Crack Spread 101 (Part 4: Effect on refiner margins)
Continued from Part 3
The effect of crack spreads on refiner margins
A typical refinery company’s financial statement (through the operating income line) would read like this:
- Revenues (generally the amount received from finished products, and this depends on the price at which the finished products sell multiplied by the volume of the finished products)
- Less the cost of products sold (generally the cost of the crude oil purchased)
- Less direct operating expenses (such as natural gas used for fuel, chemicals and catalysts, utilities)
- Less selling, general, and administrative expenses
- Less depreciation and amortization
- Equals operating income
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Investors can use crack spreads as a rough proxy for a refiner’s revenues less cost of products sold. Directionally, where crack spreads trade should also indicate how strong earnings should be and therefore where refiner stocks should trade.
Examples: Using crack spreads as a rough proxy for refiner revenues
Let’s take the example of Western Refining (WNR). The company gave guidance for its El Paso Refinery of throughput of 133,000 to 138,000 barrels per day in 2Q13, and direct operating expenses of $4.15 per barrel. It also gave guidance for its Gallup Refinery of 22,000 to 25,000 barrels per day in 2Q13, and direct operating expenses of $9.25 per barrel. Other guidance includes $27 million to $28 million of costs for SG&A (selling, general, and administrative expense), $15 million to $16 million for interest expense, and $25 million for depreciation and amortization.
WNR stated for last quarter (1Q13), that its gross margin at El Paso was $34.57 per barrel and at Gallup was $26.77 per barrel. Let’s assume that gross operating margins for 2Q13 will be the same (but note that this is unlikely, given the volatility in crack spreads).
Using these assumptions, we show a simple calculation of EBITDA—or earnings before interest, taxes, depreciation, and amortization (excluding other ancillary sales or costs). In Example A, El Paso’s gross margin is calculated using midpoint of throughput guidance of 135,500 barrels per day times 91 days in 2Q13 times $34.57 (1Q13’s gross margin). We use the same logic for the Gallup refinery. In Example B, we look at how a $10 per barrel negative change in gross margin affects EBITDA, so we use $24.57 per barrel.
This also shows how a refiner’s earnings can be very volatile. Because of the variant nature of crack spreads, a change of $10 per barrel from one quarter to the next isn’t improbable, and this results in a significant difference in earnings. This volatility makes pure-play refiners one of the most volatile segments in energy—and the overall market.
Continue to Part 5: Regional differences