How refined energy products trade

A manufactured commodity 

Crude oil is not usable as a fuel. It is a feedstock, and everything that is actually burned in an engine or a boiler has been made from it by a refinery that heats it, separates it into fractions by boiling point, and chemically reworks the heavier fractions into lighter ones. The products that come out are what the world actually consumes, and each of them has its own market, its own specification and its own seasonal pattern. Three of them are carried in the catalog: Gasoline RBOB, Heating Oil and Ethanol.

The important structural fact is that a product price contains two components. One is the cost of the input, which moves with crude or, in the case of ethanol, with the crop it is fermented from. The other is the processing margin, which is set by how much refining capacity is available relative to how much product is wanted. Those two components can move in opposite directions, so a product price can rise while crude falls, or fall while crude rises, and neither case is an anomaly.

What each of the three specifies 

• Gasoline RBOB. Reformulated blendstock for oxygenate blending, meaning gasoline in the form a refinery delivers it, before the ethanol that finishes it is added at the terminal. It is quoted in US dollars per gallon and is a North American specification. Its demand is transport, so it is tied to road travel and to the driving season rather than to industry.
• Heating Oil. A middle distillate quoted in US dollars per gallon. Its name understates it: the same distillate cut produces diesel and jet fuel, so the contract is used as the hedging reference for the whole middle of the barrel and its demand is freight, agriculture, aviation and heating together rather than heating alone.
• Ethanol. An alcohol fermented from a crop, in North America overwhelmingly from corn, and blended into gasoline as an oxygenate. It is quoted in US dollars per gallon and it is the instrument where the energy complex and the agricultural complex meet: its input cost is a grain price and its demand is a fuel demand.

The crack spread, and what it measures 

A refiner's economic exposure is not to the price of crude and not to the price of products. It is to the difference between them, because a refinery buys the one and sells the other and keeps whatever separates them after costs. That difference is called the crack spread, and it is the number a refiner hedges. The word crack refers to the process of breaking heavier hydrocarbon chains into lighter ones, and the spread is expressed per barrel of crude processed so that the input and the output can be compared in one unit.

Comparing them requires one conversion, because crude is quoted per barrel and products are quoted per gallon. The standard barrel used in the oil trade is a fixed number of gallons, so a product price per gallon multiplied by that number gives the value per barrel of product. The conventional composite spread weights the products roughly in the proportion a typical refinery yields them, and the widely quoted version takes three barrels of crude against two of gasoline and one of distillate.

The spread is informative beyond the refining industry, because it separates two questions that a crude price alone conflates. A wide spread says product demand is strong relative to the capacity available to make it, which is a statement about refineries. A narrow spread with a high crude price says the constraint is upstream instead. Reading a rise in a gasoline price as a rise in the oil price without checking which of the two components moved is the standard error here.

Seasonality, and why it is written into the specification 

Gasoline carries a seasonality that is regulatory as well as behavioural. Fuel sold in the warm months must meet a stricter limit on how readily it evaporates, so refiners switch to a summer blend that is more expensive to produce, and back to a cheaper winter blend afterwards. The transition dates are set by regulation rather than by the market, and the futures contracts for the months either side of a transition are written on different specifications, which is why the price step between them is not a forecast of anything.

Demand seasonality runs alongside it. Road travel peaks in the northern summer, distillate demand peaks with winter heating and with the freight and harvest cycles, and refineries schedule their major maintenance in the shoulder periods between the two peaks, deliberately taking capacity offline when it is least needed. A maintenance season that overruns, or an unplanned outage at a large refinery, removes supply at the moment there is least slack elsewhere.

Ethanol has a different calendar again, because its input is harvested once a year. Its cost base moves with the corn crop, and its demand is set principally by the blending requirements written into fuel regulation, so a change in a mandate or in the treatment of the compliance certificates attached to it moves the market for reasons that have nothing to do with either energy or agriculture in the ordinary sense.

Who trades them 

• Refiners, hedging the spread between the crude they buy and the products they sell rather than either price on its own.
• Blenders, terminal operators and distributors, who hold physical product in tanks between the refinery and the retail site and are exposed to price for as long as they hold it.
• Transport consumers. Airlines hedge jet fuel through the distillate contract because it is the liquid instrument closest to their actual exposure, and hauliers and shipping lines hedge diesel and bunker fuel similarly.
• Ethanol producers and the agricultural processors who own them, whose margin is the difference between a corn price and a fuel price.
• Financial participants providing depth on the other side, though it is materially thinner here than in crude.

When they trade 

The product contracts follow the same electronic session as crude, running from the Sunday evening open to the Friday close with a daily maintenance break, and the exact session for each instrument is published in its specifications. Depth concentrates in the North American morning, particularly around the weekly inventory release, which reports product stocks and refinery utilisation alongside crude. Outside those hours the product contracts are noticeably thinner than crude, and quoted spreads reflect it.

How a CFD on a refined product settles 

A contract for difference on a refined product references its price and settles in cash. No fuel is delivered and no tank is filled. Quotes are in US dollars per gallon, so the price is a small number quoted to four decimal places, and the contract multiplier is correspondingly large. The difference between the opening and closing price is multiplied by the number of gallons the contract covers, and that amount passes between the parties.

Profit and loss is calculated on the full notional value while only a percentage of it is posted as margin, so an adverse move is measured against the whole contract and a loss can exhaust the margin posted rather than being limited to it, with a favourable move measured identically. Product contracts are written on dated delivery months, so an instrument referencing one inherits that month's last trading day and is closed at the prevailing price or rolled into the following month on a date published in the specifications. Where a transition between summer and winter gasoline specifications falls between two months, the price difference across the roll reflects a change in what the contract specifies rather than a change in the market.