Oil Prices and Gasoline Prices: An Interesting Divergence

Those trading energy stocks must always follow crude oil prices.  This is especially important for investors in Transocean, Inc. (RIG) and Global SantaFe (GSF), both stocks that we hold in trading and individual portfolios.

Even though the front-month spot price has a lot of variation, the energy ETF’s seem to follow the front month.  This makes no sense for stocks that are "upstream" like RIG and GSF,  but it fits the pattern.

We have observed that futures trading sometimes seems irrational.  The common scenario is that there is some problem with refinery capacity.  When these stories have hit in the past, often due to weather, crude oil futures have spiked.

Economic analysis suggests that the opposite should occur.  If refineries have reduced capacity, the demand for crude is reduced.  That demand curve should shift, leading to lower crude prices.

The countervailing force is trade in the "crack spread."  Traders study and trade the relationship between the price of a barrel of oil and the price of refined products, using ratios that vary according to the season.  When the crack spread reaches an extreme, there is a mean-reverting trade.  This causes buys in crude.

Today we saw an interesting divergence, noted in the Wall Street Journal.  Crude prices fell in the face of reduced refinery capacity.  This is new!

At "A Dash" we continue to believe that investors in energy stocks can use these moves to adjust  positions.  If the investor is focused on the long-term demand for future drilling, any dip provides an opportunity.


Equity investors do not study the futures markets and the forces behind that trading.  Those that do can gain a significant advantage in their stock trading.

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  • RB May 25, 2007  

    I’m afraid I did not understand what you were saying about the latest divergence. As I understand it from your explanation, the “crack spread” should prevent this from happening, so why do you suppose this is happening? (no WSJ subscription so perhaps you could elaborate)

  • Wolf Stone May 25, 2007  

    Hello Prof,
    Another discrepancy we see in the energy markets is that brent crude trading higher and west texas crude trading lower even though WTI is much better suited to gasoline refining. Just wanted to thorw this tidbit of information in as you were discussing crack spreads and divergences in energy !!

  • VennData May 31, 2007  

    The anticipation of the new Dubai oil contract plus the Kuwatis starting the de-linking to the dollar could have a bit to do with the WTI Brent spread beyond the obvious refinery issue

  • Jeff Miller May 31, 2007  

    Thanks to all for the comments. The various discrepancies in crude oil trading generate both short-term losses for those owning upstream energy companies, usually unwarranted, and also some opportunities.
    The crack spread is traded on a mean-reverting basis by many in the energy futures crowd. Sometimes the refinery capacity throws this off.

  • Mike July 5, 2007  

    Interesting. I had an entirely different–and much less appealing–interpretation of the phrase “crack spread”. 🙂