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Introduction to Oil Refiners and Crack Spreads


How are Refiners Differentiated?


SHAWN REYNOLDS: Refiners differ quite a bit relative to many other sub-industries or other companies in the energy industry in that they are not entirely dependent on oil prices for their gains or losses, as opposed to the upstream companies or even some of the oil service companies in the midstream, i.e., pipeline companies, for whom higher oil prices is a benefit to revenues. For the refining companies, crude oil is just the input to their overall complex. It is no different than making a loaf of bread. You need some wheat to make the loaf of bread. Even though the price of wheat is important, it's really the price of the loaf that is critical in terms of profitability. It is the same thing with oil. A refinery takes that oil, refines it into gasoline, kerosene, jet fuel, or diesel fuel, and it is the prices of those products that determine the ultimate profitability.


What is a Crack Spread?


REYNOLDS: A crack spread is the difference between crude oil prices and the products that they make. When a barrel of crude oil enters a refinery, it is refined into several different types of products. The most typical ones we talk about are gasoline, diesel fuel, fuel oil, kerosene, or jet fuel. Typically one barrel of crude will make a fraction of a barrel or you can say the typical crack spread is 3-2-1. Three barrels of crude oil make two barrels of gasoline and one barrel of diesel oil. It is the pricing of those two barrels of gasoline and that one barrel of diesel oil less the price of the barrel of crude; that is a generic crack spread. That is currently the general way we look at profitability margins within the refining sector.


How Sensitive are Refiners to Crude Oil Prices?


REYNOLDS: They are fairly sensitive. There is a bit of a lag, particularly on the retail side. But on the wholesale side, which is what the refinery receives, it is close, particularly on the spot. There might be a short term lag, but when oil prices go up there is some sort of following usually. It depends on the demand side for the individual products. Cracks themselves, that is crack spreads, which are the difference between the oil price and the product price, are very sensitive to the overall supply and demand on the product side. However, there certainly is some general movement in oil price and in following with a little bit of lag.