Refiners play a huge role in the global energy sector. They convert crude products into consumable items, like petrol, diesel and gasoline. Like the producers, refiners too are driven by profits. Their profits margin is known as “crack spread.”
A basic crack spread represents the price difference between the end-products (which translates into refiner revenues) and the cost of crude oil. The price of crude oil is one of the vital costs for refiners. Crack spreads are quoted in US Dollars per barrel. It is volatile in nature, because commodity prices can be volatile.
For energy traders, these crack spreads are important to understand. Refiners mitigate inflation risks by hedging the spreads through oil futures. Futures traders can use the crack spread to hedge against other investments or speculate on future oil price fluctuations. One of the most followed crack spreads is the RBOB/Brent Crack Spread.
RBOB stands for “Reformulated Gasoline Blendstock for Oxygen Blending.” This is a benchmark for gasoline trading on the Chicago Mercantile Exchange (CME). This newer blend of gas contains 10% ethanol, without any MTBE (Methyl tert-butyl ether). The RBOB futures provide a way for market participants to speculate or hedge in the gasoline market.
Gasoline is refined from crude oil. So, there exists a high degree of correlation between RBOB gasoline futures and crude oil prices. Some of the global factors that influence crude oil prices also impacts RBOB futures.
This futures contract is cash settled. It is quoted in US Dollars and cents per gallon. Each contract contains 42,000 gallons of gasoline. So, if the futures are trading at $3/gallon, the value of the contract will be ($3 x 42,000) or $126,000. The units of trading are usually 1,000 barrels, where each barrel contains 42 gallons of gasoline.
RBOB gasoline is generally used as vehicle fuel, generator fuel and pressure washers. The United States is the largest consumer of gasoline globally, so demand in the country is a huge factor in RBOB gasoline trading momentum. This gas futures tends to fall in the winter months of November to January and rise during April and May, when US consumers go on road trips for their summer vacations.
Extracted from the North Sea, Brent Crude oil is a light sweet crude oil that serves as a global benchmark in oil trading. The Brent/RBOB crack spread is calculated as the price difference between Brent crude oil and that of RBOB gasoline. Brent Crude is quoted in US Dollars/barrel.
Refiners look for positive crack spreads, which means they want the finished goods to be sold at a higher price than the cost of crude oil. So, suppose the price of Brent crude is $68.00/barrel and the RBOB gasoline is priced at $1.75. There are 42 gallons per barrel, so the price would be $1.75 x 42, which is $73.50.
So, a refiner gets $73.50 for every barrel of gasoline, for a crack spread of $5.5/BBL, which can be locked in with futures contracts.
When the crack spread is negative, the refiners (US-based refineries) don’t have an incentive to purchase and refine Brent Crude oil. This can happen in recessionary periods or when supply disruptions cause shortages.
Traders can go long or short on the crack spread. If they go long, they usually look for the refining margins to grow stronger. This could mean that crude oil prices are falling or that refined products are high in demand. Shorting the crack spread means that crude oil prices could be rising or demand for refined products is low. A trader could sell the RBOB futures and buy Brent crude futures.
The crack spread could also be a signal of future market conditions. If this spread widens, it could indicate that price of refined products is rising in comparison to crude oil price. Many investors could see this as a possibility of future crude oil price hikes. When the crack spread tightens, refiners are likely to go easy on supply, until a point where demand gets back on track to restore their profit margins. This means that crude oil price could decline in the future.
The factors that influence global crude oil and refined oil prices also impact the RBOB/Brent Crude crack spread.
The balance between global supply and demand for oil affects prices. Recently, non-OECD (Organisation for Economic Cooperation and Development) countries have been consuming more oil due to economic development. Production outside the OPEC (Organization of the Petroleum Exporting Countries) nations has increased, with the US producing large quantities of shale oil. OPEC countries are major price setters. They meet periodically to decide on oil supply and price levels.
The rising demand for renewable sources of energy, like solar power, nuclear and natural gas, also plays a role in this equation.
Rising demand for car fuel creates greater demand for gasoline. Higher oil prices can lead to higher gasoline prices. Also, other groups of similar products, like jet fuel, kerosene and heating oil, have all unique demand drivers.
Supply is impacted by refinery capacities. A greater number of refineries operating might lower the value of the crack spread. Extreme weather conditions, like earthquakes and hurricanes, can force refineries to shut down, creating a short-term spike in the crack spread. Also, major refineries have “turnaround periods,” where they deliberately close down to carry out maintenance or repair. This also temporarily raises refining crack spreads.
Crack spread can vary across geographical locations. Brent Crude is considered easier to extract than the West Texas Intermediate (WTI). The relative ease of transportation for Brent and its high quality play a major role in its adoption as the major oil benchmark price for trading.
RBOB futures are traded on the CME, under the ticker RB. These futures are traded on margins, which can magnify losses too. It is prudent to deploy risk management tactics to prevent any downside risks.