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Delta Refinery - Should Delta Have Bought the Refinery to Get Control of Fuel Costs?

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Should Delta have bought the refinery to get control of fuel costs?

To answer this question, we shall use three conditions, outlined in the article Porter’s “From Competitive Advantage to Corporate Strategy” to determine whether Delta’s decision to acquire the refinery makes sense:

1 - The attractiveness test. In other words, what is the ROI. Per article, Delta estimates that buying the Trainer refinery would save US$100MM in fuel costs in 2012, assuming the infrastructure is in place by 3rd quarter 2012. So the expectation is Delta would save around about US$400MM or more per year, assuming US$100MM * 4 quarters. The article also said last year, Delta spent 12 bln last year, up from 3 bln the year before. Assuming that this year, they end up spending 15 bln on fuel, which equates to 40% of delta’s costs, the savings is between 2 % and 3 % (400MM / 15 Bln) of the total % Delta spends on fuel, which sounds like a really low ROI.  

2 - The cost-of entry test. The Cost of entry is 150MM+30MM+100MM+2.5bln = US$2.83bln to kick start.

Delta spent $12 bln on fuel last year, up from $9 bln the year before, and we shall assume this year the amount to be spent on fuel goes up by another $3 bln, to $15 bln.   40% of delta’s costs equates to $15 bln spent on fuel. So cost of entry at around $3 bln is approx another 20% of total % Delta spends on fuel. Relatively speaking, the cost is not substantial.

3 - The better off test. The fact that Delta entered a 3 year agreement with BP so the refinery produces gasoline, diesel and other petroleum products in exchange for jet fuel means that they would need to spend another unknown amount just to operate the refinery. Delta already spends 1/3 of the airline’s operating costs on fuel – this decision will cause the costs to shoot up substantially. Delta decided to leave the refinery project in the capable hands of executives with refining experience, but that is not enough to justify the decision. Per article, Delta never owned nor run a refinery. So there is simply no current infrastructure nor process in place to support such a business.  In addition, based on the recent turn of events of crude oil prices- Oil prices have dropped by 30% in the last several weeks to US$40 a barrel – external forces has already helped push oil prices down since we’ve produced too much oil globally, which defeats the purpose of Delta’s original refinery decision . My recommendation is that Delta sells the refinery to an oil company as soon as possible. If Delta cannot sell the refinery at a profit, they should shut it down.  

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