Negative Gasoline Crack Spread Unsustainable

The US refining industry is currently experiencing a very rare event, a negative prompt month futures gasoline crack spread.

The chart below reflects the value of this spread dating back to 1990. Over nearly three decades, this spread has bottomed in the $1.00-2.50 range. Recently this spread has been forced into negative territory off the back of 1) position liquidation driven by the global credit crisis and 2) demand destruction driven by weakening economic conditions and lack of supply following the 2008 hurricane season.

click to enlarge images

This spread is calculated utilizing the NYMEX prompt month futures markets. Therefore, the chart above represents gasoline delivered at NY harbor vs. WTI crude oil delivered at Cushing, OK. Despite the location basis, the chart provides information which is quite useful in understanding the cash flow of refining businesses.

1. Gasoline crack spreads are volatile, tending to spike during periods of tight supply/demand.
2. Price spikes are not sustainable; rather the spread tends to return to variable cost levels once the period of tight supply/demand is relieved.
3. A refinery hedging strategy which advantages this dynamic may provide superior cash flows during periods of spread downturns. If properly managed, the gasoline crack spread volatility can become a competitive advantage.

Generally speaking, US refiners are getting hammered by the gasoline crack spread. Expect to hear stories of refiners reducing gasoline production (to the most efficient point on their cost curve) and extended shutdowns for maintenance. The chart below reflects a two year history of the equity price of an equal weighting of Tesoro (TSO), Western Resources (WNR), Sunoco (SUN), and Valero (VLO). The oversold state of this group of refiners is quite clear.

Just as price spikes in the gasoline crack spread are not sustainable, negative gasoline crack spreads are not sustainable either. In the interest of disclosure, as of this writing the author of this article holds a long position in refining equities and energy futures markets.

Disclosure: Author holds a long position in WNR and energy commodity futures and options

Comments

[Medlo:]

Keep in mind that Petrochemical demand in Asia is off a cliff, Naphtha is trading well below WTI, this will continue to weigh on gasoline. Also, natural gas is very inexpensive vs crude, so butane is cheap and during the winter, butane content in gasoline increases, also adding to the supply glut. Demand trends are down, the drop in prices will not reverse this in the US as people are finally waking up to the benefits of smaller efficient cars, realizing that money wated ina gas guzzler is better used for the kids education, food, etc. As long as distillate cracks are holding up, refiners will continue to run and one can easily see a prolonged negative gas crack. Also keep in mind many refiners run lower quality crude oil that trades at several dollars less than WTI.

2008 Nov 03 09:06 AM

[Steve Murphy:]

Medlo,

You make valid points. However, demand will respond to lower gasoline prices. Additionally, refinery configurations range from the simple to the complex. Refiners running heavy, sour crudes have the advantage, especially while the distaillates sector of the barrel continue to perform economically. You will see reductions in refinery runs from the owners of simple configurations. Several have already been announced in recent days.

(money.cnn.com/news/new...)

A combination of renewed demand from lower prices and several production curtailments can tighten things in a hurry.



On Nov 03 09:06 AM Medlo wrote:

> Keep in mind that Petrochemical demand in Asia is off a cliff, Naphtha
> is trading well below WTI, this will continue to weigh on gasoline.
> Also, natural gas is very inexpensive vs crude, so butane is cheap
> and during the winter, butane content in gasoline increases, also
> adding to the supply glut. Demand trends are down, the drop in prices
> will not reverse this in the US as people are finally waking up to
> the benefits of smaller efficient cars, realizing that money wated
> ina gas guzzler is better used for the kids education, food, etc.
> As long as distillate cracks are holding up, refiners will continue
> to run and one can easily see a prolonged negative gas crack. Also
> keep in mind many refiners run lower quality crude oil that trades
> at several dollars less than WTI.

2008 Nov 03 01:35 PM

[Ben Simonton:]

Is there a web resource that tracks the crack spread?

Best regards, Ben

2008 Nov 09 08:06 PM