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Crack Spread 101 (Part 3: Crack spread volatility)

Ingrid Pan, Sr Energy Analyst

Continued from Part 2

Several commodity products depend on prices, which means crack spreads are extremely volatile

As we’ve seen, crack spreads can be extremely volatile. In the U.S. Energy Information Administration’s (EIA) own words, “Because the 3:2:1 crack spread is a product of the interplay of three commodity prices, each subject to different but interconnected supply and demand balances, the range of values can vary widely. Product supply shortages resulting from serious disruptions such as hurricanes or other refinery or pipeline outages can cause large spikes of short duration.”

As you can see in the graph above, the Gulf Coast 3-2-1 crack has ranged from below $0.00 per barrel at points to over $40.00 per barrel in just the past five years. This variation makes a huge difference for refiners’ profits. The table below shows various measures of crack spread levels, showing the standard deviations, averages, minimums, and maximums of three benchmark 3-2-1 crack spreads.

Note that one factor in crack spreads is a refinery’s location, and we’ll discuss this consideration later in this series.

(Read more: Bakken crude begins to trade at premium to WTI, benefiting North Dakota names such as Whiting)

Because crack spreads are volatile, so are refining companies’ earnings

Crack spreads are a major determinant of refinery earnings. Due to the volatile nature of crack spreads, earnings of refining companies can also vary widely from period to period. Because refiners’ earnings can be volatile, refiner valuations can be too. Additionally, refining stocks tend be higher beta than other energy stocks.

(Read more: Brent crude prices advanced along with WTI crude, but tighter spread)

The chart above displays the betas of various pure-play refiner stocks versus some of the most prominent master limited partnerships (MLPs) and upstream energy stocks as well as the AMLP (Alerian MLP ETF) and XLE (Energy Select SPDR Fund). Generally, pure play refiners are higher beta than upstream energy companies and MLPs.

(Read more: Why ethane stopped trading like crude and started trading like nat gas (part II))

Continue to Part 4: Effect on refiner margins

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