Cyclicality of crack spread
The crack spread is the difference between the market cost of the crude derivative product and crude oil and is an important indicator of the profitability of downstream companies. In general, the crack spread moves in a cycle. Normally it picks up for the first two quarters of a year, saturates, then bottoms out. Between September to December of every year it bottoms out relative to its movement at the start of the year. Revenue and EPS (earnings per share) growth also follow the same pattern.
The revenue and EPS growth on a quarter-over-quarter basis for downstream companies such as Tesoro (TSO), Phillips66 (PSX), Valero Energy (VLO), Marathon Petroleum (MPC), and other refiners follow the same pattern on an average basis. Refiners comprise ~11.6% of the Energy Select Sector SPDR Fund (XLE).
Quarterly correlation between crack spread, WTI spot prices
To illustrate how investors can take advantage of allocating towards refiners, a simple correlation analysis of the downstream sector’s main driver versus crude can be helpful. The third quarter of 2015 saw a correlation between crack spread and WTI (West Texas Intermediate) spot prices at 0.3. The average correlation factor per quarter since 4Q14 is ~0.4. In 4Q14, the correlation between the crack spread and WTI crude oil was higher, at 0.8x.
One reason for an elevated correlation during the fourth quarter of 2014 was the cyclical nature of crack spread. Generally, the fourth quarter sees a higher correlation between these commodities and can serve as a good pivot point for portfolio rebalancing. As an example, the very next quarter, 1Q15, saw correlations fall back to near zero. Crack spread moved up by around 121% in 1Q15 over 4Q14. Please note that all price-related data in this series is as of December 9.