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Do you know what a crack spread is, and how it translates into the state of the oil market? Listen to this clip to find out.
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Investors with a short-term perspective can buy the stock of Mangalore Refinery and Petrochemicals Ltd (MRPL) at current levels. On Wednesday, MRPL jumped 4.5 with good volume breaking above the key...
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Reuters  Apr 12  Comment 
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Oil refinery in Alaska

From crayons to jet fuel, refined petroleum has myriad uses in the modern economy. When extracted from the earth, crude oil has a characteristically obsidian color. Gasoline and other fuels, for example, are nearly clear. Oil refining is the process that takes us from crude oil to refined finished products.

The central process in refining involves distillation, or heating crude oil to a variety of different temperatures, utilizing the different boiling points of its various components to separate them. These components are then further refined (e.g., "cracked" into shorter chains of hydrocarbons) and/or mixed with additives to create end products.[1] In addition to distillation, lower quality crude oil undergoes a more complex refining process because there are more impurities to remove.[2]

In general, the role of the oil refiner is to use these processes to transform low-valued feedstock into higher-valued, refined petroleum products. Refining and distribution represents the "downstream" piece of the oil value chain, where crude oil that has been located and extracted is refined for consumer use and shipped to airports, power plants, and, of course, gas stations, where it is ultimately consumed by end users.[3] Oil refining can either be part and parcel of an integrated oil & gas operation like Exxon Mobil (XOM) or Chevron Corporation (CVX), or can occur independently.

Refineries come with a high price tag, they typically cost billions of dollars to build and millions to maintain. Facilities can be as large as several hundred footballs fields and workers may use bicycles to move around the massive complexes. In addition to their large size, refineries run 24 hours a day every day of the year.[4]

Companies Affected by the Price of Refined Petroleum

The prices of crude oil and refined petroleum products have an impact that reaches beyond the refining and oil companies. For airline companies the price of jet fuel is a crucial determinant of their flight costs and yearly profits.[5] During 2008, American Airlines (AMR), United Airlines (UAUA), JetBlue Airways (JBLU) and Southwest Airlines Company (LUV) each on average cut 10-15 older, less fuel-efficient planes in order to cope with rising fuel costs.[6] The transportation fees of shipping companies, like United Parcel Service (UPS) and FedEx (FDX), also are affected by the price of gasoline.[7] Gasoline prices also determine travel expenses for companies that own their own delivery vehicles.[8]

According the U.S. Department of Energy, 18 percent of crude oil is used in the production of petrochemical feedstock, mainly for synthetic rubber and plastics. [9] Therefore, crude oil prices directly establish the material costs for companies that manufacture petrochemicals, rubber, or plastics.[10] In particular, the material costs to produce tires and automobiles depend of the price of a barrel of crude oil.

Airline Travel Industry

Transportation Companies

Chemical Companies

Rubber and Plastics Manufactures

Tire and Automobile Companies

Mike,This might be a great fuel for our Farmers. If I had 5000 acres in sufolnwers or grain to harvest, I'd sure look hard at running this crude IF I could buy it cheaper. Opps.. I think I see the stopper right now, it's not low sulphur, it's not an EPA approved fuel.

Trends and Forces

Increases in freight and shipping activity boost diesel demand and profits

Approximately 9.6% more freight was moved by trucks in April 2010 than in same period in 2009, which has led to an increase in the need for diesel fuel.[11] Reflecting this, demand for the fuel increased 12% for four weeks ended June 11, 2010 compared to the same period in 2009.[12] With the increase in demand prices have also improved, as of June 2010 prices are nearly double their levels in June 2009. Due to a recovering economy, consumption of U.S. distillates are predicted to expand 1.4% this year, which is the largest annual increase since 2005.[13]

According to Valero CEO Bill Klessen April 2010, distillate demand in the world is growing at a rate two to three times greater than the rate of gasoline demand.[14] Declining domestic inventories in Europe have made it more profitable for traders to ship U.S. fuel to Europe than to purchase it domestically.[15] Competitors like Valero are responding to the increase in export demand by creating more diesel-making hydrocracker plants. Not only can these plants produce diesel for consumption in the U.S., but they also will continue to expand exports.[16]

Gasoline Demand and Prices Mimicking Price Shocks of early 1980’s

Percent Changes in Motor Gasoline Consumption and Other Indicators
1980 1982 2007 2008(forecast) 2009(forecast)
Motor Gasoline Consumption -6.5 -0.7 +0.4 -3.4 -0.6
Vehicle Miles Traveled -0.8 +2.7 -0.6 -3.8 +.4
Fuel Efficiency (MPG) +6.4 +3.4 -0.9 -0.3 +0.9
GDP -0.2 -1.9 +2.0 +1.3 -1.3

Source: EIA Weekly Petroleum Report, December 10, 2008[17]

According to an Energy Information Administration(EIA) report, gasoline consumption in 2008 is expected to drop 3.4 percent, or 320,00 bpd, from its 2007 levels and continue to decline 0.6 percent during 2009.[18] In the report, analysts at the EIA argue that declines in gasoline consumption during 2008 and 2009 are being brought about by consumer’s reaction to high summer gasoline prices, which peaked at $4.11 per gallon, as well as slowing economic growth.[19] Gasoline consumption declines are best reflected in highway travel, which declined by 2 percent in 2007 and 2008; real-fuel costs rose by 10 percent per year in the same period.[20] December 2008 crude oil prices, which were down up to 70% from their July 2008 levels, reflected investor’s beliefs that oil suppliers would not be able cut supply to match declining demand of refined products.[21] While refining margins improved for most of the second half of 2008, due to lower material costs [22], profit will remain a challenge for refiners because consumption of gasoline and other refined petroleum are expected to decline in 2009.[23] Meanwhile, the NYMEX crack spread suggests early 2009 gross refining margins of around 8% for refiners.[24]

Analysts at Merrill Lynch are predicting a barrel of crude oil to hit $25 in 2009 before slowly returning to its expected $70-$80 level in 2009.[25] For refiners, responding to these price cuts is a crucial determinant of its 2009 revenue and profit. If refining crude into gasoline continues to provide low or negative returns, many refiners will cut production or switch to producing more profitable petroleum products.[26]

Although crude and gasoline prices have been relatively low since September 2008, recession-conscious consumers and companies have been consuming less refined petroleum products.[27] Because sales of refined goods are the primary determinant of an independent refiner's revenue and profits, many refineries in the U.S. have cut refinery production, expansion plans, and equipment upgrades in order to generate some profit.[28] Integrated oil and gas companies have been able to offset refining declines with exploration and production operations. Unlike many small refining companies, the cash-heavy oil majors, like Exxon Mobil (XOM), have been able to spend during the recession and invest in producing more profitable energy products like diesel fuel.[29] Because future gasoline prices are uncertain and because independent refiners do not have as much on-hand cash, investments, whether in equipment or acquisitions, will continue to be a challenge. [30]

Refining Technology and Equipment: A More Important Role in a Refiner's Future

Although the known oil reserves in the world are approximately 1.2 trillion barrels, experts estimate that there are 4.6 trillion barrels of heavy and unconventional oil reserves.[31] At current U.S. consumption rates, 10 to 15 percent of these hard-to-refine oil reserves would last 70 years.[32] As the quantity of “light” crude declines, oil companies like Chevron have started investing in new refining technology that can convert oil with lower hydrocarbon levels, known as “heavy” crude, into light, clear gasoline.

When the price of light, sweet crude rose to $147 per barrel in July 2008, many of the Oil Majors began investing in equipment capable of producing and refining relatively-cheaper heavy crude oil.[33] However, investments in equipment designed to process heavy crude are expensive, and the cost-benefit ratiod depends on the price differential between light and heavy crude.[34] If the price of light crude rises, companies with substantial cash on hand will be able to upgrade or alter their refineries in order to extract more valuable, light refined products per barrel of low-valued heavy crude. Companies with these capabilities include Exxon Mobil (XOM), Chevron Corporation (CVX), BP (BP), Valero Energy (VLO), and Royal Dutch Shell (RDS'A).

If Demand for Gasoline is low, then Why did Prices rise in January and February 2009?

According to a report by the EIA, the average retail price of regular gasoline rose by 21% from the end of December 2008 to February 16, 2009.[35] However, the price for WTI crude oil, the NYMEX's most reported oil price, was volatile.[36] While the price of WTI on the New York Mercantile Exchange (NYMEX) did not indicate an upward trend in crude and gasoline prices, the prices of other types of crude oil have been rising during the first two months of 2009. An EIA composite price, which represents two-thirds of the crude oil input to U.S. refineries including imported crude oil, has risen by over $8 per barrel since the beginning of 2009.[37] The change of this composite's price reflects the changes in retail gasoline better that the changes of WTI.

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The spot prices of WTI, Brent, and U.S.-imported crude oil from November 2008 to February 25, 2009[38]

Gasoline prices have also increased as refiners produce more distillates and gasoline inventories decrease.[39] For refiners like Valero Energy (VLO), the profit margin on distillate products rose 30% in the third and fourth quarter of 2008, and, as a result, the refiner began processing more crude oil into diesel and jet fuel.[40] While gasoline profit margins were low, many refiners began producing distillate fuel as a more profitable alternative to gasoline. By producing less gasoline, refiners decreased the supply levels of gasoline relative to demand. As a result, retail gasoline prices began rising beginning in 2009. [41]

Gulf Coast Exposure to Hurricanes and Seasonal Storms

Accounting for nearly half of the United States' refinery capacity, the Gulf Coast and Louisiana refineries are among those most exposed to tropical storms and hurricanes. Given their exposure, the United States’ refining capacity is vulnerable to sharp declines in crude supplies and higher gasoline prices during the summer storm season. During the 2008 hurricane season, as Gulf Coast refiners shut down production to prepare for hurricanes Gustav and Ike, crude prices fell below $100 per barrel, a 50% drop from 3 months earlier, and gasoline prices rose.[42] Crude and gasoline prices moved in opposite directions because many offshore and coastal refineries closed in an effort to reduce damage, thereby reducing demand for crude while decreasing supply of refined petroleum. It took Shell (RDSA) two years to fully repair damages to the platforms, pipelines, and refineries destroyed by Hurricane Katrina.[43]

All oil and refining companies that operate on the Gulf Coast are vulnerable to storm damages. In particular, the majors have large operations in this region. Not only is it costly and time consuming to repair damages to oil refineries and offshore rigs, companies like Exxon Mobil (XOM), Chevron Corporation (CVX) , ConocoPhillips (COP) , and Royal Dutch Shell (RDS'A) had to temporarily stop production on several of their Gulf Coast rigs and refineries in order to prepare for the 2008 hurricane season.[44] In the United States, many independent refiners, like Western Refining (WNR), Valero Energy (VLO), and Sunoco (SUN), benefit from higher gasoline prices and reduced Gulf Coast competition during hurricane seasons.[45]

Seasonal Maintenance

Refinery utilization tends to drop early in the 4th quarter as well, as many refining companies do maintenance during this period. In the first week of April 2009, for example, refinery utilization was at 81.8%, as compared to 85.8% in November of 2008.[46]

Higher MPG and Environmental Standards

While consumers cut back highway travel during 2008 in response to high gasoline prices, the rise in ethanol content of motor gasoline has the potential to make the decline in gasoline consumption even larger. Ethanol production, measured in barrels per day, was 635,000 in 2008 and is expected to rise in 2009.[47] Another contributor to future declines in gasoline consumption is the fuel-efficiency response to high gasoline prices during the first half of 2008. According to an EPA report, motor vehicle fuel economies have risen 1.5 percent since 2005, reaching 20.6 MPG in 2007 and an estimated 20.8MPG in 2008.[48] The Energy Independence and Security Act of 2007 hopes to reduce the U.S.'s dependence on foreign oil by raising the automobile fuel economy standards to 35 mpg by 2020.[49] Although the $17.4 billion auto bailout package the Bush Administration approved in December 2008 does not have explicit fuel economy mandates for General Motors (GM) and Chrysler, the bailout is nonbinding and subject to change by the next administration in 2009.[50] Given Obama's pro-environmental stance during the election, the new administration is likely to mandate better fuel efficiencies on auto makers that receive money from the government.[51]

Refiners Entering the Biofuels Industry

Some oil refiners, including Valero Energy (VLO), are partnering with ethanol producers in an effort to hedge against an industry-wide shift towards biofuels. In Valero's case, the company has acquired seven ethanol plants from the bankrupt Verasun Energy (VSE). Valero stated that it plans to run the plants at full capacity, not in order to sell the biofuels independently, but rather in order to blend the ethanol into its gasoline - effectively, the acquisition of the plants are an attempt by Valero to vertically integrate, as the U.S. Renewable Fuel Standard act requires an increase in the volume of biofuels blended into gasoline.[52]

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