Master the dynamics of various crack spreads and perform market risk management.
You act in the role of a (crude and products) trader at an oil company.
You act in the capacity of aggressor.
Your task is to secure the future processing margin, by selling the so-called ‘crack spread’. This way, you secure the future cash flows relating to your oil refinery (i.e. hedging). In other words, source (purchase) the input commodity (hence, setup a long crude futures position) while you, simultaneously, sell the output commodities (hence, you set up short refinery product futures positions). On the basis of your realised prices, you should calculate the gross processing margin you have secured for your employer. For this calculation you need to consider the relative volumes of the crude versus the product slate (input-output ratio). As a matter of guidance, consider the following ratios which are reflected real-time (on screen) on the basis of actual market prices (mid price):
The 3:2:1 crack spread:
Spread = (the value of 2 barrels of gasoline, plus the value of 1 barrel of heating oil) minus the value of 3 barrels of crude.
The 5:3:2 crack spread:
Spread = (the value of 3 barrels of gasoline, plus the value of 2 barrels of heating oil) minus the value of 5 barrels of crude.
The 2:1:1 crack spread:
Spread = (the value of 1 barrel of gasoline, plus the value of 1 barrel of heating oil) minus the value of 2 barrels of crude.
Note: diesel is typically hedged with gasoline futures, while kerosene is often hedged with heating oil futures.
The aim of this simulation is manifold, namely to understand that there are different ratios for the crack spread, to see that all of them are dynamic and to experience that transacting requires swift action in all legs.
At the end of the simulation, analyse your performance. See what you have done and when you have done this and whether it could have been optimised. This way, you learn and optimise your competences.