Checked Your Crack Spread Lately?
Research for Online Investors

by John Dalt

12/02/09

One of the things that can lower your IQ is listening to a politician.  When I served on a local school board, every proposal to curtail spending was met with, “We just want what is best for the children.”  After being beat over the head with this a few times, I began every proposal with, “We all want what is best for the children.”  It didn’t always stop the mantra, but left some speechless because they did not know what else to say.

Every discussion about energy independence involves some repeat of this statistic.  “The U.S. hasn’t built a refinery in the last thirty years!”  Every politician has it written on a 3 X 5 card, ready to pull out, like “break glass in case of a fire.”

This is like scratching a chalkboard to me.  The U.S. doesn’t build refineries; private business still does this piece of heavy lifting.  The government has passed so many regulations, who in their right mind would risk capital to site a new refinery?  The cost of compliance with regulations has made operating a refinery a marginal business, why go to the expense of building a new one?  New refineries are being built overseas, and in the newest twist, on floating platforms so they have no government oversight.

There are no “new” refineries in the U.S., but many have been expanded.  The refining business was actually very profitable from 2004 through 2007 as Americans drove to hockey games and work.  Retail gasoline prices pushing $4.00 per gallon slowed down consumption in 2008, and it has not recovered.  Lower demand combined with cheap refined products, coming from locations with less regulatory cost, have made the refining business in the U.S. a loser.

Profitability in refining is measured by the “crack spread.”  This refers to the chemical process to ‘crack’ the large crude oil molecule to smaller refined product’s molecules.  Crack Spread is the difference in the cost of crude oil and the price at which the derived refined products can be sold. A barrel of oil is 42 gallons, producing approximately 28 gallons of gasoline and 14 gallons of distillates (diesel).  Multiply these numbers times the wholesale price for each product.  The total of these numbers is the gross proceeds for a barrel of refined crude oil.  Subtract the cost of crude oil; the balance is the “crack spread.”  You can come close to the wholesale price of refined products by subtracting $0.20 from the cheapest retail price found.  This approximates the retail markup and transportation costs from port or wellhead to pump.

If gasoline is $2.44 per gallon and diesel is $2.56, subtract 0.20 to arrive at wholesale prices.

28 x 2.24 = 62.72
14 x 2.36 = 33.04

Gross:        95.76
Crude:       - 79.50
Crack Spread:
                 $16.26

The crack spread approached $40 after Hurricane Katrina because of shutdowns and shortage of refining capacity.

There are ancillary products such as propane and asphalt, but they make up a small portion of the refiners operation.

According to the Energy Information Agency (EIA), refining capacity in the U.S. has actually increased in the last decade, because of the expansion of existing refineries.

This week’s inventory report showed a 2.1 million build in crude oil supplies.  This was larger than expected.  I expected a larger drop in imports than the actual 500 thousand barrels.  I also expected gasoline stocks to drop with heavy holiday travel, they did not.  Gasoline stocks actually increased 4 million barrels.  Distillate stocks decreased 1.2 million barrels, but there is so much distillate you could miss this much.  Inventories of distillates are 32% above last year’s levels.

Maobama did a nice job of boring us to death last night.  He should make a few trips to Afghanistan, like President Bush did to Iraq.  Osama might give up if he had to listen to the Teleprompter President day and night.

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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