Managing Editor

Tracking Crack Spreads

Emthree -

Let me try to clear up the terminology more succinctly. The "crack" in oil traders' parlance refers to the refining (or "cracking") products -- heating oil and gasoline.

When one "buys the crack," he/she is buying the refining output products and selling the crude oil input. Conversely, "selling the crack" means a trader is buying crude oil and selling the prioducts.

The "spread" refers the (usual) premium commanded by the products over the cost of crude oil.

Diagrammed,a crack spread looks like this:

Buy (Long) Sell (Short) Buy (Long)

CL - (HO +RB) = Spread

While the guys and gals on the trading floor may be "selling the crack," they are at the same time "buying the spread." They want the spread--the products' premium--to migrate in a positive direction (to increase) over the life of the trade.

Capice?

Tracking Crack Spreads

Anachronist -

Natural gas isn't a product of oil refining, so its value doesn't figure into refining margins. Propane can be an output of either natural gas or petroleum distillate production. On the refining side, it's a relatively small factor.

The other products you mentioned don't have futures, so can't be readily proxied. Without real-time price discovery, the spreads utilizing them wouldn't reflect current reality.

As you pointed out, the two distillates--heating oil and gasoline--make up most of the refining output. They're the most marketable products, so their prices influence a refiner's bottom line most significantly.

Tracking Crack Spreads

Bobbo -

The crack spread shown uses product contracts one month forward of the crude futures employed, as stated: "To better simulate real-world conditions, use the distillate prices a month out from the crude delivery to allow for a storage, refining and marketing cycle."

Refinery capacity has NOT been all that that high. Refiners are using only 85%-87% of operable capacity in this high-priced oil environment.

Emthree -

Buying the crack or selling the crack depends upon your context. If you're talking about the spread "cheapening," for example, our lexicon demands that you "sell" now to make a profit. When diagramming the trade, however, the sequence would be:

Long CL--Short HO&RB--Long Spread.

Tracking Crack Spreads

DC Reader -

Valero actually refines more oil in the United States than ExxonMobil does in its company-owned facilities. Valero cranks out 2,112,000 barrels a day from 13 sites while ExxonMobil churns 1,880,500 barrels out of a half-dozen refineries. Of course, Valero's production is strictly domestic. ExxonMobal operates globally.

The Oil & Gas Journal keeps tracks of such things.

Larry -

The spread seasonally cheapens through the fall. Last October, in fact, it contracted to 12 cents a barrel before rebounding.

Trading the reverse crack spread (selling crude short and buying the products) is an option if you think crude's headed lower, but it's a much riskier proposition. It's better for most traders to await the bottoming.

Tracking Crack Spreads

User -

It depends on how "short" the "short" in your term is.

And whether or not you can go "short." Seasonally, margins are softening now. If you're especially aggressive--and some might say, foolish--you could sell the independents now.

Or you could wait for heating oil season when retooling and maintenance operations curb production (look for that 5% margin differential ) to buy the stocks.

Tracking Crack Spreads

ihl - Thanks for your comments.

maximax - Thanks for yours as well.

Your point's well-taken. Coking spreads take into account more than just two products on the output side, namely WTS, dated Brent and No. 6 fuel oil.

Coking operations, too, are multiplying.

The point of the article, however, was to offer a basic model for those unfamiliar with refinery operations in terms that they've likely encountered in investment articles.

Crack spreads are discussed in investment terms more often than coking spreads.

Investors, too, are much more likely to grab the two crack spread output prices from retail sources than the less transparent coking components.

There are a limited set of products, too, for retail investors to use (ETFs) to capture refining margins.

In a nutshell, this article wasn't destined for professional hedgers or industry insiders. Rather, it's an overview of a concept often encountered by, but seldom adequately explained to, retail investors.

Tracking Crack Spreads

User -

Not the TWO margins. The DIFFERENCE between the two margins.

One tracks the spread between the input price and the prices of the outputs (the apprarent refining margin), the other (gross profit margin, basis the cost of goods sold) the profit represented by the per-barrel crack against the sale prices of the outputs. Gross and grosser, you might say.