The devil is in the details. That’s what I thought when I read that Delta (NYSE:DAL) may be hopping into bed with JPMorgan (NYSE:JPM).
According to various reports, Delta is in talks to purchase the idled “Trainer” refinery facility in Philadelphia with assistance from JPMorgan as its financier. On the surface, the deal seems to make perfect sense, as jet fuel is very expensive.
Delivering jet fuel to New York Harbor would have cost you $1.94 a gallon five years ago. Today it’s $3.12, or 60.82% higher according to Bloomberg. Owning a refinery would be a good way to lock up supplies and keep fuel costs down in today’s world.
It’s so smart I’d watch for United (NYSE:UAL), British Airlines and Lufthansa (PINK:DLAKY) to do the same in short order. Perhaps even the regional carriers will get in on the action at some point, too.
All are “route heavy” on the Eastern U.S. seaboard where many refineries have to pay for more expensive imported Brent crude because they can’t access less expensive West Texas blends or alternatives coming from North Dakota shale fields.
But what the frack?
Ordinarily, airlines would simply hedge price increases like this in the futures markets.
So there must be something else at work that would make Delta and presumably other carriers so desperate they’re willing to enter the refinery business. After all, it’s a tough business — even for oil companies.
Two thoughts come to mind specifically about Delta: a) its geographic concentration, and b) its credit rating, which stinks, and may be so bad the airline can’t cost effectively hedge in the open markets.
Few people realize this but several major oil companies, including Sunoco (NYSE:SUN), Hess (NYSE:HES), Valero (NYSE:VLO) and ConocoPhillips (NYSE:COP) — just to name a few — are planning to close, idle or otherwise shut down refineries on the east coast.
That would remove 51% of U.S. East Coast refinery capacity from the equation by some accounts.
This means that delivering fuel into the northeast corridor’s airports is going to become especially problematic and more expensive. In that sense, one could argue that Delta is taking prudent steps to secure its own supplies while building in defenses against higher prices ahead.
I can’t find fault with that given that every penny increase per gallon costs Delta $40 million more on an annualized basis, according to Bloomberg. I would be thinking along the same lines.
But I don’t “buy” it even though the airline spent $11.8 billion on fuel last year and understandably wants to save money.
Here’s where it gets interesting (and I get suspicious).
Dimes to Dollars: A Deal Delta Can’t Refuse
CNBC reported on Wednesday that none other than JPMorgan is reportedly going to finance the acquisition while reportedly also handling sales of other products the “Delta” refinery would produce, but which the airline would not use.
Geographic arguments aside, this seems to reinforce the notion that Delta’s credit rating is challenged enough that it may be having trouble obtaining the financing it needs to hedge using futures.
It could also suggest that Delta’s counter party risk is so high that other market participants are backing away and refusing to trade with the airline.
Counter party risk, also called default risk, is the risk a trading partner has to bear if the opposite side of the trade collapses and the other party is either unable to pay, deliver or otherwise meet the terms of a given trade, –in this case, fuel.
I’ll bet dimes to dollars, though, that JPMorgan (which has specific expertise in structured products) has got something up its sleeve in another part of the world that will help it to help Delta offset risks associated with uncertain fuel procurement costs. This is presumably why they’re involved – because they’re experts in obtaining otherwise tough financing.
If I’m correct, the terms of such a transaction are probably not too different in concept from the swaps Goldman Sachs (NYSE:GS) engineered for Greece in an effort to help that country appear like it was carrying less debt than it actually was.
Is Delta Being Set Up Like Greece?
If you recall, it was those Goldman-arranged swaps that let Greece borrow a billion euros without officially adding to its public debt. Of course, we also know that Goldman shorted Greek debt after it arranged the swaps, effectively driving Greece over the edge of the proverbial cliff by making cost-effective access to capital markets a near impossibility. And we all know how that ended….or rather, is supposedly ending.
If I were in Richard Anderson’s shoes (he’s Delta’s CEO), I’d be very nervous:
- At this point, it’s an open secret that big Wall Street houses can and frequently do trade actively against the interests of their clients.
- Fuel supplies are being restricted at a time when refineries are exiting the business. Airline stock prices have historically fallen when fuel costs rise.
- Short interest in Delta’s stock has dropped steadily from 13.8 million shares a year ago to just under 8 million shares as of March 30, 2012 according to Nasdaq.com – which is just the sort of pump priming I’d want to see as an institutional trader looking to “rip somebody’s face off.”
Not surprisingly, nobody’s talking. Delta and JPMorgan are both silent on the matter as of press time, as are the other airlines.
But stay tuned…this could get very interesting very quickly.
Oh…and hang on to your wallet.
I have a sneaking suspicion that flying anywhere on the East Coast could get a lot more expensive in the near future.