What Is a Crack Spread?
A crack spread refers to the normal pricing difference between a barrel of crude oil and the petroleum products refined from it. It is an industry-specific type of gross processing margin. The “crack” being referred to is an {{industry}} period of time for breaking apart crude oil into the phase products, in conjunction with gases like propane, heating fuel, fuel, delicate distillates, like jet fuel, intermediate distillates, like diesel fuel, and heavy distillates, like grease.
Key Takeaways
- A crack spread is all the pricing difference between a barrel of crude oil and the petroleum products refined from it.
- The price of a barrel of crude oil and the prices of the opposite products derived from it are not always in sync, ensuing within the spread in prices.
- The difference in prices is important to oil refiners as it will smartly have an effect on their get advantages margins.
- To mitigate the pricing likelihood, refiners use futures to hedge the crack spread. Futures and alternatives can also be used by consumers to hedge other investments or speculate throughout the oil market.
- Crack spreads can be used as a market signal for price movements in oil and mild products depending on whether or not or now not the spread is tightening or widening.
Working out a Crack Spread
The price of a barrel of crude oil and the rather a large number of prices of the products refined from it are not always in perfect conceivable synchronization. Depending on the time of year, the weather, international supplies, and a variety of other elements, the supply and demand for specific distillates ends up in pricing changes that can have an effect on the convenience margins on a barrel of crude oil for the refiner.
To mitigate pricing risks, refiners use futures to hedge the crack spread. Futures and alternatives consumers can also use the crack spread to hedge other investments or speculate on attainable price changes in oil and mild petroleum products.
Using a Crack Spread to Hedge Price Chance
The traditional crack spread strategies used to hedge against the ones risks comprise the refiner purchasing oil futures and offsetting the location by the use of selling fuel, heating oil, or other distillate futures that they’re going to be producing from those barrels.
Refiners can use this hedge to lock in a get advantages. Essentially, refiners need a robust positive spread between the price of a barrel of oil and the price of its refined products; that implies a barrel of oil is significantly reasonably priced than the subtle products.
To resolve if there is a positive crack spread, you take the price of a barrel of crude oil—in this case, WTI at $51.02/barrel, for example—and read about it in your decided on refined product. Let’s say RBOB fuel futures at $1.5860 in step with gallon. There are 42 gallons in step with barrel, so a refiner gets $66.61 for each and every barrel of fuel for a crack spread of $15.59 that can be locked in with futures contracts. This is the most common crack spread play, and it’s referred to as the 1:1 crack spread.
In reality, it is a little little bit of an oversimplification of the refining process as one barrel of oil does now not make exactly one barrel of fuel and, yet again, different product mixes are dependent on the refinery. So there are other crack spread plays where you buy 3 oil futures after which are compatible the distillates mix further closely, as two barrels worth of fuel contracts and one worth of heating oil, for example.
This is known as a 3:2:1 crack spread and there are even 5:3:2 crack spreads, and they are able to also be used as one of those hedging. For lots of consumers, then again, the 1:1 crack spread captures the basic market dynamic they are attempting to industry on.
Purchasing and promoting a Crack Spread
Usually, you could be each buying or selling the crack spread. If you are buying it, you expect that the crack spread will toughen, that implies the refining margins are emerging on account of crude oil prices are falling or name for for the subtle products is emerging. Selling the crack spread method you expect that the decision for for refined products is weakening or the spread itself is tightening on account of changes in oil pricing, in order that you advertise the subtle product futures and buy crude futures.
Finding out a Crack Spread as a Market Signal
Even though you aren’t having a look to industry the crack spread itself, it will smartly act as a useful market signal on attainable price moves in each and every the oil and mild product market. If the crack spread widens significantly, that implies the price of refined products is outpacing the price of oil, many consumers see that as a sign that crude oil will in any case upward push in price to tighten the spread once more up to ancient norms.
In a similar way, if the spread is just too tight, consumers see that as a sign that refiners will slow production to tighten supply to some extent where the decision for will restore their margins. This, in the end, has a dampening have an effect on on the price of crude oil. So, whether or not or now not you intend to industry it or not, the crack spread is worth maintaining a tally of as a market signal.
