Refining and the Airline October 23, 2012 Contents “Delta 101” Why Trainer and why now? Market reaction Delta holds a long heritage as the world’s leading airline Delta is the world's largest airline by passenger miles 5th oldest airline founded in 1928 (Delta’s legacy includes the former Northwest, Pan Am, Republic, Western, Northeastern, and Hughes AirWest airlines) Founding member of the SkyTeam Alliance, Joint-Venture partner with AirFrance/KLM and Alitalia and partial owner of AeroMexico and GOL of Brazil Fortune Magazine’s 2011 World’s Most Admired Airline $35 billion in annual revenue 160 million customers annually served through 340 destinations $44 billion in assets More than 700 mainlines aircraft plus 700 regional jets 80,000 employees plus ~100,000 contractors Hubs located in Atlanta, New York’s JFK and LaGuardia, Detroit, Minneapolis, Cincinnati, Memphis, Salt Lake City, Los Angeles, and overseas in Tokyo, Amsterdam, and Paris 2 Operational focus is critical to run Delta’s complex business Operations 1,400 airplanes moving 500,000 passengers per day Zero fault tolerance environment for equipment (12-sigma equivalence in quality) while still providing >99.8% equipment availability Largest carrier in the world has gone 24 years without a major aviation incident (roughly 40 million flights) Manufacturing Delta TechOps has 10,000 employees rebuilding airplanes and engines Delta performs its own maintenance plus it serves 150 other carriers making it the third largest MRO business in the world 3 million square feet of manufacturing space in Atlanta plus facilities in Minneapolis and Mexico Real Estate $3 billion in spending on current projects In-house management of major construction projects such as the JFK Terminal 4 complex, LAX and La Guardia expansions >30 million square feet of commercial space is managed by Delta 3 Delta developed an internal oil company long before Trainer Fuel value chain for Delta Refining Point where airlines traditionally have engaged in the value chain Logistics Terminalling Delta has been one Delta controls of the largest several hundred shippers on the thousand barrels Colonial, Plantation, of storage Buckeye, and Teppco outside of its pipeline systems airports to moving upwards of facilitate its self175,000 bpd supply function On-site Facilities Fuel Loading Delta owns, leases, co- Several thousand owns, and/or oversees fuel loadings per 26 on-airport fuel day – each facilities with their requiring a associated fuel tanks, specialized filtration equipment, technician, a load distribution pipelines, planner, and 30-90 hydrants, and fuel carts minutes to execute If Delta’s fuel function (ex-Trainer) were to be a separate company, it would constitute the following: Approximately 1,100 employees and contractors More than $1bn in fixed assets Roughly $500mn in working capital Annual revenue of $12bn Delta is the world’s largest private consumer of fuel 261 248 Airlines UAL/CO 114 Southwest Air Tran 77 27 FEDEX 138 Air & ground BNSF Railroad Denmark Portugal Would be in the world’s top 50 as a standalone country 184 American US Air Other (all consumption) Daily Fuel Consumption (000s bpd of all fuels) Delta 110 167 276 Contents “Delta 101” Why Trainer and why now? Market reaction Delta’s exposure to fuel price is not a simple crude short… Risk Type Root Causes of volatility Natural Hedge for Delta $/bbl Crude oil price risk 130 120 110 100 90 80 70 Economic growth combined with higher production costs Brent Economic growth 25 Refining Margin Risk 20 Supply shocks Heat Crack 15 Price levels can be passed through to customers Delta’s loss Some price risk can be passed through Supply constraints 10 5 Supply shocks and weather events All risk borne by Delta 8 Jet Fuel Specific Risk 6 4 2 0 -2 Jet versus Heat Regional market variations All risk borne by Delta …the jet crack is the fastest growing element of fuel expense… Fuel Expense Transport Pipeline & barge $430mn Taxes Fuel excise taxes $240mn Product Markup Represents the profit margin and marketing spread that a refiner and reseller/trader gain from jet sales, which are typically the most profitable sales at the refinery $2.2bn Refining Cost Operating cost $590mn Crude Oil Purchase cost of the average source feedstock for jet fuel (all crude contains jet fuel, some contain more than others) $8.5bn Total 100% 2.1% 3.6% 18.5% Jet crack spread tripled since 2009 5% 71% $12bn 8 …driven by dieselization and slowing demand for gasoline Gasoline Diesel & Jet Daily transportation fuel consumption in 000s bpd United States European Union 10,000 8,000 9,000 7,000 China 4,000 +13% 3,500 3,000 8,000 6,000 2,500 7,000 +125% 5,000 2,000 6,000 4,000 5,000 2000 3,000 2005 2010 2000 -21% 2005 2010 1,500 1,000 2000 2005 European fuel switching from gasoline to diesel and voracious BRIC demand for middle distillates are driving the global imbalance between gasoline and diesel Source: BP Statistical Yearbook 2010 Criteria for purchasing a refinery Beliefs about the market The jet-crack will remain high for several years Refinery capacity shut-ins will drive margin volatility and regional shortages Properly sized – large enough to make a material impact on the company’s profitability but not larger than Delta’s consumption Criteria for the refinery A Relevant to the company’s demand centers (domestic, USGC or USEC based) B Flexible refining kit able to maximize jet production with minimal investment Well-maintained plant that had not suffered from under-investment Actionable within a year Criteria for the deal C Viable as a stand-alone business D Provide a mechanism for non-jet product disposition The Trainer deal 199,000 bpd refinery located in Trainer, Pennsylvania (Philadelphia) Asset Pipeline system and 3 oil terminals included in sale Solomon Complexity Index of 9.6 with a replacement value of $2.7 billion Price of $180 million ex-hydrocarbon inventory (6% of replacement value) Terms $30 million grant from the Commonwealth of Pennsylvania $100 million in turnaround and small capital expense for max-jet mode A Trainer is able to supply most of Delta’s northeastern fuel demand Trainer jet flows to local market Production and consumption in kbd Upstate NY LGA Buckeye Production Twin Oaks JFK EWR PHL Harbor Pipeline JFK & LGA Other Delta Consump. Trainer PIT Laurel Pipeline Monroe Pipelines Waterborne exports Swing & export 52 B The flexible refining kit at Trainer is capable of full conversion… 2-Stage Hydrocracker – 26,000 bpd Hydrotreating Units Distillate VGO HT DHT Kero HT Gasoline NHT Post-Cat NHT Reformer – 60,000 bpd Resid Fluid Catalytic Cracker – 55,000 bpd B …and a jet-optimized product yield at minimal expense Refinery Operation from 2007-2011 19% Diesel 14% Jet Pricing Monroe Planned Refinery Operation Middle distillates 18% Diesel = 50% of total margin risk 32% Jet Gasoline = 44% of total margin risk 52% Gasoline 15% Fuel Oil, LPG 44% Gasoline Byproduct = 7% of risk 7% Fuel Oil, LPG, Other C Trainer would be viable as a stand-alone business Trainer performance backcasted with Monroe’s operating plan $ million per quarter 300 275 250 225 200 Average EBIT = $551 MM/year 175 150 Average EBIT = $345 MM/year 125 100 75 50 25 0 -25 -50 Q1 2006 Q1 2007 Q1 2008 Q1 2009 Q1 2010 Q1 2011 $300 million per year in earnings appears, at first glance, to be too high for a $250 million investment, however, the returns are appropriate for a business that if newly built would cost $2.7 billion and consume an additional $500 million in working capital for a pre-tax asset return of 9% D Exchanges with P66 and BP dispose of all non-jet production while simultaneously fueling Delta’s self-supply network Delta also carries a significant tax advantage versus other refiners Effective Tax rate 2010 41% 38% Post-tax earnings benefit of $120 million per year versus ExxonMobil’s domestic tax rate at Monroe’s forecast earnings run rate 29% 2% ExxonMobil Valero Frontier Delta Monroe has a seasoned management team Years Energy Experience Team Member Background / Prior Companies Jeff Warmann CEO • • All aspects of refinery, process and trading operations Murphy Oil, Frontier Refining, Western, Williams 28 Frank Pici CFAO • • 15 years as public co. CFO in refining, upstream, MLP CVR Energy, Penn Virginia, Mariner Energy, Cabot O&G 30 Coby Stewart VP / Maintenance Lead • • Construction, maintenance, turnaround experience Frontier Refining, Chicago B&I, Flour Corp. 33 Rodney Smith VP / Controller • • Senior accounting and financial professional Delek, Western Refining, Holly Corp 20 Brian Carlson Operations Leader • • Process engineering, economics, technical background Frontier Refining, Citgo Petroleum 11 Rick Chavez Technical Leader • • Economics & Planning, M&A, project development Stancil, Williams, Lyondell, El Paso, Amerada Hess 27 Pete Pirog VP MIPC Pipeline • • Pipeline construction, scheduling , storage logistics ConocoPhillips, Buckeye Pipeline 15 Liz Lundmark Environmental Leader • • Deep environmental compliance & logistic experience Murphy Oil 22 Keenan Kendrick H&S Leader • • Process Safety Management, Change Management Western Refining, ChevronTexaco Downstream 11 18 Contents “Delta 101” Why Trainer and why now? Market reaction Market reaction Refining market “pundits” Equity Analysts If Delta thinks they will be able to lower fuel volatility, they are sadly mistaken – Phil Flynn It goes beyond Delta’s core competency – Stephen Schork It is worth a shot, the refinery is only about the cost of a single new widebody jet – Ray Neidl Business Press Trainer attracts a lot of haters of Delta’s stock – CNBC It could be brilliant or a disaster, only time will tell – CNN Money Debt Analysts Trainer is an innovative approach to the long-term management of the airline's jet fuel costs, notwithstanding the operational risks of running a refinery – Fitch Other airlines Airlines, after all, know a thing or two about managing high risk, logistics intensive, industries – Janet McGurty, Reuters Delta would get into the refinery business only because they are stupid – Ed Hirs, U. of Houston in Forbes If it works for Delta, it can work for us – and is completely reproducible – Jeff Smisek, CEO of UAL Shocking revelation… this has been done before! 1955: Malcolm McLean creates the Sea-Land shipping company to focus on containerized shipping, the company grows rapidly 1969: RJR purchases SeaLand Corp. for $530 million 1948: Aminoil (American Independent Oil Company) wins a concession to develop oil in Kuwait 1958: Aminoil builds the Mina Abdullah Refinery 1968: Aminoil expands Mina to 145,000 bpd, yields 50% bunker fuel (company nears bankruptcy) 1970: RJR purchases 100% of Aminoil for $40 million to hedge its Sea-Land’s fuel expense 1974: Earnings for Sea-Land reach $145 million; Aminoil earns $86 million 1984: RJR spins off Sea-Land (later merged to form CSX) During 14-years of vertical integration both Sea-Land and Aminoil had record years of profitability 1984: RJR sells Aminoil to Phillips 66 for $1.7 billion Questions?