Crack Spread

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Written By
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Written By
Dan Buckley
Dan Buckley is an US-based trader, consultant, and part-time writer with a background in macroeconomics and mathematical finance. He trades and writes about a variety of asset classes, including equities, fixed income, commodities, currencies, and interest rates. As a writer, his goal is to explain trading and finance concepts in levels of detail that could appeal to a range of audiences, from novice traders to those with more experienced backgrounds.
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The crack spread is a measure of the profitability of refining crude oil into various petroleum products, such as gasoline, diesel, and heating oil.

It is calculated by subtracting the cost of crude oil from the combined sales price of the refined products. The crack spread is commonly expressed in dollars per barrel.

 


Key Takeaways – Crack Spread

  1. The crack spread is a measure of the profitability of refining crude oil into gasoline and diesel fuel. It is calculated by subtracting the cost of 3 barrels of crude oil from the revenue generated by the sale of 2 barrels of gasoline and 1 barrel of diesel fuel.
  2. A high crack spread typically indicates that the refining process is profitable and that the prices of gasoline and diesel fuel are higher relative to the cost of crude oil. A low crack spread indicates that the refining process is less profitable and that the prices of gasoline and diesel fuel are lower relative to the cost of crude oil.
  3. The crack spread is closely watched by investors and analysts as it is an indicator of the profitability of refining companies and the refining industry, which can impact the value of their stocks.
  4. The crack spread can be used as a market signal, reflecting the profitability of the refining industry and the demand for transportation, which can indicate the overall health of the economy.
  5. One way to hedge against changes in the crack spread is through the use of crack spread futures contracts or options on crude oil, gasoline, and diesel fuel futures, which allows traders and refiners to lock in a specific crack spread for a future date.

 

Trading the Crack Spread

There are several ways to trade the crack spread.

One way is to buy and sell futures contracts on the individual petroleum products and the underlying crude oil, sometimes referred to as a “crack spreader.”

This allows traders to take a position on the crack spread and profit from changes in the price relationship between the products and crude oil.

Another way to trade the crack spread is to use a financial instrument that allows traders to take a position on the crack spread without having to buy and sell the various underlying futures contracts separately.

Crack spreaders can be traded on exchanges or over-the-counter and can offer a more convenient and potentially more cost-effective way to trade the crack spread.

It is important to note that trading the crack spread carries its own set of risks and requires a thorough understanding of the refining industry and the underlying market fundamentals.

 

The Crack Spread As a Market Signal

The crack spread is considered a market signal because it reflects the profitability of the refining process and can indicate the overall health of the refining industry.

A high crack spread typically indicates a strong market for refined products and a healthy demand for gasoline and diesel fuel.

This can signal that the economy is growing and that there is an increasing demand for transportation.

A low crack spread, on the other hand, can indicate that the refining industry is struggling, possibly due to oversupply of refined products, weak demand, or high costs of crude oil.

This can signal that the economy is slowing down and that there is a decreasing demand for transportation.

Additionally, the crack spread is closely watched by investors and analysts as it is an indicator of the profitability of refining companies and the refining industry, which can impact the value of their stocks.

It can also be used as a benchmark to evaluate the performance of individual refining companies, and to compare them with other companies in the industry.

 

Introduction to Oil Refiners and Crack Spreads

 

FAQs – Crack Spread

What is a 3-2-1 crack spread?

A 3-2-1 crack spread is a measure of the profitability of refining crude oil into gasoline and diesel fuel. 

It is calculated by subtracting the cost of 3 barrels of crude oil from the revenue generated by the sale of 2 barrels of gasoline and 1 barrel of diesel fuel.

The result is an estimate of the profit margin for the refining process. 

The 3-2-1 crack spread is used as a benchmark for the refining industry and can be used to evaluate the performance of individual refining companies.

What does a high crack spread mean?

A high crack spread typically indicates that the refining process is profitable and that the prices of gasoline and diesel fuel are higher relative to the cost of crude oil. 

When the crack spread is high, refineries will generally increase production to take advantage of favorable market conditions.

This can lead to increased supply and lower prices for gasoline and diesel fuel.

Conversely, a low crack spread indicates that the refining process is less profitable and that the prices of gasoline and diesel fuel are lower relative to the cost of crude oil.

When the crack spread is low, refineries may decrease production or even shut down temporarily to reduce losses.

How do refiners make money?

Refiners make money by buying crude oil at a lower price and then processing it into various products such as gasoline, diesel, jet fuel, heating oil, etc.

They then sell these products at a higher price, generating a profit margin.

A high crack spread typically indicates a profitable market for refiners, while a low crack spread indicates a less profitable market.

Additionally, some refiners also engage in trading activities to make money by buying and selling various products and derivatives based on those products.

Refiners also make money by processing crude oil into various products, such as gasoline and diesel fuel, and selling them at a higher price than the cost of the crude oil.

Factors that can affect the profitability of refining include the price of crude oil, the demand for refined products, and the cost of operating the refinery.

Can I use options to trade the crack spread?

Yes, traders can also use options on crude oil, gasoline, and diesel fuel futures to trade the crack spread, which allows them to gain exposure to the crack spread while having limited risk.

It’s worth noting that trading futures and options contracts on crack spread carries its own risks, and it’s important to have a deep understanding of the market, the specific instruments, and the trading strategies before engaging in trading activities.

 

Conclusion – Crack Spread

The crack spread refers to the difference in price between crude oil and the refined products derived from it, such as gasoline and diesel.

The crack spread is used as a measure of profitability for refiners, as the spread represents the margin they earn from refining crude oil into finished products.

Crack spreads can be influenced by a variety of factors, including the price of crude oil, the demand for refined products, and the availability of refining capacity.

The crack spread is often used as an indicator of the health of the refining industry and can provide insight into the overall state of the energy market.