Crack Spreads

A refiner buys crude oil and sells gasoline and diesel. Its profit isn't the crude price or the product price alone — it's the gap between them, the cost of turning one into the other. That gap has a name traders actually use: the crack spread, and it can be bought or sold as a position of its own, separate from taking a view on whether oil is going up or down.

Where the name and the ratio come from

"Cracking" is the refining process that breaks (cracks) heavy crude hydrocarbons into lighter products like gasoline and diesel. A simple crack spread is just:

$$\text{Crack spread} = P_{\text{product}} - P_{\text{crude}}$$

In words: the price of one barrel-equivalent of refined product minus the price of one barrel of crude that went into making it.

Because a refinery yields several products from each barrel, not just one, traders use ratio spreads that mimic a real refinery's output mix. The most common is the 3-2-1 crack spread: buy 3 barrels of crude, sell 2 barrels-equivalent of gasoline and 1 of heating oil/diesel, approximating a typical US refinery's yield.

$$\text{3-2-1 crack} = \frac{2 \times P_{gasoline} + 1 \times P_{heating\ oil}}{3} - P_{crude}$$

In words: average the revenue from the two products a refiner actually sells, weighted the way a refinery actually produces them, then subtract what the crude cost.

Worked example

Crude is $78.00/bbl. Gasoline is $2.35/gallon and heating oil is $2.55/gallon; since a barrel is 42 gallons, that's $98.70/bbl for gasoline and $107.10/bbl for heating oil.

1. Weighted product revenue: $(2 \times 98.70 + 1 \times 107.10) / 3 = (197.40 + 107.10)/3 = 101.50$
2. Subtract crude cost: $101.50 - 78.00 = 23.50$

The 3-2-1 crack spread is $23.50/bbl — roughly the refiner's gross margin per barrel processed, before fixed costs like labor and energy.

What this means in practice

A refiner can lock in that margin by selling crack-spread futures (or the equivalent combination of crude, gasoline and heating oil futures), protecting itself if crude prices spike faster than product prices can be passed on to customers. A speculator can trade the crack spread to bet purely on refining margins — say, tightening gasoline supply ahead of driving season — without taking directional crude risk at all.