Crack Spread

Question

A refinery runs a standard 3-2-1 crack: it takes 3 barrels of crude and turns them into 2 barrels of gasoline and 1 barrel of distillate. Crude costs 80 dollars a barrel. Gasoline sells for 95 dollars a barrel and distillate for 110 dollars a barrel. Running the refinery (energy, labour, catalysts, process losses) costs 8 dollars per barrel of crude.

What is the net refining margin per barrel?

Accepted Answer

Let's first get the idea straight, because the number is easy once the concept is clear. A refinery is a form-transformation plant: it takes one input (crude oil) and converts it into a slate of products worth different amounts. The crack spread is the difference between the market value of the products a refinery makes and the cost of the crude it buys. It is the traded proxy for the refining margin, and the name comes from "cracking" heavy crude molecules into lighter, more valuable ones.

This is just form arbitrage: you are not betting on whether oil goes up or down, you are capturing the gap between what the finished products are worth and what the raw input plus processing costs. A refiner (or a trader) can even lock this gap in by buying crude futures and selling product futures at the same time, which fixes the margin regardless of where the flat price of oil goes.

Because a barrel of crude yields several products in roughly fixed proportions, the market quotes a standard recipe called the 3-2-1 crack: 3 barrels of crude produce 2 barrels of gasoline and 1 barrel of distillate (diesel or heating oil). That is the recipe we are given, so let's work it step by step.

Step 1: the input cost.
Three barrels of crude at 80 dollars each: \begin{equation} 3 	imes 80 = 240 \end{equation}

Step 2: the output value.
Two barrels of gasoline at 95 dollars, plus one barrel of distillate at 110 dollars: \begin{equation} 2 	imes 95 + 1 	imes 110 = 190 + 110 = 300 \end{equation}

Step 3: the gross crack.
Output value minus input cost, spread over the three barrels of crude: \begin{equation} \frac{300 - 240}{3} = \frac{60}{3} = 20 	ext{ per barrel} \end{equation} So the gross crack is 20 dollars a barrel. This is the figure you will most often see quoted, but it is not what the refiner actually keeps.

Step 4: subtract operating costs to get the net margin.
Running the refinery is not free: energy, labour, catalysts, and the fact that a little of the crude is burned or lost in processing. Here that costs 8 dollars per barrel of crude. The net refining margin per barrel is therefore the gross crack minus the operating cost: \begin{equation} 20 - 8 = 12 	ext{ per barrel} \end{equation}

So the net refining margin is 12 dollars a barrel.

Sanity check
Let's recompute the whole thing in total dollars across the three barrels and divide once at the end, to make sure the per-barrel arithmetic lines up. The products are worth 300 dollars, the crude costs 240 dollars, and processing costs $3 	imes 8 = 24$ across the three barrels: \begin{equation} 300 - 240 - 24 = 36 	ext{ across 3 barrels} \end{equation} Divide by the three barrels of crude: \begin{equation} \frac{36}{3} = 12 	ext{ per barrel} \end{equation} Same answer, 12 dollars a barrel, so we are consistent.

One last thing worth understanding, because it is the whole reason traders watch the crack. The crack is a spread, not a flat-price bet: it can widen while oil falls and shrink while oil rises. Notice what happens if crude rallies to 90 dollars while the products lag and stay put. The gross crack collapses from $\frac{300 - 270}{3} = 10$ a barrel, and after the 8 dollars of opex the refiner is barely above breakeven, so it may cut runs or bring the maintenance forward. The crack compresses when crude gets expensive relative to products, and fattens when products outrun crude. When the crack is fat, refineries run hard and pull in every barrel of crude they can, which feeds straight back into crude grade differentials.

So a refiner with this slate is pocketing about 12 dollars of real margin on every barrel it runs!

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Crack Spread

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