The Negative Crack Spread | FT Alphaville

The Negative Crack Spread

Ah,the crack spread..

Bread and butter to the gasoline trader, unequivocal jargon to every body else..

But there is more reason than usual to look at it. The spread, which is the difference in price between WTI Nymex front-month futures and Nymex Rbob (gasoline) futures – the so-called refining margin – has gone negative. And it’s been negative since October 3. Note this chart from a Seeking Alpha post:
Crack Spreads

The above indicates that it’s currently not at all profitable for refineries to be running crudes into gasoline. More worrying, the heating oil crack has also been narrowing this month, meaning there’s fewer profits in producing middle distillates too. Middle-distillate demand (which goes into making diesel) had been the one saving grace for the products market, with refineries depending on the crack to make good on their p&ls. Many analysts even noted how the shift away from gasoline and towards distillates (presumably as US drivers switched to diesel-run cars) was leading to a situation where gasoline was after a point effectively becoming a by-product.

With these sorts of shoddy fundamentals, it now like many refineries will be forced to shut down units.
As Stephen Schork of ‘The Schork Report’ puts it:

The government is not the only one facing financial difficulty from the “problem” of Americans driving less. The benchmark NYMEX gasoline crack has not traded positive since October 03rd! Over the last week both Sunoco and Valero have reduced gasoline output because of poor economics.

Olvier Jakob of Petromatrix also warns the return of hurricane-hit capacity will only heighten the problem:

US refinery runs have come back from the storm induced lows and are close to the levels of a year ago. This will not be sustainable until demand starts to improve. Gasoline production units are starting to be put off-line and it is questionable on how long runs can be maintained purely through the HeatOil crack. The 3-2-1 Futures refinery margin is eroding further and refiners will need to cut inventories to support margins which will then push oil producers to cut supply to support their revenues. The process will be done in waves rather than in a straight line until overall leaner inventory levels can create the supporting tensions that have disappeared from the demand side.

So unless shutdowns begin, inventories will continue to rise – perhaps explaining the unusual seasonal build in distillates last week. As Stephen Schork noted:

Net distillate supplies rose for a second straight month. As of October 24th, supplies rose by 2.3 MMbbls or 1.9 percent. At this time in the season (start of heating demand, peak harvest) supplies typically draw. However, net stocks have increased by more than 2.0 MMbbls over the last two reports.

So what does this all mean? According to Schork it means Americans are clearly driving less, and markedly so. According to the latest numbers from the Federal Highway Administration (FHWA) Americans drove 15 bn fewer miles than a year ago, with the August decline the largest year-on-year on record. The FHWA has even warned there are costly implications for road and bridge repair programmes which are paid from federal fuel taxes. Note graph below:
Traffic Figures

Of course it’s never that simple when it comes to reading the US products market. There are regional differences, product specification differences and transportational constrictions all affecting prices. For one, the regions are split into different PADDs (Petroleum Administration for Defense Districts).
PADD I & II, representing the East-coast and the Midwest, are of greatest interest to market watchers eyeing economic trends, falling as they do in the industrial heartland of the US. PADD III meanwhile is where most of America’s oil and refinery infrastructure is based – so another important location.This week we saw an overall build in distillates, but there were regional variations. The same is apparent for the crack spreads, where margins are still positive, for example, in the Gulf coast – presumably due to ongoing hurricane-related shutdowns limiting production.

In gasoline, overall stocks fell last week by 0.8 per cent according to EIA data, but there are other factors to consider. Most analysts say the fall was in line with seasonal norms and therefore shouldn’t be read as a pick-up in demand just yet – something the negative crack certainly reinforces.

Harry Tchilinguirian, Senior Oil Market Analyst at BNP Paribas writes:

…the level of contraction relative to the same period a year-ago is still deep at above >3%. Demand is still weak mostly due to ‘conservation’ (rather than ‘destruction’). And while a rebound in demand may not be likely yet, we do expect that gasoline demand will stabilise given the sizeable decline in prices at the pump, (now significantly below $3 a gallon nation-wide).

It seems there is no escaping the broader demand trend and what’s worse many don’t expect a reversal any time soon. As Schork writes:

The relative weakness in overall gasoline blending reflects the lousy economics. For instance, last week the implied crack on the NYMEX for the winter-spec contracts (Dec-08, Jan-09, Feb-09 and Mar-09) all finished negative, i.e. RBOB below the price of crude oil. What’s more, the entire strip for the 2009/2010 winter finished negative as well.

Clearly, demand for gasoline is off… and with it, demand for ethanol. On the other hand, aside from a one week pop in September related to hurricane related disruptions, retail gasoline has dropped at the pump in 14 of the last 15 weeks since the 04th of July holiday.

So whatever the WTI price of crude does, the negative crack spread is worth remembering. Until it goes away stocks will likely continue to build – a bearish signal for oil. Note below the latest stock data relative to a 5-year average, courtesy of BNP Paribas:

Gasoline Stocks - BNP Paribas