Cracks Spreads

Cracks are a means of measuring a theoretical, per-barrel refining margin. A petroleum refiner must, on some level, consider the difference between the price of raw material required to produce a petroleum product and the market price of the refined product. Refined products like heating oil and unleaded gasoline come from crude oil, so petroleum refiners are subject to risks that individuals who sell crude oil at the wellhead are not. Cracks, an inter-commodity spread technique, enable you to measure this risk exposure.

There are a variety of crack ratios. The two more common ratios are 3:2:1, 5:3:2. Both of these ratios are designed to measure a different exposure to risk.

A crack ratio consists of three products: crude oil, gasoline, and heating oil, respectively. While crude oil trades in dollars per barrel, gasoline and heating oil trade in cents per gallon, so some simple math is required to convert gas and heating oil prices into the units necessary to make the ratio elements even. There are 42 gallons in a barrel of crude oil, so multiplying gasoline and heating oil prices by 42 achieves the necessary equality.

The Gross Cracking Margin (GCM) is calculated by adding the equalized prices of refined products (gasoline and heating oil), and multiplying the per-barrel price of raw material (crude oil) by the number of barrels specified by the ratio. The sum of refined products is then subtracted from the product of raw material (crude oil). This difference is then divided by the number of number of barrels of raw material (again, crude oil) employed by the ratio. This quotient represents a per-barrel value, or crack.

Gasoline output is roughly double that of heating oil and diesel fuel, so a high yield gasoline refiner employs a 3:2:1 crack. Obviously, the 3:2:1 crack is not useful to lower yield gasoline refiners, who employ the 5:3:2 crack ratio. Aspen Graphics provides user-defined formulae for these more common cracks.

Refiners use cracks to lock in the prices of raw materials, and to guarantee a particular profit for the refined product ultimately brought to market. To ensure a profit level that permits a refiner to stay in business, the refiner simultaneously buys raw material at a favorable price and sells a refined product at a particular profit, thereby mitigating any negative effects of future price changes.