Why Refining MLPs Are Benefiting from Rising Crack Spreads
High-Return Refining MLPs: The 4 Investors Should Watch
Crack spreads
The refining process involves transforming crude oil into refined products such as gasoline, diesel, and fuel oils. The crack spread measures the difference between the price of the refined product and the price of crude oil. The benchmark US Gulf Coast 3:2:1 crack spread is a popular crack spread measure. It was $14 per barrel on August 26, 2015. The year-to-date average spread is $17.80 compared to an average of $7 per barrel in the last quarter of 2014. The US Gulf Coast region accounts for more than 50% of the total US refining capacity.
The US Gulf Coast 3:2:1 crack spread assumes that refining three barrels of crude oil produces two barrels of gasoline and one barrel of distillate fuel. It’s calculated by deducting the price of three barrels of WTI (West Texas Intermediate) Cushing crude oil from the combined price of two barrels of US Gulf Coast conventional gasoline and one barrel of US Gulf Coast ultra-low sulfur diesel. You can read more about it in Crack Spread 101 (Part 1: What’s a crack spread?).
How crack spreads impact MLPs
The rise in crack spreads reflects the decline in crude oil prices without a proportionate decline in the prices of refined products, especially gasoline, over the last one year. This helps improve profitability of refining MLPs such as Alon USA Partners (ALDW), Calumet Specialty Products Partners (CLMT), Northern Tier Energy (NTI), and CVR Refining (CVRR), as their input costs decrease more than the decline in revenues. The above graph shows the US Gulf Coast 3:2:1 crack spread over the last 12 months. NTI forms 1.6% of the Multi-Asset Diversified Income ETF (MDIV).
Investors should note that crack spreads vary according to region due to the regional differences in the prices of crude oil and refined products. For example, ALDW benefited from the oversupply of West Texas crude oil in the Midland region during the second quarter of 2015. The MLP has its refinery in Texas. Logistical and infrastructure constraints in the region limited the transport of Permian Basin production to Cushing and to the Gulf Coast during the quarter. ALDW benefited by sourcing crude oil input directly from Midland at depressed prices. This also eliminated the cost of transportation to and from Cushing. Thus, an increase in the WTI Cushing less WTI Midland spread favorably impacts ALDW. An easing of the logistical constraints, on the other hand, could adversely impact ALDW.
Next, we’ll see how crack spreads relate to refining MLPs’ operating margins.
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