Apetroleum refiner, like most manufacturers, is caught between two markets: the raw materials he needs to purchase and the finished products he offers for sale. The prices of crude oil and its principal refined products, heating oil and unleaded gasoline, are often independently subject to variables of supply, demand, production economics, environmental regulations, and other factors. As such, refiners and non-integrated marketers can be at enormous risk when the prices of crude oil rise while the prices of the finished products remain static, or even decline. Such a situation can severely narrow the crack spread, the margin a refiner realizes when he procures crude oil while simultaneously selling the products into an increasingly competitive market. Because refiners are on both sides of the market at once, their exposure to market risk can be greater than that incurred by companies who simply sell crude oil at the wellhead, or sell products to the wholesale and retail markets. Market participants have been trading crack spreads — also known as intercommodity spreads — on the New York Mercantile Exchange, Inc., for more than a decade, using heating oil, gasoline, and crude oil futures. The term derives from the refining process which “cracks” crude oil into its constituent products. In recent years, the use of crack spreads has become more widespread in response to dramatic price fluctuations caused by extreme weather conditions or political crises. The impact of extremely cold weather in recent winters, the Persian Gulf crisis of 1990 through 1991, record low prices and depressed margins in 1998 and early 1999, the run-up of prices in 2000, and other world and national events have sometimes generated high margins for refiners and marketers, but at other times severely squeezed their profitability. Other changes in market conditions and practices can have a more subtle, but still significant impact on prices. The recent controversy over environmental rules governing the formulation of gasoline and the sulfur content of distillate fuels has certainly been felt in the marketplace.
