Crack Definition

What Is a Crack?

A crack, or crack spread, is a period of time used inside the energy markets to represent the differences between crude oil and the prices of the wholesale petroleum products that derive from it, similar to jet fuel, kerosene, area heating oil, and fuel.

Crack or crack spread is a purchasing and promoting method used in energy futures to determine a refining margin. Crack is one primary indicator of oil refining companies’ source of revenue. Crack lets in refining companies to hedge in opposition to the dangers associated with crude oil and those associated with petroleum products.

Via at the same time as purchasing crude oil futures and selling petroleum product futures, a broker is making an attempt to determine an artificial position inside the refinement of oil created by way of a wide range.

Figuring out a Crack

The period of time crack is derived from the fluid catalytic cracking of crude oil, which is used to refine crude oil into petroleum products, similar to fuel and heating oil. Crack is a simple calculation that is regularly used to estimate refining margins and is according to one or two petroleum products produced in a refinery. On the other hand, crack does now not think about refineries’ revenues and costs, merely the cost of the associated fee in step with barrel of crude oil.

The comparison between the prices of crude oil to those of subtle products might indicate {the marketplace}’s supply state of affairs. A crack spread is usually a hedge created by way of going long in oil futures while shorting fuel and heating oil futures.

Parts That Impact Cracks

The proportions of petroleum products a refinery produces from crude oil can also affect crack spreads. A couple of of those products include asphalt, aviation fuel, diesel, fuel, and kerosene. In some circumstances, the percentage produced varies according to name for from the local market. 

The mix of products moreover is determined by the kind of crude oil processed. Heavier crude oils are tougher to refine into lighter products like fuel. Refineries that use more effective refining processes is also restricted in their ability to offer products from heavy crude oil.

Examples of a Crack

Single Product Crack

A single product crack presentations the difference between the prices of one barrel of crude oil and one barrel of a specified product. As an example, a crude oil refiner believes that fuel prices will keep robust over the next two months and wishes to lock inside the margins now. In February, the refiner notices that May West Texas Intermediate (WTI) crude oil futures are purchasing and promoting at $45 in step with barrel and June New York Harbor RBOB fuel futures are purchasing and promoting at $2.15 in step with gallon, or $90.30 in step with barrel. The refiner believes it is a favorable single product crack spread of $45.30 in step with barrel, or $90.30 – $45.

Since refiners achieve crude oil to refine the commodity into a petroleum product, the refiner decides to shop for the May WTI crude oil futures while at the same time as selling the June RBOB fuel futures. Consequently, the refiner has locked in a crack of $45.30.

A few Product Crack

Refiners and consumers moreover put into effect crack strategies on a few products. As an example, a refiner targets to hedge in opposition to the danger of increasing WTI crude oil prices and falling petroleum product prices. The refiner might hedge the danger with the 3-2-1 crack spread.

Using the equivalent futures prices and expiration dates for WTI crude oil and RBOB fuel, the refiner might achieve 3 crude oil futures contracts and advertise two RBOB fuel futures contracts. Assuming that June heating oil futures are purchasing and promoting at $1.40 in step with gallon, or $58.80 in step with barrel, the refiner would moreover advertise one futures contract on the commodity. Consequently, the refiner locks in a favorable margin of $34.80 in step with barrel, or ($58.80 + 2 * $90.30 – 3 * $45)/3.