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Economy in Brief

"Crack Spread" Widens for Oil Refiners, But Percentage Premium in Gasoline and Oil Values Is Not "High"
by Carol Stone August 18, 2005

The current extraordinary developments in the energy sector are teaching all of us new ideas and concepts. One of these recently called to our attention by a client is the refinery crack spread. Besides the surging price of crude oil, refiners are currently also able to increase the spread they receive from breaking the crude into its products, or "cracking" it. The common measure of this process assumes that a barrel of crude is broken two-thirds into gasoline and one-third into fuel oil -- or 3 barrels of crude make 2 barrels of gasoline and 1 barrel of fuel oil. This spread is thus called the "3-2-1 crack spread". This is such a common measure that there is futures market for it on the NYMEX, alongside crude and gasoline futures. Haver carries data for this in its OILWKLY database, which is supplied by the "Oil & Gas Journal".

The table below shows 1-month futures information: the estimated value of the gasoline and fuel oil produced by refiners and the resulting crack spread compared with the nearby future for West Texas Intermediate crude oil. We see that through last week, crude oil prices have risen 43.4% from a year ago while the refiners' crack spread has more than doubled from about $6.85/barrel to $14.06. The spread now adds a premium of 21.7% to the crude price compared with 15.1% a year ago. This is wide relative to the most recent past, but historical data show that this margin has been as high as nearly 49% with several periods sustained around 23-24%. So current values are hardly unprecedented, at least on a relative basis.

The other point clearly evident in both of our charts is the volatility of the crack spread from week to week. Such swings make it easy to see that refiners would want a futures market to hedge the spread, particularly given the substantial fixed costs of a refining plant. As refiners seek to cover these costs, plus labor and supplies, they face not only widely swinging crude oil prices, but also a margin on refining operations that is far from stable. One disclaimer: it is necessary to note also that relationships among these price measures are not exact. Other products come from the refining process -- residual fuel oil, jet fuel and gas oil are three notable ones -- so that the spread measure that includes only gasoline and distillate fuel oil is only a proxy, albeit a handy, easily understood one. Its recent widening indicates that demand for gasoline and fuel oil has been an important force supporting product prices: gasoline users have -- at least up to now -- been willing to pay these prices. With daily increases in gasoline, though, one wonders how long that will continue.

Aug 13, 2004
1-Month Futures, $/Barrel Aug 12, 2005 May 13, 2005 2004 2003 2002
$ Yr/Yr %
Crude Oil, WTI 64.91 50.35 45.25 43.4% 41.29 30.98 26.04
Estimated Product Value 78.974 60.576 52.096 51.6% 48.985 36.755 30.580
Crack Spread 14.060 10.224 6.848 105.32% 7.690 5.782 4.537
Spread as % of Crude Price 21.7% 20.3% 15.1% +6.6% 19.1% 18.7% 17.6%
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