Delta’s refinery foray a challenge so far

It seemed to Delta Air Lines like a brilliant solution to combat rising jet fuel prices — buy an oil refinery.

But nearly a year after announcing the deal, getting the mothballed refinery fully operational and profitable has turned out to be more difficult than Delta ever expected.

The idea of expanding into a new frontier can tempt companies with the allure of big opportunities for innovative expansion or cost savings. But branching out into a new line of business can also bring unknown risks, unwelcome surprises and big challenges.

It’s still early in Delta’s efforts, and the refinery may yet pay off. But Delta’s struggles so far demonstrate the challenges companies face when delving into areas where they have little expertise. Local behemoths from Coke to Home Depot have also wrestled with attempts at branching out into new territory in the past.

Ed Bastian, president of the Atlanta-based airline, admitted last week the company has experienced “teething pains” in the start-up.

“Running an oil refinery, much like running an airline, is not for the faint of heart,” Bastian said at a presentation to investors in New York.

The refinery was expected to save Delta money on jet fuel and be profitable in its first quarter of operations at the end of 2012, but it instead lost $63 million that quarter and is expected to break even this quarter. Hopes are now pinned on making a profit next quarter.

“Like anything that’s big and new and different, it has taken us a little bit longer to turn on than we thought,” Bastian said.

It was almost a year ago that Delta announced the deal to create a subsidiary called Monroe Energy to acquire the mothballed refinery in Trainer, Pa. It was one of the surprising, potentially precedent-setting efforts by Delta and its audacious management team led by CEO Richard Anderson. It was applauded by some industry analysts as a smart move. Monroe started up operations of the Trainer refinery last September.

But then Superstorm Sandy hit in late October. Though the refinery itself was not damaged, the company said the storm damaged regional pipelines and terminals, reducing its ability to distribute the products.

Bastian told investors that subsequent delays kept Delta from getting the plant up to full operations until now. With the plant running at only 75 percent capacity for most of the quarter, Bastian called the new expectation to break even "very meaningful."

Aside from the effects from the storm, Delta has also had trouble getting enough crude oil from the Bakken oil field in North Dakota, which is lower cost oil than the crude from Africa that traditionally supplied the refinery. Delta hired experienced refinery managers to run the operation, but “even if you have the best people, they’re going to face difficulties in these sorts of challenging circumstances,” said University of Houston energy economist Ed Hirs.

“If Phillips 66 had thought they could make money with that refinery, they would have kept it,” he said.

Some companies have made similar ventures into the unknown.

Coca-Cola in the past owned Columbia Pictures and a wine business, before selling those businesses off.

“They realized this doesn’t make any sense. There are other people who run the movie business better,” said William C. Bogner, an associate professor of managerial sciences at Georgia State University. And with the wine business, “the skill in actually producing the products, marketing the products — they’re completely different.”

Now, Coke focuses specifically on “non-alcoholic ready-to-drink beverages” — even as competitor PepsiCo owns a diversified portfolio of businesses including Quaker Oats and Frito Lay.

University of Houston professor of finance and economist Craig Pirrong noted specialization has its advantages. “You can’t be good at everything,” he said.

Do-it-yourself specialist Home Depot has tried other ventures like more upscale Expo home design stores, before closing them in 2009.

Yet many other ventures are successful and now part of the fabric of companies — such as personal computer maker Apple’s launch of iPods and iPhones or Disney Cruise Line.

In a presentation last April aimed at allaying doubts about the refinery deal as it was announced, Delta said it would not only turn a profit on the refinery in 2012 but also pay back its $250 investment in less than a year.

With partnerships to supply crude oil and market refined products and other measures, “We’ve covered all of these risks,” CEO Anderson said at the time.

The initial losses now make it much more difficult to reach the payback goal in the first year. Bastian projected a second quarter refinery profit of $75 million to $100 million.

“Typically, an airline has no clue what is involved in an oil refinery operation,” said Columbia Business School professor of management Awi Federgruen.

And the refinery industry today faces serious logistical challenges, Pirrong said. “So given all that, it’s not really surprising that the profit always seems to be just around the corner.

“This will be an interesting case study to see how Delta handles this,” he said.

The idea Delta has in mind is reducing the mark-up it pays on jet fuel.

But, “unless you have some special capabilities that the other people don’t have, there’s no reason to think you would be better at running the refinery than other people,” said University of Connecticut economist Richard Langlois. “And if you don’t have any experience running a refinery, you could be worse at it.”

What’s more, Delta was not acquiring an existing operation that was running smoothly.

“When we’re frustrated with a problem like high fuel prices, we can sometimes talk ourselves into thinking we’ve got a solution, even when there are a lot more uncertainties and risks to the solution than we’d like to admit,” Bogner said. In business management, “you have very confident, very successful people who got to the top because they worked their way through problems successfully and they say, ‘Yeah, we’ll be able to do that.’”

About the Author

ajc.com

Editors' Picks