From the October 01, 2012 issue of Futures Magazine • Subscribe!

Exploiting crack spreads with options

Energy companies for which refining crude oil is a large part of their business are subject to variations in the crack spread: The difference between the cost per barrel of crude oil and the two major products of the refining, or cracking, process. The products are heating oil and gasoline, both of which have a certain amount of price volatility that is transferred, along with variations in the price of crude oil, to the crack spread. 

The energy crack spread is defined in terms of futures on crude oil, heating oil and gasoline. There are 42 gallons of heating oil, and 84 gallons of gasoline, for every three barrels of crude oil. Each heating oil and gasoline futures contract equals 1,000 barrels, or 42,000 gallons.

For example, on July 16, 2012, December 2012 heating oil, gasoline or RBOB (Reformulated gasoline Blendstock for Oxygen Blending) and crude oil futures had closing prices of $2.7932, $2.9711 and $87.10, respectively. To compute the crack spread, the total price of three barrels of crude oil, $261.30, is subtracted from the sale of 42 gallons of heating oil and 84 gallons of gasoline, and the difference is divided by three. This is what is known as the “3-2-1 crack spread”:

($117.31 + $249.57 – $261.30) / 3 = $35.19

Spread over time

Over the past five years, the crack spread has varied from a low near $5 to highs around $35. The current rising trend in the crack spread is shown on “Energy equities and the crack spread” (below). Although the difference between crude oil prices and a refiner’s product prices would seem to be a possible predictor of a petroleum company’s stock price, this chart does not confirm the theory. Note that two significant short-term price trends — up and down — are led by Valero and Tesoro stock prices. In any case, the equities are more volatile than the crack spread, with cumulative percentage changes varying over a 40-percentage-point range compared with the crack spread’s 20-point range. 

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