Wall Street Manna

An irreverent look at Wall Street

Thursday, September 27, 2007

Crack Spreads

The refiners have been getting clocked as they've been getting squeezed by the crack spread. What's a crack spread? The "3-2-1" crack spread is simply this: From 3 barrels of oil, you get 2 barrels of gasoline, and 1 barrel of heating oil. But it takes time to refine the oil. So the futures market can do it for you. If you buy 30,000 barrels of oil, and sell 20,000 barrels of unleaded gasoline and 10,000 barrels of heating oil for the next month you have a crack spread. And the wider the spread, the more profitable it is for refiners.

The price of oil has gone up, but gasoline hasn't. So now you have a crack spread as tight as Jessica Alba, and it's about $4, down from $24. So Tesoro (TSO 47.14), Valero (VLO 67.56), Western Refining (WNR 40.30) have all been beaten up. But it takes work to keep the crack spread as tight as it is now. I'm sure the administration has been jawboning the oil companies to keep the price of gasoline down, despite the rise in crude. But give it time, and nature will take it's course, and the spread will widen. And then the refiners profit margins will fatten.

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