The crack spread is the difference in market price between the finished products (gasoline and heating oil) and the feedstock (usually crude oil). The higher the crack spread the better for the refiners of energy products, and also for the profits of the refiners, as the happy shareholders of Valero (VLO), Tesoro (TSO), Marathon Oil (MRO). Frontier OIl (FTO), Western Refining (WNR) and others have found out. This morning's 60/40 crack spread is over $19 per barrel, to the delight of this group, which went through about seven quarters of losing money in 2009 and early 2010. (Note: 60/40 is just the weighted average using 60% of the unleaded margin, and 40% of the distillate margin.)
Here's a graph of the 60/40 crack spread since the introduction of the RBOB contract in 2005:
The five-year average crack spread has been $11.25 per barrel, with a standard deviation of $5 per barrel which means that two-thirds of the time this number fluctuates between $6 and $16 per barrel, so this little period over $19 is rare, and welcome indeed. Most of the independent refiners need a refining margin of about $9 per barrel to cover their conversion costs and make a little money to keep the lights on. Things have been looking up since fall, despite the rally in crude oil prices.
Here is the differential between gasoline and heating oil. Gasoline usually trades at a slightly higher price, but the opposite has been the case lately. The condition started at the same time as the crude oil price rally started last fall. Today's differential is 24 cents, and except for the chaos period in 2008 this is a pretty unusual condition: The 5-year average differential is 6 cents; since January 1, 2010 the average has been 3 cents, so the current differential is an unusual condition.
So it is not too much to say that the current situation is unusual, and attributable to relatively higher distillate prices. Going into winter, that is also not too big of a stretch of the imagination.
According to the EIA, last week's PADD-I (Northeast U.S.) inventory of distillates was over 60 million barrels. Even for this chilly area of the country, this is on the high end, so there is not a shortage condition. Every few years, during a severe winter, there is a big drawdown in inventory, the last one of which was in 2003, when we went from 50 million barrels down to 25 in the six weeks starting at the end of January, so even a winter like that would still leave a pretty sizeable inventory by the time the weather warms up.
The final piece of evidence is from the experts themselves: The nation's refiners only ran at 82% capacity last week ... which suggests that the real experts in this business, the people who are trying to make money at it, think there are enough finished products around or else they'd be willing to produce more of them. The distillate and unleaded demand are still both well below 2007 levels, and there are plenty of products around.
If you're looking for an example of how temporary these high margins can be, you need only look at 2009:
in a 10-day trading period, starting in early February, the crack spread went from nearly 20 down into the single digits as the weather thawed out a little.
So, the evidence is, the current situation on refining margins is temporary, probably weather-driven, and could turn around pretty quickly. Obviously a lot can happen ... political chaos on one hand, and pledges by OPEC to keep the market well supplied on the other ... and as we keep saying, the world is chaotic.
There are plenty of counterarguments, but keep all of this in mind when looking at the quarterly reports of Valero and Tesoro and the other refiners as they come out in the next couple of weeks.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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