Interesting article today about a potential deal between Delta And JP Morgan’s Commodity team that may lead to Delta owning it’s own refinery as a way to help curb it’s fuel expense.

According to the Reuters article below, Delta may decide to spend $100-200 million dollars to purchase an idled ConocoPhillips refinery in Trainer, Pennsylvania. The deal would have JP Morgan actually manage the refinery and then sell the jet fuel exclusively to Delta at wholesale prices. JP Morgan would sell the non-jet fuel by-products in the open market and keep the proceeds for it’s own coffers.

This is certainly an interesting idea and in theory it should work (stress the “in theory” part). Large industrial complexes (airports, etc) usually have their own power generation stations, so why can’t an airline have its own gas pump? Delta may be on to something, but to play devil’s advocate, what happens to Delta’s return on investment should oil prices ever fall to levels we had 10-15 years ago? Refineries usually get shuttered when they don’t make sense to operate due low energy prices. However in this environment the thought of record low fuel prices seems like a ridiculous notion….

The Reuters Article:

NEW YORK (Reuters)-Delta Air Lines may partner with JP Morgan to help run the ConocoPhillips’ idled 185,000 barrel per day Trainer, Pa., refinery if the carrier decides to purchase the plant, CNBC reported on Wednesday, citing sources familiar with the matter.

Under the proposal, the No. 2 U.S. air carrier would purchase the refinery for $100 million to $200 million, and JP Morgan’s commodities team would finance the refining process, including purchasing and shipping crude from overseas, CNBC reported.

Delta, which has struggled with high fuel costs, would then buy the jet fuel from JP Morgan at a wholesale rate, and the bank would sell the other products made by the refinery into the market, the report said.

In addition, CNBC said, at least two oil companies have partnered with Delta in a swaps arrangement in which they would give the airline jet fuel in exchange for some of the other fuel produced by the refinery. The report did not identify which oil companies are involved in the swap deal.

A source familiar with negotiations told Reuters the deal had not been sealed and that the Trainer refinery had several other bidders besides Delta.

A JP Morgan spokeswoman contacted by Reuters declined to comment on the report. A Delta spokesman said the airline cannot comment on the CNBC story or rumors on the refinery.

“J.P. Morgan is most likely insisting that that if they are going to manage the crude, they are going to manage the product offtake as well,” one veteran oil products trader, who asked not to be named, told Reuters. “There is a lot of financial risk for the Trainer deal. This would be one way for JPM to keep tabs on what Delta is doing.”

Earlier this month, the board of Delta had met twice to discuss a potential bid in an unprecedented effort to hedge fuel costs for Delta, the world’s largest commercial buyer of jet fuel, a source familiar with the negotiations told Reuters.

Trainer is one of three refineries in the Philadelphia area which have been pushed to the brink of closure by the high cost of crude oil feedstock and waning fuel demand. The plant makes a higher percentage of jet fuel than any other refinery on the East Coast, accounting for a third of the jet-kerosene capacity for the region.

Delta spent $12 billion on jet fuel last year, with its average pricing rising by 31 percent to $3.06 a gallon. Last year, the company’s aircraft consumed 3.86 billion gallons or just over 250,000 barrels per day (bpd) of jet fuel.

While many airlines use derivatives or even long-term physical deals in an effort to control their future jet fuel costs, buying a whole refinery would mark an extraordinary step to ease the pain of rising prices.

Analysts have said Delta could struggle to make the refinery profitable after many integrated oil companies and independent refiners have incurred large losses in their downstream business as high crude costs have squeezed margins.

Tom Claugus, founder of GMT Capital Corp., a hedge fund in Atlanta that owns Delta Air Lines shares, said earlier this week that buying a refinery was a bad idea for the carrier.

“It’s good for management teams to think very broadly and look at all sorts of different options, but my own view would be that owning a refinery borders on the bizarre,” he said. “It would be a significant error.”