The role of the refiner should not be underestimated as it allows crude products to be altered into a consumable good such as gasoline, diesel fuel or jet fuel. The refiner, just like the producer and consumer is incentivised by profits. Fortunately, traders can evaluate refiners profits by analyzing the margins they produce. The profit margins a petroleum refiner sees is referred to as the crack spread. One of the most well-known refinings crack spreads is the RBOB/Brent crack spread.
What is RBOB?
RBOB is an acronym for “Reformulated Gasoline Blendstock for Oxygen Blending”. This type of gasoline is used as the benchmark for gasoline trading on the Chicago Mercantile Exchange. The term “reformulated” describes gasoline that does not have any MTBE “Methyl tert-butyl ether”.
RBOB became the benchmark in the United States largely because of legislation banning gasoline with the chemical MTBE which was found in unleaded gas prior to legislation. MTBE was tied to the pollution of groundwater which threatened the health and safety of humans and wildlife. Since the legislation was introduced in the United States, RBOB futures has even become the new benchmark gasoline futures contract.
Each RBOB futures contract contains 42,000 of gasoline. RBOB futures contracts trade in US dollars per gallon. The smallest tick size for each contract is 0.0001 per gallon = $4.20. The Chicago Mercantile Exchange provide the most liquid RBOB contract.
What is Brent Crude Oil?
Brent crude oil is one of several types of light sweet crude oil that serves as the global benchmark for crude oil. Brent is described as light because of its relatively low density, and sweet because of its low sulfur content. Brent Crude is extracted from the North Sea and comprises Brent Blend, Forties Blend, Oseberg and Ekofisk crudes. Brent crude oil is used to price nearly 65% of all global crude oils.
What is the RBOB / Brent Crack Spread?
The term crack spread describes the difference between the value of gasoline and crude oil. The refining process turns crude oil into crude oil products. This activity is known as the downstream process of oil and gas companies. In the refining process, crude oil is heated and introduced into the distillation tower. In the tower, oil is broken down into various petroleum products. Liquids and gases are separated into components by weight and boiling point. The lightest components, such as gasoline rise to the top while the heaviest components, such as residual oil, fall to the bottom. Light components include gasoline, which is condensed from a gas back into a liquid.
There are two components to the profit margin that a refiner can achieve. The first is the difference between the price of crude oil and the price of gasoline. The second is the difference between the cost to generate gasoline and the price where gasoline can be sold is the profit margin. The cost to generate gasoline is the value of crude oil plus the distillation process.
The RBOB / Brent crack spread describes the difference between the price of RBOB gasoline and the price of Brent crude oil. RBOB Gasoline is quoted in US cents per gallon and Brent crude oil is quoted in US dollars per barrel. To generate an “apples to apples” comparison, the crack is quoted in US dollars per barrel. To create this quote, RBOB gasoline is converted into US dollars per barrel. This can be accomplished by multiplying RBOB gasoline by 42, which converts the cents per gallon quote into a US dollars per barrel quote. You can then subtract the price of Brent crude oil from the price of RBOB gasoline to derive the crack spread.
The weekly chart of the RBOB Brent crack spread shows that at times the crack was as high as $28 dollars per barrel and as low as -$5.5 per barrel. When the crack spread is negative there is no incentive for refiners to purchase and refine Brent oil. This generally occurs during a recession or Brent oil is artificially buoyed by supply disruptions. When the crack spread is elevated and the price is well above the cost for refiners to convert Brent into RBOB, there is a large incentive to purchase and refine as much crude oil as possible.
Brent versus WTI
Another very actively traded crude oil is WTI (West Texas Intermediate). This is another light sweet crude oil that is used in the refining process to create gasoline. WTI is the US benchmark and since the US is the largest consumer of gasoline world-wide, WTI is an actively traded crude oil benchmark.
Since both producers of WTI and Brent compete for the same refiners as customers, the spread between the two oils is an important metrics for refiners. WTI is quoted on the Chicago Mercantile Exchange for pickup in Cushing Oklahoma. This area is landlocked and therefore requires shipment via pipeline or rail. WTI is also quoted in US dollars per barrel.
The spread between Brent and WTI has been as high at $28 per barrel and as low as -$3.6 per barrel. When the spread is elevated there is an incentive for US refiners to purchase WTI over Brent. When the spread is negative, the reverse is the case.
- RBOB gasoline is the benchmark US gasoline traded in the United States
- Brent crude oil is the global crude oil benchmark
- The RBOB/Brent crack spread is the difference between the price of RBOB gasoline converted into dollars per barrel and Brent crude oil.
- WTI (West Texas Intermediate) is the US crude oil benchmark
- The Brent versus WTI spread describes the difference between the global benchmark of crude oil and the US crude oil benchmark.
This article is brought to you by the courtesy of Skilling.
This article was originally posted on FX Empire
More From FXEMPIRE:
- Classic Make or Break Session
- Facebook’s Libra Cryptocurrency is Already Facing Some Challenges
- GBP/USD Daily Forecast – A Potential Bear Flag is Forming
- Weak Job Openings Report Points to Slowing U.S. Labor Market
- U.S. Dollar Index Futures (DX) Technical Analysis – August 7, 2019 Forecast
- USD/CAD Daily Forecast – Bulls Resiliently Hovering Near Multi-Month Top