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Regarding the comment from Norm about refinery margins being more
important to CHV versus the absolute price of gasoline etc/ and Don's
attempt at the charting of this spread...
Here's some more info on all that:
a/ There are 3 types of companies in the oil business: The oil
extractors, the oil refiners, and the oil marketers/shippers
(pipeline companies, gas stations etc) - and of course the
ancilliaries that support the whole infrastructure like Schlumberger.
b/ In the whole food chain, it doesn't matter to anybody what the
absolute price of ANYTHING is - not crude, not gaso/heat, not any of
the other derivative products & chemicals. The only place where price
of crude oil makes a difference is to those countries sitting on
reserves, whose revenues go up/down with Crude prices.
c/ The whole food chain makes money off of the spreads between demand
time pricing & supply time pricing, the crude-to-product conversion
pricing, and the tactical retail market spot pricing relative to spot
futures pricing.
d/ Most companies in this sector experience cyclicality, of boom-bust
proportions. The larger ones have learned to offset some of the
cyclicality with either hedging their margins or buying into
upstream/downstream food chain capacity. They have also learned to
store money for bad cycle times and to use it to their advantage to
do the acquisition activity during that bad cycle time. The smaller
ones running undercapitalized operations during boom times either get
wiped out or get bought out during the busts.
e/ Therefore, almost everything we see these days in the media is
hype. Gas price $2/gal at retail incl tax ($1.00 wholesale, which is
pretax, by the way) doesn't do diddly squat for a refinery if its
crude cost was higher than $42/barrel, and that's at cost-of-
production.
f/ In reality, therefore, refiners make money if the conversion from
Crude Oil into refined products (heat, gaso, lots of chemicals) can
be resold for greater than the cost of the crude plus the cost of
conversion plus the overhead of maintaining/running that conversion
machinery, people, electricity, storage of crude etc. That conversion
process is collectively referred to as "Cracking" and the resultant
margin desired to make money is called the "Crack". The two products
on which futures are traded in America are Heat & Gaso, so we have
the Heat Crack and the Gas Crack.
g/ However, once a barrel of crude is emptied into the hopper, you
don't get only heat or only gaso as the output. You end up getting
both, and with some tinkering you can get more of this or less of
that, but you gotta live with both (and all the other chemicals).
h/ Therefore the market compensates the refiner for producing heating
oil in gasoline season, and the reverse in winter - by building in a
storage + financing that storage component.
i/ This compensation sets a "floor" on the crack margin that you will
get to see on the exchange traded derivatives. Rarely (like it did in
99) will a crack trade negative. If that happens beyond bad data and
beyond a single session, then the market is paying the producer to
produce less of that commodity, but the market will in turn give the
other crack extra margin because sub-standard margin on both products
will make the producer stop producing altogether.
j/ This flows through with a lot of financial filtering to the
operating margins statements of refineries, best seen at SEC-Edgar.
k/ Mr Jennings commented on seasonality, and this year we had two
simultaneous occurences: The driving season arrived as it usually
does, and the market gave gasoline crack a lot of margin - of the
type seen rarely in history. This happened long enough for the
financial engineering geniuses at refineries to not shield it too
much, hence you see all refineries across the board showing huge
sequential and yoy gains.
l/ Why the market gave the gas crack so much boost is not my place to
answer, but it did, and thence the profits. These typically get
hidden in the larger, diversified companies like Shell, Exxon,
Chevron because they are typically hurting elsewhere (which is why
they diversified in the 1st place). In this year, they are hurting
from inability to find pricing power for their Crude oil inventory,
they are hurting from their inability to get more crude out of
Indonesia due to unrest relative to the crude they get out of Saudi
(there is a 22% cost difference) or elsewhere. This hurting is in
relation to LAST YEAR's prices, of course - on an absolute cash flow
basis they are making out like bandits. They are hurting because
there is a demand for simultaneous capital outlays in pipelines, in
refining, and there is a high profile energy crisis fostered by
entities and events outside their control, but they get blamed for it
anyway (Big Oil). And they know that the entire food chain gets
cyclical pricing power - in that they are making out like bandits
this year, but that does not guarantee pricing power even this winter.
m/ For Don Ewers and anybody else interested in charting cracks: It
may pay for you to chart the contracts' equity values against one
another, instead of just contract a price from quote feed minus
contract b price from quote feed. You'll still get the same picture,
but you'll understand better how much/less the refinery component is
making this year.
n/ Supply relationships between different months are also measurable
and tradable, and they are economic reality based. This is why you
will see gasoline in latter months of summer being traded at lower
prices than the front month gaso, there is no shortage in the
intermediate term even though shortages may develop today/next week.
Whatever shortages exist today/next week will be easily taken care of
by the time the back month contracts become front month contract -
after all, this is a sub-100% capacity utilization industry. This is
probably why Don is unable to match his Wave 3's for contracts out
into the summer - and this is why continuous contracts really don't
add value to the trader of energy derivatives. Perhaps the grain
traders would understand this because they have to deal with winter
crop etc details.
I hope this gives some perspective.
It may pay, therefore, to trade Chevron for Chevron chart reasons
instead of trading it due to refinery margin expansion reasons.
However, Valero is a different kind of energy company, so there the
impact of refinery margins may be the better predictor of margin
expansion/contraction.
More info on cracks etc are at Nymex's website, www.nymex.com
Gitanshu
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