April 5, 2012 / 2:57 PM / 5 years ago

COLUMN-A refinery: a terrible oil price hedge-Campbell

By Robert Campbell	
    NEW YORK, April 5 (Reuters) - Delta Air Lines is
reportedly considering a bid for ConocoPhillips' 
shuttered Trainer, Pennsylvania refinery. News perhaps more
suitable for April 1, but if true, an amazing, and baffling,
proposal.	
    A source familiar with the negotiations confirmed the talks
on Wednesday. Delta and Conoco both declined to
comment.	
    Leaving aside the thorny questions about Delta management's
ability to efficiently manage a business they've never before
been in and one that has cost previous owners tens of millions
of dollars in losses, the transaction itself seems wrong-headed.	
    For one thing an oil refinery, much like an airline, is
structurally short oil prices. Buying a refinery will actually
increase Delta's oil price exposure.	
    After all, a refinery has to go out into the market and buy
crude with the hope of recovering its costs and earning a profit
by passing the products on to its customers.	
    Not surprisingly a considerable amount of the business of an
oil refinery revolves around trying to control these risks. 	
    Delta already tries to cover its own oil price risk with
hedges. But once it has a refinery its hedging program will have
to get far more complex.	
    And here's the second problem with this proposal.
Unfortunately you cannot just put oil into a refinery and get
out the products you want. 	
    Delta might find itself to be able to make a fair bit of jet
fuel, and, indeed, would probably attempt to swing distillates
production away from diesel and into the jet pool.	
    But there is a limit to these efforts. A 185,000 barrels per
day refinery like Trainer necessarily produces far more gasoline
and diesel than it does jet.	
    So Delta will be stuck disposing of that unwanted fuel.

    WALL STREET REFINER	
    The funny thing here is that Delta will probably seek to
outsource both its crude oil sourcing and oil products sales as
other small refiners do.	
    The main players in this space are Wall Street firms and the
oil majors, the same companies that probably arrange Delta's
current, and presumably unsatisfactory, hedges.	
    But returning to the proposal it is even harder to see how
this might be a better hedge than its existing programs. Trainer
was shut down by ConocoPhillips because it couldn't compete with
other refineries.	
    In a brutally competitive industry plagued with overcapacity
--something, incidentally, airlines should know all about--
Atlantic basin refiners have little individual control over
margins.	
    With many of the plants that were supposedly to be shut down
this year actually getting a second lease on life, reviving
Trainer may well only result in tougher competition.	
    Indeed the entry of a big player into the market biased
towards jet fuel production will probably only result in
regional refiners cutting jet fuel production and directing
arbitrage shipments elsewhere.	
    So why not make it simpler? Why not just buy an upstream oil
producer? Probably because a company that produces as much oil
as Delta buys --reportedly 250,000 barrels per day-- is too
expensive. 	
    Many airlines have tried, and failed, to control their oil
price exposure by deepening their presence in the physical
market. Adding even more complexity to the hedge is unlikely to
result in any better results.

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