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Delta, Carlyle to Source Railed Bakken Crude

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Bypassing both Brent and WTI, Delta and other new owners of East Coast refineries may opt to use Bakken.

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MINYANVILLE ORIGINAL As Delta Air Lines (DAL) starts its Trainer refinery three months after its famed purchase of the then-idled 185,000 barrel-per-day (bbl/d) facility from Phillips 66 (PSX), it revealed last Thursday the possibility of jumping on the Bakken bandwagon in an attempt to source cheap crude oil from the North Dakotan shale formation.

Monroe Energy, Delta's subsidiary which acquired Trainer, currently obtains more expensive oil from Europe for the refinery – Brent crude settled on Friday at an $18.32 premium to West Texas Intermediate ("WTI") crude, which tends to trade at a price near that of Bakken crude. Both Bakken and WTI crudes are "landlocked"; as production continues to increase without corresponding growth in offtake capacity, the result is a supply glut and consequent price discount to Brent crude.

The nearby Philadelphia Girard Point refinery is currently owned by Philadelphia Energy Solutions, a joint venture of The Carlyle Group (CG) and Sunoco (SUN). In what is expected to be a paradigm of increasing reliance on domestic energy, it also plans to source Bakken crude in addition to Marcellus shale natural gas as inputs for operations.

During the Deutsche Bank Aviation and Transportation Conference last Thursday, Delta's president, Ed Bastian, provided an update on the company's third quarter financials and operations. The presentation included an announcement that its newly acquired Trainer refinery "is on track to begin jet fuel production by the end of September." Soon afterward, he mentioned that the company is "looking at options to be able to bring in Bakken crude from the Dakotas at net prices that would be equivalent to WTI or even lower," which would "lead to even larger savings."

If Delta's plan to utilize Bakken crude is ultimately carried out, it would effectively be placing a bet that the WTI / Brent spread (price difference between the two crude grades) will not converge in the near future.

Delving deeper into the company's financials, Bastian also explained that while non-fuel and crude oil costs rose 1% and 10%, respectively, over the past two years, costs related to the jet fuel crack spread (difference in price between jet fuel and crude oil) increased by 73% during the same time period. For this reason, Delta argued that purchasing the refinery was a sound investment decision, as it would provide significant savings in the way of stemming losses that were the result of directly obtaining expensive jet fuel for its fleet.



While the utilization of Bakken crude in the Trainer refinery certainly makes sense for now, there still lies the uncertainty of accurate estimates of recoverable oil within the North Dakotan shale formation. According to the state's Department of Mineral Resources, during June 2012, approximately 594,000 bbls/d were produced from the source rock, 85% greater than during the previous June. At the same time, the rate of production per well now stands at 144 barrels/day (bpd).

This figure has remained relatively steady since January, trending in a range of 139 to 144 bpd, in comparison to the 18 bbls/d level seen as recently as 2006. The stabilizing rate may imply that increasing production in the future will require significantly more investment than before-each additional barrel will be more expensive to remove from the ground than the one preceding it. In any case, diversifying Trainer's input mix between Bakken and European crudes will most probably facilitate an overall de-risking of its cost profile.

The Bakken shale revolution has not only had the direct effect of reducing unemployment as workers flock to North Dakota to satisfy companies' hunger for any and all types of labor, but also reverberations that extend to an impending boom within the generally quiet railroad industry.

On August 2, Tesoro (TSO) CEO Greg Goff announced that the company will increase capacity for a rail unloading facility at its Anacortes, WA refinery in order to reduce reliance on more expensive Alaska North Slope ("ANS") crude. Burlington Northern Santa Fe, a subsidiary of Berkshire Hathaway Inc. (BRK-A), announced last Tuesday that it has seen growth of Bakken crude shipments "from 1.3 million barrels in 2008 to 88.9 million in 2012," an almost 70-fold increase in only five years that demonstrates how rapidly railroad companies must boost capacity in order to attempt to keep up with oil production in the basin.

Despite the numerous criticisms and befuddled reactions Delta received while purchasing the Trainer refinery only a few months ago, perhaps its foresight will bring cost savings in excess of those originally predicted.

Still, the question remains, will we see more vertically integrating refinery purchases similar to Delta's as facilities that are perfectly placed to take advantage of both "rail-able" Bakken crude and nearby Marcellus shale natural gas provide significant potential for cost savings? Only time will tell, but the trend as of late suggests that whatever the answer (and whoever is elected President in November), the American energy renaissance is here to stay and thrive.

(See also: Why Are Private Equity Firms Buying Up Refineries on the East Coast?)
No positions in stocks mentioned.

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