Continued from Introduction
The crack spread and refiner stocks
Investors who are thinking of buying refiner stocks should know that one of the primary indicators of refiners’ earnings is the crack spread.
Essentially, refiners take crude oil (which generally can’t be used in its raw form) and turn it into refined products such as gasoline, diesel, and jet fuel. The crack spread represents the price difference between the finished, refined products (which translate into refiner revenues) and the price of crude oil (one of the primary factors in refiner costs). Because commodity prices can be incredibly volatile, refiners’ margins can too.
The above chart is the “Gulf Coast 3-2-1 Crack Spread.” This metric assumes that for every three barrels of crude oil, refiners produce two barrels of gasoline and one barrel of distillate fuel (but note that output varies across refineries and this metric is used just as a proxy), using posted prices closest to what Gulf Coast refineries would receive for finished products and pay for crude oil. Both gasoline and distillates are fuels refiners produce for end use—the only difference is that they’re of slightly different chemical make-up, with gasoline generally being a lighter compound.
Calculating the spread
So, to calculate the Gulf Coast 3-2-1 spread, you take the price for two barrels of Gulf Coast gasoline plus the price of one barrel of Gulf Coast ultra-low sulfur diesel (ULSD) and subtract the price of three barrels of crude oil.
We use the example of the “Bloomberg WTI Cushing Crude Oil 321 Crack Spread/Gulf Coast” (Bloomberg ticker CRKS321 Index). Bloomberg notes that the inputs are the following:
- Crude oil – WTI at Cushing (USCRWTIC Index ) – closing price at July 19, 2013, of $108.05 per barrel
- Gasoline – U.S. Gulf prompt 87 Octane gasoline (MOIGC87P Index) – closing price at July 19, 2013, of $2.92 per gallon (multiply by 42 to get price per barrel of $122.64)
- Heating oil or gasoil – U.S. Gulf No. 2 Oil (NO2IGCPR index) – closing price at July 19, 2013, of $2.87 per gallon (multiply by 42 to get price per barrel of $120.54)
- (Two barrels of gasoline + one barrel of heating oil or gasoil – three barrels of crude oil) / 3 = crack spread
- (2 * $122.64 + $120.54 – 3 * $108.05) / 3 = crack spread
- $41.67 / 3 = $13.89 per barrel
Differences in crack spreads
Note that the chart above and the example show the Gulf Coast 3-2-1 using WTI Cushing oil as the input price, but not all Gulf Coast refineries use crude benchmarked to Cushing. Some use crudes closer in price to Louisiana Light Sweet (LLS), a Gulf Coast crude that’s waterborne. For most of the past two years, LLS traded significantly above WTI and has traded closer to Brent due to significant growth in production of crude oil in inland regions such as North Dakota and West Texas. Please see What happened to the WTI-Brent spread? for more information on why WTI and Brent diverged in price. We’ll also discuss regional differences in crack spreads later in this series.
Continue to Part 2: Factors that affect crack spreads