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

Exploiting crack spreads with options

Ethanol & corn

The growth of ethanol as an energy source requires adding the spread between ethanol and corn prices to the 3-2-1 crude oil, heating oil and gasoline crack spread.

During June 2012, Valero Energy Corp. idled two ethanol plants, each with more than 110 million gallons per year capacity. This action is due at least in part to the reduction in the margin of income over cost, as shown on “Ethanol/corn spread” (below). After a period of slowly declining positive margins, the price of corn accelerated much faster than the price of ethanol starting in mid-June (47% for corn vs. 32% for ethanol from June 18 to July 18). Although this situation is a temporary problem for Valero, it illustrates the need to expand the usual definition of crack spread to include other energy sources.

The relative importance of ethanol in Valero’s inventory mix was outlined in notes to the company’s financial statements dated March 31, 2011. Refinery feedstocks equaled $2.8 billion, refined products and blendstocks were $988 million, and ethanol feedstocks and products were $250 million. 

We noted that energy stock prices do not correspond well with the crude oil crack spread. One reason for this is the increasing role of alternative fuels and their varied impacts on earnings and stock prices. Another important reason is the hedging of costs (crude oil and corn, for example) by petroleum refiners and ethanol producers.

Ultimately, energy crack spreads may be viewed as a measure for the need to hedge, with declining positive, or negative, spreads resulting in a potential increase in the volume and open interest in trading of futures, options and swaps related to energy derivatives.

Paul Cretien is an investment analyst and financial case writer. His e-mail is

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