Monday, October 24, 2005

CRACK SPREADS READY TO FALL! (no link as subscription is required) posts the price of heating oil versus crude to show that the crack spread is huge. The laws of economics will not let this situation last long term. This winter is going to tough. Heating oil and natural gas will both still be at high prices this winter but probably not as high as current prices. Again, the laws of economics and the simple fact that various refineries will restart soon mean that the crack spread will narrow sharply. This means the retail price of heating oil is going to drop faster than the wholesale price over the next few months.

The crack spread is tricky to figure because wholesale prices are posted in price per barrel and retail prices are posted in price per gallon. Also, the calculation is usually based on the 3-2-1 formula for converting 3 barrels of crude into two barrels of heating oil and one barrel of gasoline. This formula changes a little based on the set of the refinery and the relative sweetness of the crude.

The calculation is not the important point. The reality is that the price of oil, metals and a number of CRB items were causing an inflation scare. As these prices decline, the rational for focusing on core inflation will become apparent. The jump in price of crude from $59 to $71 is fast becoming irrelevant because it was a short term blip. It costs consumers a significant sum of money in the short run but it caused many to park their SUV and to drive the family "little car". Demand for gasoline is down 4%! This is a huge number. Annual growth for many years has averaged only 1.2%. We are now using at the rate of 4 years ago!

As the oil price falls, are you making money? The rotation is out of oil and into transportation and technology. I suspect there will be a bounce in oil but rather than play the bounce, I would go for the longer term plays. Non bankrupted legacy carriers such as CAL and AMR, out of bankruptcy carriers such as LCC and technology stocks. One can also seek safe haven and good profits in consumer staples such as WMT.