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It is no secret that the biggest unknown for airlines’ operating costs comes from fuel prices. In an industry with profit margins of a meager 1.8 percent last year, as re- ported by IATA, a small change in fuel prices can have a huge impact on profitability.
In an attempt to control ticket prices, Southwest Airlines pioneered the use of fuel hedging be- tween 1999 and 2008 and saved billions, enough to reinvest into creating the US’s fourth largest airline.
Other companies now use the same practice, but Atlanta-based Delta Air Lines (DAL) took the idea one step further when it decided to go straight to the source. In April 2012, Delta announced on its website that its subsidiary Monroe Energy had acquired former Phil- lips 66’s (PSX-WI) Trainer refinery complex in Pennsylvania for $150m, after $30m tax credit.
The move was hailed as amazingly advantageous for the company for several reasons. First, Delta stood to reduce its fuel expense by $300m annually and ensured that it had a steady supply of jet fuel at the crown jewel of its international operation: JFK International Air- port.
Secondly, falling transportation costs for fuel and rising production in the Bakken fields of North Dakota and Marcellus Shale of Pennsylvania meant that Delta could possibly save even more in the future as it sources more fuel locally.
Finally, the operation was seen as a form of diversification for the company. Gasoline and other byproducts of fuel enjoy a steady revenue stream which should help shore up company profits during slower months, or even be used to reinvest in the airline’s infrastructure.
After getting off to a bumpy start with Hurricane Sandy and delaying the refinery’s opening by an entire quarter, the operation lost $63m. But Monroe Energy worked out its operational kinks in 2013, and, by the end of 2013, was producing 30,000bpd of jet fuel, a fraction of the plant’s total production capacity of 185,000bpd.
Last year the refinery was estimated to turn a profit of up to $100m in the second quarter. But new EPA standards for biofuel mixing may put an end to Delta’s dream of commanding its own fuel supply, or at least significantly re- duce the anticipated savings.
Due to environmental concerns, the federal government now mandates refiners incorporate up to 36 billion gallons of biofuel into their diesel and gasoline production by 2022.
The scheme was developed with diversified and vertically-integrated refining operations in mind, but will hurt companies that do not have the necessary means to blend their own oil.
Delta’s flaw is that its operation was intended to largely produce high octane jet fuels to realize a cost-savings for the company by offsetting purchases from other fi rms. This new legislation is not conducive to biofuel blending that is not yet acceptable fuel for most commercial aircrafts.
Furthermore, the refineries that lack blending capabilities must purchase credits to offset their lack of biofuel blending, further eating into Delta’s cost-savings.
Currently, Monroe Energy and several other firms are engaged in a lawsuit to fight the requirements. The verdict will not be seen for several months. Delta’s attempt to control the wildly fluctuating prices of jet fuel may very well backfire if it does not win the law- suit with the EPA, acquire blending infrastructure for the plant, or find a way to acquire cheap credits for their scheme.
The issue may seem of little importance to the average flier, but, with airfare on the rise and competition in the airline industry heating up, these policies may eventually be passed on to consumers in the form of higher and less predictable transportation prices.
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