Colonial Pipeline plan to cut off dirty jet fuel could hit airlines

[November 02, 2016]  By Devika Krishna Kumar and Liz Hampton

NEW YORK/HOUSTON (Reuters) - Major airlines including Delta, United and American could face higher fuel costs if U.S. regulators allow Colonial Pipeline Co to stop shipping a dirtier blend of jet fuel by 2018.

The Colonial system carries most of the jet fuel that is delivered via pipeline to the East Coast and used by busy airports serving New York, Washington, D.C. and Atlanta, along with U.S. military bases.

The pipeline company said earlier this month it would ask the Federal Energy Regulatory Commission for permission to halt shipments of high-sulfur jet fuel and diesel.

Preliminary estimates indicate that jet fuel prices could rise significantly if Colonial wins approval, said John Heimlich, chief economist for the industry trade group Airlines for America (A4A).

Rising fuel prices could make certain flights unprofitable, forcing airlines to cut service and sell fewer seats - likely at higher prices.

It would take jet fuel price increases of 30 to 50 cents per gallon to have a big impact on pricing or flight availability, said Robert Mann, an industry consultant and former executive at American and other airlines. Jet fuel in the New York Harbor traded at about $1.44 per gallon as of Tuesday.

A Colonial spokeswoman said the pipeline company was discussing its regulatory proposal with affected airlines but declined further comment to Reuters.

The move would allow Colonial, which daily ships more than 3 million barrels of petroleum products, to more efficiently move more low-sulfur products through its pipeline. Cutting down on dirtier fuels would reduce so-called "transmix," which occurs when high-sulfur and low-sulfur products are combined. The resulting mixture has to be refined or blended again.

Colonial has not specified what it intends to ship in place of high-sulfur fuels. But the pipeline has been full for about four years, and Colonial would likely see strong demand for any open space.

The company shut its gasoline pipeline for the second time in less than two months on Monday after an explosion in Alabama killed one worker and injured five others. It briefly shut the distillates line as well, which transports jet fuel.

American Airlines Group Inc, United Continental Holdings Inc and JetBlue Airways Corp declined to comment on Colonial's regulatory proposal, referring questions to A4A. A spokeswoman for Southwest Airlines Co declined to comment, saying the airline is still evaluating the plan.

Delta Air Lines Inc may be more insulated from fuel price shocks than others because the company operates a refinery in the northeast U.S. that is heavily geared toward jet fuel production. Delta did not respond to requests for comment.

SHIFTING REGULATIONS, DEMAND

Colonial's plan is driven largely by waning demand for high-sulfur fuels. Railroad and marine transportation companies, for instance, are using less high-sulfur diesel fuel in response to environmental regulations.

Sulfur levels in jet fuel are not currently regulated, however, and the industry still uses high-sulfur fuels widely, in part because they have better lubricating qualities for airplane engines.

Airlines can and do use a range of cleaner fuels, Heimlich said, which Colonial would continue to ship under its proposal. But airlines are concerned that many refiners could take years to make upgrades required to produce jet fuel to Colonial's proposed low-sulfur standard.

Some refiners would need to invest in desulfurization units known as hydrotreaters, said David Hackett, president of the energy consultancy Stillwater Associates. Or they could update their facilities to process sweet crude instead of high-sulfur sour crude.

Either way, refinery costs would go up, and the transition would take time, raising the prospect of airline fuel shortages.

"Three years is minimum," Hackett said.

POLITICAL, LOGISTICAL CHALLENGES

Colonial needs permission from the energy commission to stop shipments of high-sulfur fuel, and the airlines can exert influence on that process.

A commission spokeswoman declined to comment, noting that Colonial's proposal has not been formally filed with the agency.

At stake is a large portion of the about 400,000 barrels per day (bpd) of jet fuel that moves from the U.S. Gulf to the East Coast via pipeline, according to U.S. Energy Department data. About two-thirds of East Coast jet fuel demand is currently met by pipeline flows from the Gulf Coast, according to analysts at Energy Aspects.

If Colonial wins approval, airports in the southeastern U.S. may turn to Kinder Morgan's 700,000 barrel-per-day Plantation Pipeline, which has less than a third of Colonial's capacity. Kinder Morgan, in a statement, said it is "evaluating the changing market conditions" before considering any expansion of shipping high-sulfur jet fuel.

If Plantation and other interstate pipelines followed Colonial's lead, it could make supplying airports even more challenging.

Trucking fuel to major airports is not feasible due to the sheer volume of fuel needed.

Waterborne shipments could be expensive, in part due to the Jones Act, a maritime policy which requires goods transported by water between U.S. ports to be carried on U.S.-flagged ships. That may make it cheaper to import jet fuel, particularly from Europe.

(Reporting by Devika Krishna Kumar in New York and Liz Hampton in Houston; additional reporting by Jeffrey Dastin in New York; Editing by David Gaffen and Brian Thevenot)

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