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The wonderful part of this analysis is that
there is no
blame assigning.
Nothing but simple accounting of the facts
of the energy
business as it applies to oil.
I started in this business in 1955 and have
been through
several "boom/bust" cycles which were
characteristic of
the business in the past -- certainly the
companies have
found ways of ameliorating the boom/bust
characteristics
of the business with good financial
planning.
BUT, it ain't near the fun it was when we
really depended
on the "wildcatters" for
excitement.
Clyde
- - - - - - - - - - - - - - - - - - - - - - - - - - - -Clyde
Lee
Chairman/CEO (Home of
SwingMachine)SYTECH
Corporation email: <A
href="mailto:clydelee@xxxxxxxxxxxx";>clydelee@xxxxxxxxxxxx 7910
Westglen, Suite 105
Office: (713) 783-9540Houston, TX
77063
Fax: (713) 783-1092Details
at:
www.theswingmachine.com- - - -
- - - - - - - - - - - - - - - - - - - - - - - -
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----- Original Message -----
<DIV
style="BACKGROUND: #e4e4e4; FONT: 10pt arial; font-color: black">From:
<A title=onwingsofeagles@xxxxxxxxxxxxx
href="mailto:onwingsofeagles@xxxxxxxxxxxxx";>onwingsofeagles@xxxxxxxxxxxxx
To: <A title=realtraders@xxxxxxxxxxxxxxx
href="mailto:realtraders@xxxxxxxxxxxxxxx";>realtraders@xxxxxxxxxxxxxxx
Sent: Tuesday, June 05, 2001 19:19
Subject: [RT] CHV, Refinery margins
etc
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.comGitanshuTo
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