Delta Airlines and the March of Folly

"Beauty, supported by Prudence, Scorns the Offering of Folly", by Angelica Kauffman - 1780 (neoclassic allegorical painting, now on exhibition at the Kadriorg Palace, Art Museum of Estonia, Tallinn, Estonia)

Corporations are not unknown for making dumb decisions and stupid moves.

Some are patently obvious on their face, like the Netflix/Qwikster fiasco, some are revealed as idiotic only in retrospect (such as Decca Records deciding NOT to sign up the Beatles).  Still other boneheaded moves just leave some of the outside watchers shaking their head, softly muttering under their breath, “They’ll be soooorry”.

I must have been living under a rock since last April 30th, when Delta Airlines broke the news that they had purchased from Philips 66  its currently idled refinery in Trainer, Pennsylvania, for the sum total of $180 million.  In the press, Delta executives droned on at length about synergies, saving of $300 million a year, market opportunities, strategic visionzzzzz….

For their part, the executive team at ConocoPhillips discreetly refrained from excessive comments, restricting the hysterical laughter, high fives and champagne-popping to the confines of wood-paneled boardrooms.

On news of the acquisition, Delta stock shares gained nicely, because you know, the market’s all efficient like that.

Why Oh Why?

*not that kind of crack spread

The purported goal of this acquisition for Delta is to reduce exposure to the Crack Spread.  The crack spread* is is simply the difference between the market price of a barrel of crude oil, and the total revenue from the mix of refined petroleum products derived from said barrel.  These products could be jet fuel, diesel, gasoline, naphta, and lubricants, to name a few.

Delta’s CEO Richard Anderson calls the pig-in-a-poke moneypit sinkhole refinery a relatively “modest” investment, comparable to buying a new Boeing 777 (except that airlines don’t buy their aircraft, they lease them).  $180 million for a corporation with a $9 -billion-and-change market capitalization is probably that, small by comparison.

Granted, they’ll have to inject an  wildly optimistic underestimated estimated $100 million or so to re-tool the plant to make more jet fuel, but they’ve got a plan.

Sure.  Refining is a crappy, capital-intensive business (so are airlines).  It is especially difficult in the Northeast, where refiners have been bleeding arterial red for quite some time.

Access to quality feedstock is limited, forcing refiners to either be vertically integrated with exploration and production (such as Hess), or shed refining assets to survive, like Sunoco.

Philadelphia-based Sunoco sold out their Tulsa lubricants refinery last year to HollyFrontier.  Refiners in the Northeast have been bleeding arterial red for quite some time.  To hear Sunoco tell it:

And with Philadelphia-based Sunoco set to close the largest refinery in the region in July, expect gas prices to keep going higher. “Our Northeast refining business has lost nearly a billion dollars in the past three years, and those losses have threatened Sunoco’s very existence as a company,” said a Sunoco spokesman. (source)

There’s a damn reason ConocoPhillips idled the Trainer plant. It simply wasn’t making any money.

But never fear, Delta shareholders, an airline sure knows how to run a refinery on the East Coast.  Next stop in the vertical integration merry-go-round, Delta plans to resurrect the McDonnell-Douglas brand and make their own aircraft.

The March of Folly

In her classic book “The March of Folly”, historian Barbara Tuchman goes on at length about four periods in history where actors and institutions persevered on courses of action which ultimately led to ruin.

The Trojan Horse, the Protestant secession, the American Revolution, and the U.S. war in Vietnam. In each of those cases, even though the present course of action might have been recognized as profoundly counter-productive, the decision-makers or institutions just kept at it.

The Catholic Popes kept on issuing Indulgences and partying it up, never mind that Martin Luther was working up a hissy fit of reform and righteousness.

King George kept on blithely proclaiming new and nifty taxes, and went on his way erecting a multitude of New Offices, sending hither swarms of Officers to harass the people, and eat out their substance.

Trojan Horse? Self-explanatory.  Vietnam?  Let’s not go there.

Who knows how this turd of an idea got squeezed out at Delta Airlines.  Perhaps the CEO woke up at two in the morning with a mental light bulb flashing.  Perhaps the greasy advisory team at JP Morgan (who will be handling the commodities transations — for a fat fee, of course) really turned on the charm at the golf course. What’s for almost certain is that Delta will stay on course to lose operational money from this decision, and will keep on doing it for quite some time before crying “Uncle!”

Unknown who the naysayers at Delta were or if dissenting voices against this folly were raised. I’d wager not.  Junior executives and yes-men do just that, keep mum and keep their job.  No personal profit in speaking out.  Are you going to tell the CEO that this whole refinery deal is batshit crazy?  Yeah, you go right ahead Sparky, no skin off my nose, I like my corner office, leather chair and expense account.

In general, were there dissenting voices heard? Sure.  Knowledgeable oil industry analysts were consistent in their head-scratching.  And not just oil industry insiders, in obscure journals and publications. This from mainstream Bloomberg columnist Virginia Postrel:

The proposed purchase “doesn’t make a huge amount of economic sense — in fact quite the opposite,” says Craig Pirrong, a finance professor and director of the Global Energy Management Institute at the University of Houston’s Bauer College of Business.  Pirrong notes, crude oil prices affect the profits of airlines and oil refineries exactly the same way. When oil prices go up, their profits go down. Owning a refinery would simply magnify the effect. “If anything,” he says, “it increases the risk exposure that has bedeviled the airline industry for years.”

Ms. Postrel’s column ran on April 19th.

So in Conclusion… What?

In the spirit of disclosure, I hold a few ConocoPhillips shares, purchased before the spin-off of the Phillips 66 refining operations.  The few shares of PSX were disposed of, and the balance re-invested in COP.  Will likely not be purchasing any Delta shares.  In fact, online payday loans might be a better risk (just an opinion).

About the only exposure to Delta is the 190,000 miles in the 101C SkyMiles account balance. Now with rumors swirling that Delta might devalue its miles (again), cashing them in for awards or tickets might happen sooner rather than later.

And lastly, readers would be well advised to stay away from any investments having to do with airlines. This whole refinery thing for Delta will likely be the equivalent of skateboard dude trying the ride the rail, and ending up nutting himself. Temporary pain, but he’ll survive.

Delta will survive. But running an airline is still a crappy business.

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