‘Tis The Season To Be Oily

My kids groan whenever I try to regale them with tales of the past. The grumbling begins as soon as I say “You know, back in my day …”

Groan alert: I’m about to regale you.

I come from the commodities world — a place where real goods like gold, soybeans and crude oil are traded. And back in my day (cue the grumbling) we traders speculated on the profitability of oil refining by keeping a close eye on the “crack spread.” The spread’s earned for cracking input crude oil into distillates such as gasoline and heating oil.  

If you want to emulate the refining and merchandising cycle now, you’d buy three December light crude contracts and simultaneously sell short two January RBOB gasoline contracts together with one January ULSD fuel oil contract. At current prices, that would lock in a crack spread of nearly $14 a barrel.

That’s not bad, considering spot crude oil’s selling for $50 a barrel. In fact, that translates into a gross refining margin (GRM) of better than 27 percent. Still, the margin’s been fatter. A lot fatter. Back in February, when crude oil prices tumbled below the $30 level, the crack spread was worth $20 a barrel as the GRM spiked above 77 percent.

February, in fact, tends to be a peak time for GRMs. You can see this in the chart below which plots the GRM — based on a 3-2-1 crack spread – against the spot oil price.

(Click on image to enlarge)

You can see that refining margins tend to be inversely related to oil prices. Crude prices drive the cost of gasoline and gasoline, in turn, makes up the bulk of the crack spread’s sales side.

There’s a confluence of forces at work on the petroleum complex in the first quarter of each year. In February, the petroleum industry begins its switchover to summer blend fuels. Domestic gasoline demand is lowest then, so that’s when refinery maintenance is typically scheduled. These turnarounds require the shutdown of refinery process units for anywhere between one to four weeks. On average, refineries schedule turnarounds every four years, so about one-quarter of the country’s refining capacity can be offline sometime in the year’s first quarter.

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DisclosureBrad Zigler pens Wealthmanagement.com's Alternative Insights newsletter. Formerly, he headed up marketing and research for the Pacific Exchange's (now NYSE Arca) ...

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