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Delta Acquires Conoco Oil Refinery

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The second largest U.S. airline Delta Air Lines Inc. (DAL) has become the first carrier to enter into the fuel business with its purchase of Trainer refinery in suburban Philadelphia from Phillips 66 (PSX), the downstream business spin-off of ConocoPhillips (COP). The deal was announced at the end of April.

This strategic move will help Delta to reduce fuel costs by $300 million per year and ensure availability of jet fuel in the Northeast, which is currently experiencing a shortfall in fuel supplies. The facility can currently refine about 185,000 barrels per day. Delta intends to spend $100 million to upgrade the facility that would, in turn, boost jet fuel production of about 52,000 barrels per day. The transaction would further provide about 80% of the company’s domestic jet fuel needs.

The Trainer refinery was shut down last year as it was struggling to generate profitable business given rising crude prices, which were weighing on its margins. Delta expects to restart the production in September.

Delta spent an average of $2.86 per gallon for jet fuel prices last year, up 37% from $2.09 in 2007, according to statistics from the Bureau of Transportation. Based on this data, the company’s fuel expenses accounted for 36% of total operating expenses last year.

Besides, Delta Air Lines is making continued efforts to reduce its fuel costs through fare hikes, hedging strategies and capacity cuts. The company is successfully passing the increased fuel costs to customers in the form of fare hikes. Delta is planning cautiously on capacity cuts, which is expected to be down 1–3% year over year in the second quarter, with a 1–3% reduction in both domestic and international capacity. However, Pacific capacity is expected to grow 7–9% on the resumption of Detroit-Narita flights and the normalization of capacity for Japan.

Additionally, Delta Air Lines is involved in fuel hedging strategies, which provide a cushion to the rising fuel prices. Delta Air Lines is 70% hedged for the second quarter at a jet fuel price of $3.05–$3.40 per gallon and 40% hedged for the third quarter at a jet fuel price between $3.05 and $3.45 per gallon using collars and call spreads.

We are currently maintaining our long-term Neutral recommendation on Delta Air Lines. For the short term, the stock retains a Zacks #3 (Hold) Rank.

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