-effective supplies of aviation fuel. At the time, Delta had reached an agreement with Conoco Phillips to purchase a previously idled Trainer Pennsylvania refinery for $150 million with plans to invest an additional $100 million to retrofit the refinery to optimize its ability to refine jet fuel, while securing additional distribution agreements for the gasoline and diesel fuels produced by the refinery. We committed to our readers to periodically update on the results of that bold strategy.
In January of this year we extracted information from Delta’s financial results for period ending in December 2013. At that time, Delta reported that operations at the Trainer refinery produced a $46 million loss for the December quarter and a $116 million loss for the full year. However, the refinery was forecasted to turn a “modest” profit in 2014.
This week, Delta reported its Q1 financial results. Delta was one of very few airlines that demonstrated record quarterly earnings despite the impact of severe winter weather on operations during the quarter. During January and February, Delta was forced to cancel 17,000 flights because of weather conditions, which resulted in $90 million in lost revenue and a $55 million impact on pretax income. Despite these setbacks, Delta was able to report $213 million in earnings, up from $7 million in the year earlier quarter.
Supply Chain Matters reviewed the earnings briefing transcript from Delta executives for any information regarding the refinery. Delta’s CFO noted in the briefing that in the March quarter, operations at the refinery produced a $41 million loss. Production was actually reduced during the quarter because one of the refinery’s crude units was shut down for scheduled modifications. These modifications were described as part of the planned initiative to increase the production of higher value distillates such as jet and diesel fuel. Those two products are expected to account for roughly 50 percent of the production output for the Trainer refinery going forward.
Delta further reported that average jet fuel costs in the quarter amounted to an average of $3.03 and included $107 million in fuel hedge gains, which helped to offset direct losses at the refinery. Delta is projecting a fuel price for the June quarter to be in the range of $2.97 to $3.02 per gallon including refinery benefits and an expected $100 million of hedge gains. To put some perspective on that number, Southwest Airlines has long been noted in the airline industry for conducting a savvy fuel hedging and fuel cost strategy. In its most recent quarter, Southwest indicated that its average fuel cost during the quarter was $3.08 per gallon, and active hedging contracts were in place.
Delta teams were also reported to be hard at work on another major initiative for the Trainer refinery relative to inbound domestic crude oil sourcing which accounted for 50,000 barrels per day of Trainer’s needs during the quarter. Delta expects this input sourcing to continue ramp up to a full year average of 70,000 barrels per day for 2014.
Approaching the two year mark since Delta’s bold supply chain vertical integration move, the airline appears to be managing its investment in a patient and methodical way. Planned investment costs for the refinery appear to be offset by active fuel hedging strategies and although the refinery continues to produce loses, Delta is demonstrating trajectory for a rather competitive or perhaps industry leading fuel cost advantage. The rest of 2014 will obviously add more perspective to the overall strategy.
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