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What Is A Crack Spread?

What is a crack spread?

October 18, 2016

A Dynamic Commodities Exclusive

In the world of commodities, a processing spread is the price differential for taking one raw material and refining or turning it into another. There are many examples of processing spreads across the myriad of commodities that trade on futures exchanges around the world.

When it comes to crude oil, the processing spread for refining petroleum into oil products are crack spreads. The reason for the name, oil is passed through a catalytic cracking process in a refinery where the molecules of hydrocarbons transform into products like gasoline, heating oil, diesel fuel, jet fuel, and other products of the raw energy commodity.

The cracking process occurs as crude oil heats to varying temperatures. Oil is composed of hundreds of different hydrocarbon molecules that separate through the refining process. There are three steps in the process: separation, conversion, and treatment. During separation, crude oil is heated in a furnace so that the hydrocarbons separate by their boiling point. Inside refining towers, heated petroleum vapors separate into fractions according to weight and boiling point. The lightest fractions, which include gasoline, rise to the top before they condense back into liquids. The heavier fractions settle at the bottom as they condense earlier.

Conversion is changing one hydrocarbon into another using heat and pressure to break heavier elements into lighter ones. Alkylation is another common process which is the opposite of cracking; small gaseous byproducts are combined to form larger hydrocarbons.

Treatment is the final process of refining, and it is the most time-consuming part of the process. Treatment includes combining processed products to create various octane levels or to remove sulfur from fuels to meet environmental requirements.

The hydrocarbons in gasoline have a carbon chain from 4 to 12 carbons. In heating oil, the carbon chain length is from 8 to 21 carbon atoms. Heating oil and fuel oil are less pure than other refined oil products and contain a broader range of hydrocarbons and contain more pollutants when burned. Jet fuel has specific characteristics and must have low flammability and a very low freezing point as planes fly at high altitudes with very low temperatures.

The crack spread is the economics of refining raw crude oil into any of these oil products. Gasoline and heating oil crack spreads trade on the New York Mercantile Exchange. The level for a crack spread is often a real-time indicator of the profitability of those companies that refine gasoline. The higher the crack spread, the more money they earn. When crack spreads fall refineries make less money and in some cases can experience economic losses.

In the oil industry, companies operate in different parts of the business. Exploration and producing companies are directly involved in searching for and extracting the raw energy commodity. The share prices of these enterprises tend to move up and down with the price of raw crude oil. Oil servicing companies that provide infrastructure and other necessary components to exploration and producing firms will move higher and lower as business conditions within the oil patch vary with the price of petroleum. The share prices of those companies that are involved in refining only are at risk for changes in crack spreads. These companies buy raw crude oil at market prices and then sell their refined products at market prices. The economics of the crack spread ultimately defines their profitability. Therefore, when investing in oil refining companies, it makes sense to monitor crack spreads for gasoline and heating oil. You can find these cracks spreads on the NYMEX division of the Chicago Mercantile Exchange website. Additionally, crack spreads often signal periods of high or low demand for raw crude oil as the petroleum is the input required to produce products.

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