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Delta Airlines' (NYSE:DAL) agreement to buy a ConocoPhilips (NYSE:COP) refinery in Pennsylvania is all about Southwest Air (NYSE:LUV).

Delta's ongoing battle with Southwest is about costs. Delta's hub-and-spoke system is inherently less efficient than Southwest's network of short flights that just go back-and-forth. But because Southwest has now been around for a generation and accepted unions, while Delta has always pushed back against workers, it may actually have an advantage in labor costs.

The deal is for a refinery near Philadelphia, plus pipelines and other assets that reach its New York hubs. There are $30 million in government incentives on the deal, and Delta has already made deals with BP and Phillips for sourcing oil and selling products other than jet fuel.

Delta figures it can handle 80% of its U.S. jet fuel needs through the deal, saving up to $300 million/year. Put those savings onto its bottom line and profits rise 15%.

While the bet carries risks, the bigger risk may have been not pulling the trigger. There were no other bidders on the property, which could have shut down, meaning a net increase in Delta's fuel costs. Now, in theory, it has the kind of cost advantage on profitable East Coast routes.

Quietly, Delta has been on kind of a tear in its growing competition with Southwest, which entered Delta's home market of Atlanta just this year. Since the start of the year the stock is up by a third, while LUV is flat. Last year Delta had a net income of $854 million on revenues of $31.28 billion, against net of $178 million on $14.87 million in revenue for Southwest. So a few more pennies on each dollar are already flowing to Delta's bottom line than its rival's.

There remains one big problem for Delta. Its fleet averages 15.9 years in age, against 12.1 years for Southwest. The two airliners' fleets are becoming increasingly similar, however. Southwest flies Boeing 737s almost exclusively, and Delta ordered 100 of those same planes to replace its aging DC-9s, among the oldest planes in the air.

So Delta has competitive labor costs, lower fuel costs, and a compatible fleet. I have to head to Houston next week, and even with the single bag charge Delta's price is slightly below the Southwest "gotta get away" fare.

This just got interesting.

Source: Delta Refinery Deal All About Southwest