Sunoco sold...

[seand]

I

I'm not saying it is going to break Delta. I am saying the "conventional wisdom" about acquiring vertical inputs doesn't pan out when there is an efficient market structure for the inputs (which there is).

Not so much in this case. Airlines work on hubs and 1/4 of the refining capacity gone where your hub happpens to be is going to affect the efficiency of that market for you, worse than some of your competitors at other hubs certainly. Its a small investment to guarantee that the market remains efficient in the exact region you are already committed to working in.

Thats the point. Refining is a big investment to set up. Its not an ideal market where transportation costs from one region to the other are neglible.

I get your point that giving yourelf wholesale doesn't make the supplier you just bought any more profitiable but refineries and pipelines are not something you can just pick up and move down the road. Switching suppliers is not that efficient as a result. Regional production plays a significant component on cost, especially for airlines when fuel is so much of operating expense.

[Bob_Head]

I've already addressed that point up thread. Correct, Delta can buy from their own refinery "at cost". The problem is, it is at the expense of the refinery selling the fuel to other people at markup. There is no net gain.

Again, airlines don't buy fuel on a traditional market, but a hedge market. When it works it works well. When it doesn't, the failure has a huge impact (just ask Soutwest). And you're looking at this deal far too simplistically. Delta Refinery Deal All About Southwest - Seeking Alpha

[seand]

Delta acquiring it as an investment as if it is acquiring a piece of real estate, sure, but it doesn't give it any strategic edge than if an independent refiner acquired it. Actually, the best part of the deal for Delta is likely that PA tax money is giving it a $30 million mark down.

No. Transportation costs are significant in this market. There was no independent bidder to run it for them. Having the abiliity to micro manage production schedules directly for 80% of your biggest operating expense means you are stronger than your competitors in the specific trans-Atlantic niche. Not the whole airline market, but its a real advantage in that niche.

[raider.adam]

I'll say that if the end result is that they buy it to keep the market stable and sell it off when they find a buyer, I will say that yes, that is a smart move. Again, I am merely saying that the premise most people are pushing, that they will make out because they are their own wholesaler, is likely not accurate.

[billy ross]

This deal is costing Delta $250m soup to nuts. They calculate it'll save them $300m per year. Last year they spent $11.8b for fuel, so maybe the $300m projected savings is reasonable. If so this is a slam dunk. Are you questioning their numbers? You seem to be. I think this is another case of your blind faith in markets and their supposed perfection. It reqires arbitragers to perfect markets. I personally tink this is a brilliant deal, if their Numbers are good. The way they figured out who gets and delivers what product is quite impressive. They're removing a lot of risk and a lot of transportation costs with this deal.

Actually, I don't think it makes much sense for Delta Airlines. In reality, how does it control their fluctuating cost of fuel? The only way they can do anything about the cost of fuel is if they lower the cost of refining. But even then, if they are able to make a "cheaper product" and use it exclusively for themselves instead of selling it, they are just trading profits on fuel for lowering costs for the airline.

Acquisition of vertical supply chains as a reason to benefit the end of the line business doesn't seem to work out unless there is a failed market in acquiring the items. Fuel has a very well functioning market delivery system.

[billy ross]

I used to buy 8,000 gallons of fuel oil, right about this time every year. They were giving the stuff away at the end of the season - $1.99 per gallon. Then I switched my heating and domestic hot water plants over to natural gas.

If you own the refinery, you presumably also have a lot of storage. You get a marginally better rate on the fuel but you can also budget against when summer driving gas consumption and also summer jet travel drive up retail fuel costs, you can compensate for short term global geo-political instability.

We are all focused on Sunoco as lost jobs but it also means that the whole mid-Atlantic is likely to see higher gas prices regionally because we still have a huge market and its much more expensive to bring in refined fuel a tanker truck at a time than crude a giant ship at a time.

For Delta, NY will always be a major trans-Atlantic hub and protecting themselves against an underserved regional number of refineries might be a good move.

To hear phillie aggie tell it, it will be years before regional refinery capacity is back up to force. If that delay coincides with a recovering economy i.e. spike in demand it could be a good move for Delta.

[billy ross]

What if Delta is in a joint venture with a company with a West Coast facility and Delta agrees to exchange byproducts from the East Coast facility for jet fuel from the West Coast facility? This deal makes sense if a delta steals the refinery and if it gets fuel delivered to it's door with no transport costs and no markups. All seem to be true here. Delta's already made it clear that it's return on the $250m will be in lower fuel expenses, not in cash flow from the refinery. This is strictly a cost-control measure.

But that is my point. You refine jet fuel at a cost of $5 a gallon. On the open market it sells for $6 a gallon.

Delta has two choices:

1) Buy the fuel from itself at $5 a gallon. It saves $1 on operating airline costs, but makes no profit on refinery.

2) Buy fuel on the open market for no operating cost gain, but makes $1 profit from the fuel sale.


Exactly the same monetary results. Delta doesn't gain any advantage.

[Bob_Head]

I think this is another case of your blind faith in markets and their supposed perfection.

My faith in the free market is like A.J. Liebling's faith in the free press. This is just Delta's attempt to own the market. I agree it's a brilliant idea. My only concern is that, with State money involved, if the idea works so well that they wind up selling to other airlines (a real possibility), Delta could reap a competitive advantage on the public dime.

[billy ross]

Yes, it can affect overall supply, but that still means it doesn't give Delta an edge since it will affect the same market that its competitors are purchasing in.

The simple point is, if it is looking to make money off a refinery investment, fine, but their position is that it helps Delta Airlines by having a source of jet fuel it owns. That doesn't hold up.

Same thing happened with DuPont. They got into a bidding war to purchase Conoco for a stable supply of petroleum products and some 15 years later spun it back off to concentrate on their core business because you can just buy your petroleum inputs on the open market. You don't need to own the company.

According to Adam, the guys who run Comcast are idiots for their single-minded pursuit of the ownership of content for very many years now. Clearly Adam feels that they should have just been happy to go the way of Kodak or Sun Oil and just been happy collecting their profits and paying their vendors for content that they would distribute, with not a care in the world about the changing dynamics of their market in which a train was barreling down the tracks about to blow their business model into kingdom come. Adam must have run the Pennsylvania Railroad in the late 50's, early 60's in a previous life.

Likewise, clearly Adam thinks those Chinese are morons for cornering the world market for oil and steel by buying up every available mine and oil field and oil company. Clearly their Communist business model is awful and the Chinese economy is failing stupendously, as Adam's theories would dictate.

[billy ross]

Again, you guys are saying what I am and not what Delta is. Delta is saying it helps them because they own the refinery. It doesn't. It helps them, and every other airline, that a refinery will be making jet fuel. Delta gets no benefit to its airlines whether it owns the refinery or someone independent does.


Yes, it could make sense because of diversification, but that means the money invested is no different than it being any other business they are investing in. No one would argue that Delta would be a more profitable airline if it bought a peanut farm.

Delta came up with a $300m annual fuel cost savings. As far as I know, that is relative to what they have spent over the past few years, now what they would spend were the refinery to remain closed. They actually expect their costs to go down. You're barking up the wrong tree, acting as if the deal is about preventing costs from going up.

[billy ross]

It helps Delta as an airline specifically in that a lot of their business is trans Atlantic through New York. Southwest for example flies different routes domestically and a big loss to East Coast jet fuel refining would not impact them as much but because of Delta's specific routes they have more to lose if that refinery goes away. So no this isn't a big breakthrough that all airlines will want to jump into refining, but that for airline's with Delta's specific focus in the airline market, this particular refinery makes sense.

If you believe (as Delta might) that their focus in terms of routes and hubs is strong strategically and they can buy 80% of their total fuel from a pipeline they own, it strengthens their particular strategy as an airline, but it would not be as good an investment for any other airline, no.

They're going to trade to get to 80% of their needs. They'll still need fuel in other parts of the US, and this plant will produce significantly more than jet fuel, even after it's optimized to produce jet fuel. They'll barter byproducts from this plant to get what they want. That's part of the deal, and that's why they're dealing with BP and Philips 66 on this deal. It's extremely clever on their part. I'm quite impressed that they saw how to make this work.

[raider.adam]

http://mobile.bloomberg.com/news/201...u-and-syverson

And the detailed paper:
http://home.uchicago.edu/syverson/viplantevidence.pdf

[raider.adam]

My faith in the free market is like A.J. Liebling's faith in the free press. This is just Delta's attempt to own the market. I agree it's a brilliant idea. My only concern is that, with State money involved, if the idea works so well that they wind up selling to other airlines (a real possibility), Delta could reap a competitive advantage on the public dime.

For the record, I don't see why we shouldn't have faith in market mechanisms for the buying and selling of goods. The invisible hand of market supply and demand has a hell of a lot better track record than Soviet Russia or Great Leap Forward China.

And really in this discussion, we are talking about "free market" ideology. We are discussing the efficiency of an open market in the buying and selling of goods. Market mechanisms in America and Europe are so well functioning that it is typically much better for people and businesses to specialize in something and trade their goods and services for someone else's as opposed to need to handle all aspects.

[eldondre]

My faith in the free market is like A.J. Liebling's faith in the free press. This is just Delta's attempt to own the market. I agree it's a brilliant idea. My only concern is that, with State money involved, if the idea works so well that they wind up selling to other airlines (a real possibility), Delta could reap a competitive advantage on the public dime.

there is no free market, particularly in a heavily regulated market like refining.
I like to think of this is one large hedge

..it says it can't do this cost-effectively, in part because so much refining capacity has closed down.

On this point, Delta has some justification. The Justice Department considers a market with a Herfindahl-Hirschman Index score above 2,500 to be "highly concentrated." In 2010, the East Coast refining market's score hit 3,255, against a nationwide one of 680, according to the Federal Trade Commission. If Pennsylvania's Trainer facility had stayed idle rather than be bought by Delta, the score would likely have surpassed 4,000, according to the American Antitrust Institute...Delta hopes to capture the wide profit margins refiners have taken at its expense in a classic example of vertical integration.

This is possible. But refining is deeply cyclical: Delta's own deal will alter the trend toward greater market concentration. The spread between Nymex crude oil and jet fuel was equivalent to 23% of the jet-fuel price in 2011, according to Roger King at CreditSights, meaning refiners were earning big margins. But that spread has been extremely volatile, ranging from a negative to more than 40% at various points over the past decade.

The East Coast jet-fuel market appears to have failed for now. But future changes in refinery ownership, logistical links or import volumes will likely address this. When they do, Delta will benefit from lower fuel costs. But its investment in Trainer and decision to take on the risks of running a refinery will look less advantageous.

HEARD ON THE STREET: Delta Fits Trainer Wheels for the Cycle - WSJ.com

[Bob_Head]

For the record, I don't see why we shouldn't have faith in market mechanisms for the buying and selling of goods. The invisible hand of market supply and demand has a hell of a lot better track record than Soviet Russia or Great Leap Forward China.

No doubt that markets work. It's more that they don't work as advertised. Yes, our market model is better than the Soviet Union's. But it's a mistake to assume a free market is always free and open, or that it always will be. Markets are manipulated all the time. Look at the recent surge in gas prices....supply did not change, and demand remained pretty much static. Yet the price went up, and then went back down. For the consumer the market forces, and supply and demand were totally irrelevant. The market is free to those who own the market.

Market mechanisms in America and Europe are so well functioning that it is typically much better for people and businesses to specialize in something and trade their goods and services for someone else's as opposed to need to handle all aspects.

Funny you mention this, because most of the successful oil companies are vertically integrated....they own the entire supply chain through the refining process. Which one didn't? Sunoco.

[seand]

Herfindahl-Hirschman Index score

I had never heard of a quantitative analysis for how anti-competitive/monopolistic a market is. Thats a handy thing to know. Thanks.

Also, its not like oil refining shouldn't be regulated or that regulation is the only issue. Its an incredibly large scale infrastructure-heavy endevour, there is no way to jump in on a small scale. It deals with carcinogens on a massive scale and very small variances with how effective it is at capturing sulfur released in the process have a huge impact on smog, acid rain, incidence of asthma and smog related public health (# of dangerous air quality days and senior deaths in the summer).

[raider.adam]

Who said anything about not regulating refining?

[seand]

there is no free market, particularly in a heavily regulated market like refining.

I'm just saying there are very sound reasons why its not easy to locate new refineries willy nilly in the densely populated mid-Atlantic. Like power plants, these a big infrastructure pieces where planning for community impact is a valid concern.

[eldondre]

Funny you mention this, because most of the successful oil companies are vertically integrated....they own the entire supply chain through the refining process. Which one didn't? Sunoco.

not anymore, they're specializing. the fact is business conditions change over time...and the market is full of companies speculating on the future, which is what delta is doing. markets generally work, can be manipulated, and aren't usually free. companies go back and forth on vertical integration, there really is no one right way of doing things but there definitely are wrong ways. what it comes down to is refining is a heavily regulated, high cost, low return business that the US is terrible at doing anymore for any number of reasons. why refine oil, build railroads, make stuff when you can flip houses, innovate financially and pay less taxes shuffling money than if it you own assets and make stuff with it. if you bother to go through the painful process of being in a capital intensive process, uncle sam wants to make sure you fail...if it's high taxes don't get you, they'll try to regulate you out of business. you don't even have to make money, if you even bother moving people as a transit agency they'll try to make enough assbackward rules you'll never be successful. if you're smart, you've bought off enough congressman so you can get contracts to rob taxpayers to stay in business.

On May 1, ConocoPhillips will become a pure exploration-and-production company, while its refining, midstream and chemicals segments will be part of a new company named Phillips 66. The move will mark the end of a three-year restructuring plan aimed at improving the company's finances and boosting shareholders' value.

http://online.wsj.com/article/SB1000...onoco+phillips

[phillyaggie]

haven't kept up with the full thread so perhaps i'll address other points later but for now, just wanted to address the above two posts:

a lot of this "restructuring" and mergers/spinoffs seem to be parlor room card tricks brought on by investment bankers who sell the "synergies" or "focus" to increasingly eager execs who are happy to let a perfectly fine long-term setup be tinkered with in order for quick short-term gains... the bankers make money on the transaction, the investors get a quick uptick in stock price and cash out... "everyone's" happy. The spinoff craze has been going on for a few years now.

ITT Corp split itself into three segments.

Tyco split into three; heck even the "new" Tyco is itself further splitting into 3 more splinters this fall... all the while TYC shares flying off the radar.

Cablevision split into three, getting rid of its AMC and other cable properties and also MSG... Cablevision is *not* better off for it, and will likely be a buyout bait to Time Warner or Comcast soon enough.

Fortune Brands split into three as well last year-- spinning off Jim Beam and also its golf brands.

These are just some high profile spinoffs. It's true in oil business, a bunch of companies are getting rid of their refineries in order to focus on high margin cash cow of exploration and production. But guess what? A saavy investor will buy refineries while they're cheap in order to make money off of them soon enough. That's what Valero did back in late 1990s when it became the largest refiner suddnely coming out of nowhere... people thought they were nuts, only to realize in a few years, Valero was minting a pretty penny on fat refining margins.

So these market shifts are temporary. The big players usually keep it all together. Shell, Exxon, Chevron, BP, Total haven't thought of selling off their refining assets, I don't think. Conoco is a junior to these bigs, and only got really bigger by paying a big premium a few years ago to gobble up gas-producer Global Santa Fe... at that time, gas prices were near $10/MMBTU. Now with the prices near $2/MMBTU, Conoco feels pressure of staying up with the Joneses when it comes to profitability, margins, and dividend payouts. That may be what's driving Conoco to get rid of its refining...

Sunoco's plans, in hindsight, should be been clear to everyone: sell off loss-making parts in order to put itself up for sale. Cablevision seems to have followed a similar strategy in getting rid of MSG (which, until Lin-sanity showed up, was an aging hulk of concrete losing a ton of money and needing expensive upgrades). And they spun off content in the age when "content is king" and someone like Comcast coughs up extra money to buy content. The point is that diametrically different strategies get employed by industry players, depending on end goals sought, and shouldn't be an object lesson in anything else.