The significance of crack spread on refining margin
The crack spread measures the difference between market prices for refined petroleum products and crude oil. The United States follows the 3:2:1 crack spread. The spread indicates three barrels of crude oil producing two barrels of gasoline and one barrel of diesel. A higher industry average crack spread indicates higher profitability for refiners like Phillips 66 (PSX).
Movement in crack spread
From 2012 to 2013, the average crack spread narrowed due to a decline in gasoline and distillates prices compared to crude prices. Lower demand for refined products led to lower prices in 2013. As a result, the segment’s performance deteriorated, resulting in 3.5% net income margin compared to 5.6% in 2012.
Crack spread widening brings good news
In 3Q14, Phillips 66’s refining segment’s net margin took a sharp turn when it posted $538 million earnings as opposed to a $30 million net loss posted in 3Q13. The change of fortune is even more dramatic when we consider that earnings dropped more than 14% in 2Q14 despite revenue increase in the Refining segment in that quarter.
This was a result of increased market crack spreads coupled with widening crude differentials. From 3Q13 to 3Q14, the average crack spread increased ~4%. Crack spread also affects other major U.S. refiners such as Valero Energy (VLO), Tesoro (TSO), HollyFrontier (HFC), and Marathon Petroleum (MPC). These are components of Energy Sector Select Standard and Poor’s depositary receipt (or SPDR) exchange-traded fund (or ETF) (XLE).
Note that while the 3:2:1 crack spread is a benchmark indicator for the industry, spreads vary from region to region and also from crude to crude. Phillips 66 (PSX) has access to a lot of what it calls “advantaged” crude because of its refinery locations. The company is able to increase its margin because it can lower costs through cheaper crude available at different locations. Also read about WTI-Brent crude price differentials in our article Phillips 66’s refinery margin relationship with WTI-Brent spread.
Read the following section to know Phillips 66’s (PSX) capital projects.