What Crack Spreads Say about Oil Prices

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A gasoline glut as we enter the “summer driving season.”

By Brian Noble, Oilprice.com

When there is the opportunity and the time is right to make money, most people will jump at it. Understanding that simple bit of human psychology may be a key determinant of the probable future path of crude oil (WTI) pricing.

Refinery runs or the degree of operational capacity of refiners to produce product are a useful telltale. Right now, for example, refineries are running very close to capacity at a 94.1 percent utilization rate (source: EIA), appreciably up from the three months previous in 2017 and certainly well above an average capacity utilization rate of 89.9 percent during 2016.

The reason for this is the fact that it’s currently more profitable to “crack” oil into product these days as the “crack” is currently around $18-20 per barrel depending on the grade in question, and looks to be going higher.

The crack spread is a term used both in the oil industry as a tool for producers to hedge their P&L and for futures trading as speculators trade the crack and also hedge existing WTI futures positions. In simple terms, the crack spread measures the differential between the price of WTI or Brent and the products (gasoline and distillates) extracted from it.

Consequently, the spread approximates the profit margin an oil refinery can expect to earn by cracking crude oil, which in and of itself is of no use to anybody and in that sense has no value, into useful petroleum products such as heating oil and gasoline for daily consumption.

More specifically, in global futures markets, the crack spread is a specific spread trade involving simultaneously buying and selling contracts in crude oil and one or more derivative products, typically gasoline and heating oil. Oil refineries may trade the crack spread to hedge the price risk of their operations, while speculators attempt to profit from changes in the oil/gasoline price differential.




Strong crack spreads generally should incentivize refineries to up their runs, which means that crude is being taken off the market, a bullish sign for algos reading the headlines and nothing more than that. But this also means that product builds are growing, which is ultimately bearish for WTI. In addition, given a weakening economic outlook with a low U.S. GNP print at less than 1 percent quite recently and other soft macro-economic indicators, there is also the danger that demand will prove insufficient to soak up the supply of product and consequently put a damper on the demand for WTI itself.

Something along these lines happened last week when WTI crude inventories fell though product inventories rose despite the fact that imports into the U.S. increased by over a million barrels per day to 8.912 million barrels. According to Platts (S&P Global Platts Preview of U.S. EIA Data, April 2017), the crack spread against WTI has been hovering around $20 since late March, compared with around $23-24 in late March 2016, a decrease but still a highly profitable margin for the refiners.

Refinery utilization has already risen from its recent lows, which marked the depth of the winter maintenance season. Platts also reported that analysts were looking for the refinery run rate to have increased to 89.8 percent of capacity by this point in the season, a level which has now been superseded. Another source of potential refined oil product supply is continued strength of imports, which look set to increase because of improved economics for shipping crude stateside.

Putting everything together, in addition to data regarding rig counts, domestic U.S. production increases and the continued noise out of OPEC, it is fairly clear that there is going to be a glut of product on the market as we enter the so-called summer driving season this year, which should mean that the product tail will continue to wag the WTI dog well out into the foreseeable future. By Brian Noble, Oilprice.com

What then is driving oil prices at the moment? Read…  Why Brexit, Bombs, and Trump Can’t Move Oil Prices




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  11 comments for “What Crack Spreads Say about Oil Prices

  1. Raymond Rogers
    May 3, 2017 at 1:40 pm

    Something else to consider when thinking about refineries, more so with the smaller operations, will the demand for the byproducts be present as well? When we think of refineries we usually think about transportation, heating or energy, but there is more to it.

    “a bullish sign for algos reading the headlines and nothing more than the”

    “the” should be “that”.

    • economicminor
      May 3, 2017 at 3:02 pm

      by-products? You mean like to make plastics? asphalt? what else?

      That is why economics and trading are so complicated hey!

      • Raymond C. Rogers
        May 3, 2017 at 6:25 pm

        Yes, indeed.

  2. LeClerc
    May 3, 2017 at 5:40 pm

    Congratulations for the ultimate word-salad headline.

    No blame, just saying.

  3. complete collapse in demand
    May 3, 2017 at 5:44 pm

    gas demand back to where it was in late 80’s,that’s what u call a complete collapse in demand,which will force refiners to shut down or close the doors permanently

    • May 3, 2017 at 6:13 pm

      There’s no “complete collapse in demand.” Refiners are operating near capacity and aren’t going to “close their doors permanently” anytime soon. There is a gasoline glut due to overproduction.

      US vehicle fleet has become vastly more efficient and burns up less gas since the 1980s. In urban areas, millennials like to live near the core and use cars less. Electric cars are being added to the fleet. And so on. There are lot of good reasons for the gasoline burn to edge down over the years, including less mileage driven. But this isn’t any kind of “collapse.”

  4. alex in san jose
    May 3, 2017 at 7:10 pm

    More like, summer bike riding season! I’m not one of those “all weather” riders if I can possibly avoid it, so when it’s rainy or very cold I take the bus or the light rail. But for the next several months I’ll be riding my bike a lot.

  5. Kid Sock
    May 3, 2017 at 10:05 pm

    Since China has been reported to consume 50% of all global commodities I would assume any slowdown there would precipitate a ‘collapse in oil prices’. Whether they limit oil extraction is another matter.

    China is where you should look for the price of oil.

    • vegeholic
      May 5, 2017 at 9:19 pm

      Oil Consumption by Country (Wikipedia)
      USA 20.4 %
      China 12.6
      India 4.4
      Japan 4.4
      Saudi Arabia 4.1
      Brazil 3.3
      Russia 3.3
      Korea 2.7
      Germany 2.5
      Canada 2.4
      Mexico 2.2
      France 1.9
      Iran 1.8

  6. matt
    May 5, 2017 at 4:53 am

    Crude inventories fell? LOL more like East coast storage is full so what shows up as a draw down is actually oil being refused port of entry in N Y Harbor and being moved to The Gulf Or West Coast. That Simple. Was just on a cruise along the S E coast and Bahamas . Tankers are waiting off shore to unload in FL . Filled with petro products. they are sitting all over the place in the Bahamas with no place to go to off load. . They are being paid to sit and wait right now since all the storage is at capacity. That simple. All over the world we have run out of places to store oil. Now that China has slowed down? only place oil is going is way down

  7. KB
    May 5, 2017 at 2:42 pm

    The mouth of the Chesapeake Bay is pretty much a floating tank farm with all the loaded tankers waiting on a place to unload.

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