Crack spread is the difference between input costs and output costs associated with the petroleum industry. Refinery executives are hedge this difference because profits are tied between the price of crude oil and the price of the refined products such as gasoline or diesel. It is called a “crack” spread because refiners use a process to “crack” crude oil into refined products. Refiners have substantial value exposure when the value of crude oil rises while the value of refined products such as gasoline go lower or remain stagnant. They limit this risk by hedging it through various of strategies. The crack spread is the differential obtained from the profit margin a refiner receives from obtaining crude oil and selling refined products all together. Because the refiners are on both sides of the petroleum market, there is an added risk presented unlike firms who specialize in either obtaining the crude oil or in the process of creating the end product.
Investors use crack spreads as a hedge against a refining corporation enterprise value. The uncertainty of a crack spread can cause doubts for investors because the refiner’s financial exposure is not fully understood or certain. There are situations where investors use crack spreads as a parallel trade part of their energy portfolio because of the benefits they obtain through spread credit from margining. The shift in crack spread can be used by investors as an indicator for where a company or even the whole petroleum market may shift in the short term.
When the crack spread is hedged, there are different ways to manage the price risk. Every refining company develops a strategy based upon the cash market operations and risks presented.
Crack Spread Strategies –
- Simple 1:1 Crack Spread
Compound your growth 