Tuesday, September 12, 2006

Tracking Oil Futures and Crack Spreads -- FTO, VLO

FutureSource.com has free premium charts for tracking futures prices. For example, for Oct 2006 delivery:
You can play with the URL to get different size charts, as big as you like. You can also do combinations with formulas like this:
For oil refining companies, the maximum possible profit is generally considered to be the revenue from selling gasoline and heating oil minus the cost of crude oil to produce them -- this is known as the "crack spread". The typical ratio in a crack spread is 3 barrels of crude oil produces 2 barrels of gasoline and 1 barrel of heating oil, which is known as the "3-2-1 Crack Spread". Since unleaded gasoline and heating oil are quoted in price per gallon, their prices need to be multiplied by 42 to get the price per barrel (42 gallons per barrel).

For most refineries, the crude part of the crack spread is the light, sweet variety. But two companies in particular have complex refineries that can handle a lot of heavy, sour crude instead, which is a lot cheaper than light, sweet crude -- FTO and VLO. Currently, San Joaquin heavy crude is about $53/B compared to $65/B for light-sweet. That $12 light/heavy spread is a source of additional profits for refineries specializing in heavy crude. Since most refineries use light, sweet crude instead, the prices of gasoline and heating oil are more strongly influenced by the price of light-sweet than heavy-sour. This means that companies like FTO and VLO can maintain excellent margins compared to companies that can only refine light-sweet, especially as the light/heavy spread widens -- i.e. as crude oil prices climb overall.

At the same time, when the price of crude falls, the heavy-light spread tends to narrow, thus decreasing the margins for FTO and VLO. So, if the price of crude continues to fall like it has for the last week, FTO's and VLO's stock prices may take an extra heavy hit, due to expectations of wider light/heavy spreads having previously been priced into those stocks.


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