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Commodity Investor Q&AWith Matt BadialiWednesday, June 17, 2009 Q: Here go the oil companies again, jacking up our gasoline prices. Do they all do this together so they can make a ton of money or what? – C.L.
A: Actually, C.L., the big refiners aren't making money on gasoline right now. The "crack spread" is historically narrow. Take a look...
The "Crack Spread" Is Low Once Again
 The crack spread is the profit margin (expressed as a percent) refiners can collect on the products they make. Essentially, it's the difference between the cost of a barrel of oil and the price of the products that oil becomes. The exact combination of products changes from refinery to refinery. I use a simple weighted average of gasoline, diesel, jet fuel, and heating oil to give me a broad measure of the overall refining industry.
As you can see above, the crack spread ebbs and flows, but at 13%, it's low these days. Gasoline might be matching crude oil's rise, but the prices of diesel, jet fuel, and heating oil haven't gone up nearly as fast.
And thanks to the low margins, refining stocks didn't budge when practically the entire oil industry rose double digits. Valero gained 2% from March 1 to today. In that same time, the Dow Jones U.S. Oil & Gas Index (a composite of 100 oil-industry companies) is up 35%.
The last time the crack spread was this low, from August 2007 to August 2008, the five largest independent refiners lost $32 billion in market value. Shares of the largest independent refiner, Valero, fell 44%.
But once crack spreads start to tick up, refiners can be lucrative trades. In 2004, the crack spread went from 11% to 27% in three months, and Valero shares shot up 80%. In 2005, a move from 8% to 32% in the crack spread drove Valero shares up 40% in two months.
The key for refining stocks will be a falling oil price. If current prices for gasoline and diesel hold, we'd need oil to fall back to $55 per barrel, a 20% decline, before the crack spread reached 30%.
Traders should look for a steady decline in crude oil prices. That will be your signal to load up on these beaten-up refiners. Until then, keep your distance.
Good investing,
Matt Badiali
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