Brad Zigler

Valero's Margins: A Template

There's economic merit in hedging. The crack spread (and its opposite) is used by commercials to manage cash flows. Hedging reduces volatility, allowing commercials and consumers to better plan their expenditures and revenues. Without crack spread trading (you need hedgers and speculators both for a liquid market), prices of finished products would necessarily be higher to compensate the producer for the unhedged risk.


On Dec 07 11:42 PM WayneS wrote:

> If buying refiner's shares facilitates the production of useful materials,
> then that is investing. If it is just a means of making unproductive
> money, then no. Just passing money back and forth is no more helpful
> to the public, than ENRON buying and selling their own gas numerous
> times.

Valero's Margins: A Template

Would you consider the purchase of refiners' shares investing? Why? You're essentially banking on the same condition: improving profit margins from refining operations. The only difference is that you obviate the percolation through the company's income statement.

In the crack spread, you're wagering along with the refiner: you're betting that the prices of the refined outputs will accelerate at a faster pace than the cost of the crude inputs.

Since you're selling crude and buying the crack products, the obvious answer to your question is: "your counterparties." They may be trading the legs individually or as a package (a reverse crack spread) in anticipation of declining profit margins.


On Dec 07 02:32 PM WayneS wrote:

> "For investors, though, there's a distinct advantage to playing the
> crack spread instead of buying refiners' shares. You don't have to
> wait for profits to filter down to the refiner's bottom line. The
> crack spread is the bottom line."
>
> For a second I thought you said, "playing the track." This doesn't
> sound like investing, it sounds like gambling with someone else's
> money. Crack spread sounds a lot like the point spread used in gambling
> on football. Who are the losers in a ploy like this?

Time (Again) for Crack Trades

The utilization rate for the week preceding September 19, 2008 was 66.7%.


On Oct 27 08:26 PM User 330464 wrote:

> The utilization rate in September 2008 was 74.6 percent...
>
>
> "For example, in September 2008, after the summer driving season
> ended, utilization dropped below 67 percent as refining margins thinned."

Gasoline Is All It Is Cracked up to Be

You claim that futures traders "manipulated" oil and gas last year. In what way? How?

How do you know futures didn't reflect the cash market?

A sweeping generalization doesn't establish truth.

Where's your evidence?

Crack Spread Calculations Demystified

"Sour" refers to sulfur content. WTI's is comparatively low compared to Brent or the OPEC basket grades. That's why WTI is described as "light, sweet" crude.

The "light" descriptor refers to the oil's specific gravity. Lighter, sweeter crudes are easier to refine into gasoline meeting U.S. standards.

WTI is typically priced at a premium to more viscous, sulfur-rich grades. Over the past few years, for example, the WTI premium over dated Brent ran $1.50/bbl, though daily fluctuations--especial... now--often skew mightily. The premium over OPEC basket grades can run as high as $5/bbl.

The terms "refinery margins" and "crack spreads" are sometimes used interchangeably in media reports, but they're really different numbers.

A gross refining margin represents top line operating profit, so it's expressed as a percentage of the input oil cost. You need a crack spread to derive the margin. Once you calculate the spread, simply divide the per-barrel crack by the cost of the crude.

As mentioned before, crack spreads--and the resulting refining margins--are seasonal (an explanation of this can be found in the Hard Assets Investor article, "Time For Crack Spreads" at www.hardassetsinvestor...). Over the past 3 1/2 years, the median gross margin derived from the nearby 3-2-1 crack has been 15.6%. There's a fair amount of volatility in the margin, though. Lately, it's spiked as high as 64.8% and there was a one-day excursion into negative territory associated with a short squeeze in the expiring October 2008 crude contract.

There's a visual representation of refining margins in the recent Hard Assets Investor article, "Crude Oil Takes A Back Seat To Gasoline" at www.hardassetsinvestor....

The article is part of a continuing weekly update on the petroleum complex published every Wednesday in Hard Assets Investors' (HardAssetsInvestor.com) "Brad's Desktop" column.

An optimum margin? One large enough to create a spread between the gross refining margin and the cost of goods sold of 5% or more. Read the "Time For Crack Spreads" (www.hardassetsinvestor...) article for an explanation.


On Mar 07 06:04 AM SB-tiger wrote:

> Brad:
> Thanks for a wonderful and very informative article. So I will take
> the liberty to ask a couple of questions:
> 1. What is the price differential between sour crude and WTI, and
> can the refiners use the two crudes interchangeably to get the desired
> mix – 3-2-1 or 2-1-1.
>
> 2. Are crack spreads published or they need to be computed.
>
> Thx

Crack Spread Calculations Demystified

To the degree futures track the cash market, no, the vagaries are not "caused" by hedgers and traders.Their interaction, however, INFLUENCE XOM's downstream revenues. As well they should.

It is because of the inherent fluctuations in cash market supply and demand that the futures market exists as a risk transference mechanism..



On Mar 06 10:04 AM WayneS wrote:

> So the commercial hedgers and the speculative futures traders cause
> the "vagaries" in XOM's revenue stream? I remember in the eighties
> when Exxon sold crude to their own refineries, bypassing the middlemen,
> and sold gasoline at their retail stores at a cheaper rate. The state
> of Texas fined them a couple of billion dollars for selling under
> market.

Crack Spread Calculations Demystified

Mashed in potatoes? That's funny, Jack.

But that must have been a long time ago. Potato futures were banned following allegations of maket manipulation.


On Mar 05 03:46 PM john s. gordon wrote:

> brad z -
>
> thanks for clarification, i'm not a futures trader.
> one year a friend of mine made some money in wheat futures.
> the next year he got mashed in potatoes.

Crack Spread Calculations Demystified

Keeping an eye on the crack spread -- and its seasonality -- can help you understand the vagaries in XOM's downstream revenue stream.


On Mar 05 03:30 PM cannedpawn8 wrote:

> I learn something everyday and I don't do futures...just own XOM

Crack Spread Calculations Demystified

In actuality, the operation of metals and oil futures doesn't differ appreciably from ag futures.

Very few futures contracts (on average, only 2%-3%)--ags included--are settled by delivery. Most often, commercials offset futures in the exchange market to close their hedges and make/take delivery in the local cash market.


On Mar 05 03:01 PM john s. gordon wrote:

> in the case of agricultural commodity futures, a farmer in the spring
> can pre-sell his crop and lock in a price. if the harvest proves
> to be bountiful and spot prices fall below his contract price, the
> risk is on the buyer of the futures contract. this process assists
> the farmer in his budgeting process. if on the other hand his crop
> turns out to be a disaster (bad weather etc.), he has to hustle around
> & spend some money to fulfill his contract.
>
> the operation of oil & metals contracts is somewhat different,
> these contracts are often purchased by entities (speculative type)
> that have no intention of ever taking delivery of the actual commodity.

Crack Spread Calculations Demystified

Speculative futures traders provide the liquidity needed by commercial hedgers. Without speculators willing to assume price risk, commercials-- and ultimately consumers--wouldn't be able to budget effectively.

The economic purpose served by hedging is to contain price risk which ultimately means consumers pay less for goods.


On Mar 05 02:07 PM WayneS wrote:

> I don't understand this.
> I don't trade petroleum futures.
> Would someone explain what service futures-traders
> perform. How do they facilitate getting products to
> the consumers?

More Oil, Less Gasoline

To be fair, the weekly inventory estimates referenced above aren't EIA's, but those of (mostly) sellside analysts.

A lot of misplaced opprobrium was heaped upon oil index investors for supposedly running up oil prices. The argument, however, is refuted by hard facts (see: "Congress Blames Index Speculators" at www.hardassetsinvestor...).




On Feb 14 03:07 PM BxCapricorn wrote:

> So, what all of this means is that the EIA cannot perform simple
> forecasts and estimates, Matt Simmons (and his book) was a shill
> for the oil traders, CNBC aided and abetted the crime by showing
> "The Oil Crisis" super-imposed on their broadcast screen for months,
> and that various dooms-day scenarios (i.e. world hunger/fertilizer
> production drops) are just red herrings aimed at fleecing investors.
> The SEC recently investigated charges of commodity traders, brokerages,
> etc. manipulating the cost of oil, and surprisingly found nothing.
>
>
> Did anyone apologize to the Saudis, after we spent months blaming
> them for the ramped cost of oil? They were as much a victim as everyone
> in the World whose culture is based on access to cheap energy. Now
> that the world has adjusted and usage has dropped, the oil exporting
> countries can't give their product away, and they need to, just to
> pay for the over-leveraged infrastructure and social projects they
> started during oil's climb. It will be interesting to read about
> Texas, Alaska, etc. who mocked the rest of the country's housing
> related woes during oil's peak, only to now find themselves staring
> at their own abyss.

More Oil, Less Gasoline

Well, actually crude oil DOES have a shelf, er, tank, life.

That crude CAN be stored, in-ground and in tanks, allows the current cash-and-carry trade to flourish.

A swollen crude inventory is contributing to the deep contango in the WTI market.


See "It's the Oil Carry, Not the Contango" at www.hardassetsinvestor....

On Feb 13 09:32 AM scfranklin94 wrote:

> Gasoline has a shelf life, unlike crude oil; the gasoline inventories
> are high, so it makes sense for the refineries to back off production
> and let the unleaded gasoline inventories decrease.

More Oil, Less Gasoline

Just how, in your estimation, do ETFs or ETNs "milk" investors?

Why would you except USO and UNG from your condemnation?

Why would a crack spread be a trade for the "uneducated"?


On Feb 12 11:41 AM ROLEX18 wrote:

> ETF's are ment to milk investors who don't understand how or from
> where their price is derived, when you buy/sell something you must
> first know if it's a fair market price, excluding USO and UNG for
> NatGas most other ETF and ETN are trading books, but not the asset
> you think you trade, it is very complex but understanding crack spreads
> looks like an easier option to uneducated.

More Oil, Less Gasoline

Where did you see the implication that gasoline manufacturing was the principal objective of refining?

A refinery's production mix is seasonal. Sometimes gasoline production is favored, sometimes not. That's reflected in the product cracks.

As diesel futures are moribund, retail investors have no real-time diesel pricing guidelines. Heating oil futures are active and reflect diesel pricing, so a 3-2-1 or 2-1-1 crack fairly well approximates refining yleds.

On Feb 12 11:26 AM cyberclark wrote:

> The article implies gasoline is the principal product running opposite
> oil. No refinery is in the business of making gasoline! The refineries
> are built to produce various diesel fuels. This is done by taking
> off the HVB (high vapour base).
>
> The HVB is what the gasoline is made up of. If there is no diesel
> demand there is no HVB to make gasoline with. Conversely if the gasoline
> is not sold the storage fills up. With no place to put the HVB production
> dwindles.

Oil's Well That Ends...Well

No chapter and verse here. But taking away the leverage available in futures (regarding your reference to "47 barrels traded for every barrel actually used") would denigrate the very purpose of the market which you acknowledge ("... the oil futures market, the purpose of which was to provide price stability").

If you reduce the leverage, the efficiency of hedging operations is reduced and you make it more difficult for speculative counterparties to provide liquidity.


On Jan 23 07:13 AM romerjt wrote:

> A variation of the Tragedy of the Commons or “What If Everybody Did
> It”?
>
> I know there are a lot of sophisticated financial types on this site
> and I apologize for the quaint example from a retired high school
> economics teacher.
>
> If a student came to class late very infrequently nobody would care.
> If a few more students come to class late you have to make rule to
> discourage lateness and enforce it which takes time away from the
> intended task of teaching. If many students come late the system
> breaks down and it becomes all about lateness, not learning – or
> “what if everybody did it?” Examples of this phenomenon are common
> it everyday life.
>
> Isn’t this is what happened in the oil futures market, the purpose
> of which was to provide price stability? With oil as an “asset class”,
> according to 60 Minutes, 47 barrels were traded for every barrel
> actually used, - what if everybody did it? Hasn’t this overwhelmed
> the original purpose of the oil futures market - price stability?
> Doesn’t this distort rather than help define our energy future? When
> oil was $147 I knew elderly people who were afraid of freezing to
> death because they couldn’t afford to heat their homes. They probably
> wouldn’t have partly because government would have had to increase
> the subsidies the poor for heating oil. Why should those “oil as
> asset class” investors be able to spend my tax dollars that way,
> shouldn’t they pay those (externalities) costs?
>
> Oil is Special - If only a few investors traded oil nobody would
> care or if investors wanted to use orange juice or pork bellies as
> asset class few would care but oil is so critical to the economy
> and the price swings are so harmful to markets and individuals “when
> everybody doing it”, what justification is there for allowing this
> to continue, whose interests does it serve?
>
> And if you’re kind enough to respond - please, no chapter one free
> market rhetoric. I’ve read the whole book and know it’s not that
> simple.