Complex Made Simple

Crack spread falls after Opec meeting

Wednesday, June 8th, the Organization of the Petroleum Exporting Countries (Opec) decided to keep its production output quota unchanged. This surprised the market, since a production increase had been anticipated.

Just before the Opec-meeting, the West Texas Intermediate benchmark has been under pressure and was trading around $98 per barrel. After the OPEC-decision, not to increase (nor decrease) oil production, WTI rallied nearly 4% to (almost) $102.

Opec-members Algeria, Angola, Venezuela, Iraq, Iran and Libya refused to consider a production increase. Saudi Arabia on the other hand, already planned to increase its oil production, regardless of the group’s decision.

The Opec meeting was not quite a success. Saudi oil minister Ali Naimi even stated that the meeting was one of the worst meetings in the history of Opec, since the members were not able to reach an agreement. Some members wanted an oil production increase from 29 million barrels per day to 30.3 million barrels per day.

It is feared that the unrest in Libya and Yemen could jeopardize larger oil-producing nations in the region. The oil supply of Libya normally averages 1.6 million barrels daily and together with Yemen, those countries produce less than 4% of the world’s oil demand. Saudi Arabia and other members have boosted output to compensate for much of the diminished production.

Influence on crack spread

In my previous column Commodities plunge offers trading opportunity, I signalled that the 3:2:1 (WTI) crack spread was trading at record levels, while WTI was not even close to the all time high of around $145 per barrel. That implied that gasoline and heating oil were outperforming WTI. I stated that this could offer shorting opportunities of this spread: buying WTI and sell the components gasoline and heating oil.

Selling 3:2:1 crack spread means: sell 1 heating oil futures contract and 2 gasoline futures contract and meanwhile buying 3 WTI futures. To illustrate the price development of the crack spread, I inserted (pro forma) Bloomberg charts of the crack spread, which is just a benchmark and not really traded prices.

Interestingly: the yearly chart illustrates that since May, during the sell off in the oil market, the crack spread dropped from over 30 under 25. This meant that WTI (even falling severely) was performing stronger (or less weak) than gasoline and heating oil.

The intraday charts illustrate the performance of the components and the crack spread on June 8th, just after the outcome of the (failed) Opec meeting. While WTI was rallying and closed 2% higher, heating oil closed just 0.5% higher and gasoline closed even 0.4% lower, thus putting the crack spread under pressure.

Traders who bet on a decreasing crack spread, (so far) took a good call. A logical thought would be: if WTI rallies, the components will follow suit, but that is not always the case as the chart illustrate.

To trade (crack) spreads offers market participants more opportunities to earn money or to reduce risk in stead of taking a position (long or short) in just one underlying. For instance, when having a long position in WTI and a short position in gasoline and heating oil, even when WTI is falling, the position may show a profit.