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.
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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.
- Gasoline crack spreads are volatile, tending to spike during periods of tight supply/demand.
- Price spikes are not sustainable; rather the spread tends to return to variable cost levels once the period of tight supply/demand is relieved.
- 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
