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The Market's Measure

Another Winter, Another Profit for Oil Traders

The crack spread pays off again.

I’m no biblical scholar, but I have handily quoted one verse from the Old Testament since I was a pup. It’s the third chapter of Ecclesiastes: “To every thing there is a season, and a time to every purpose under the heaven.” I can thank the Byrds for that, not Sunday school.

We financial types, especially those trading in commodities, deal with seasonality all the time. And not just for agricultural commodities. There are seasons in the energy market as well.

Imagine you’re an oil refiner. Your business is essentially a distilling operation in which you buy crude oil and sell finished products such as fuel oils and gasoline. Your distillation process, known as “cracking,” sometimes produces big margins and at other times profits are much thinner, or non-existent.

Fall and winter tend to be times when the “crack spread” tends to widen, when crude oil costs lag distillate prices. Aside from winter seasonality, refinery maintenance cycles and sustained product demand can also bolster the crack spread.

Recently, we reported that “buying” the crack spread in late October and holding the position—short crude oil and long for both heating oil and gasoline contracts—until late February can be a reliable money-maker for futures players. We set this out in a column published just before Halloween.

In that column, we also pointed out that you needn’t be a futures trader to take advantage of winter seasonality. A widening refining margin is often reflected in the stock prices of oil refiners as well. This is, in fact, 10 of the past 13 winters in which the share price of Valero Energy Corp. (NYSE: VLO) has climbed along with the crack spread. This year’s gain (Oct. 24 to Feb. 23), at 19.0 percent, was pretty average (the mean return over the past 13 seasons is 18.2 percent, with a range between 57.4 and -13.9 percent).

If you want more global exposure to refiners, there’s the VanEck Vectors Oil Refiners ETF (NYSE Arca: CRAK), which tracks an index of about two dozen oil outfits including VLO as well as Phillips 66 (NYSE: PSX) and Marathon Petroleum Corp. (NYSE: MRC) and a raft of foreign entities. CRAK’s only been around since 2015, so there’s only a three-season track record. This winter, CRAK gained 7.1 percent, on the heels of an 8.9 percent gain the previous season. In its inaugural year, the ETF’s winter gain was 2.4 percent. CRAK’s gains may seem tame compared to VLO’s, but that’s largely due to the dilutive effect of currency exposure. Two-thirds of the CRAK portfolio is held in foreign names.  

What’s ahead for the oil business? The most recent Energy Department report showed a surprising drawdown in U.S. crude inventories, triggering a bit of a run-up in domestic benchmark prices. Outsized export sales are credited for much of the offtake. Stepped-up U.S. shale production and a shrinking price differential between domestic and foreign benchmark grades may allow inventories to ramp up again. In short, the spread’s under pressure now, which, given normal cyclicality, isn’t likely to be relieved until late spring when gasoline demand ramps up.

Brad Zigler is WealthManagement’s Alternative Investments Editor. Previously, he was the head of Marketing, Research and Education for the Pacific Exchange’s (now NYSE Arca) option market and the iShares complex of exchange traded funds.

TAGS: Equities
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