EME 801
Energy Markets, Policy, and Regulation

Refinery Economics


Oil refineries produce value-added petroleum products from crude oil. Profitability is thus determined by several different variables:

  • Feedstock costs (primarily crude oil)
  • Fuel costs and other operational costs for the refinery itself
  • Costs of complying with emissions regulations (particularly NOx)
  • Market prices for the products produced.

Determining profitability for a specific refinery is very difficult since data on operational and environmental compliance costs are generally not available. A rough measure could be obtained by calculating the cost of crude-oil feedstock (though to do this with precision would require knowledge of the crude blends used in a specific refinery) and comparing that cost with the market value of the suite of products produced at the refinery. This still requires more information than might be publicly available for a typical refinery, and is subject to market conditions for the various products produced.

A useful but simplified measure of refinery profitability is the “crack spread.” The crack spread is the difference in the sales price of the refined product (gasoline and fuel oil distillates) and the price of crude oil. An average refinery would follow what is known as the 3-2-1 crack spread, meaning for every three barrels of oil the refinery produces an equivalent two barrels of gasoline and one barrel of distillate fuels (diesel and heating oil). This ratio of refined product output closely mirrors the composition in Figure 2.4, but remember that the crack spread is only a first-order approximation of how profitable a refinery would be at the margin! The higher the crack spread the more money the refinery will make, so it will be utilizing as much capacity it has available. Inversely, at some lower crack spread prices, it actually may be in the refinery’s best interest, due to costs for the plant, to scale back the amount of capacity utilized.

Calculating the 3-2-1 crack spread typically uses published prices for crude oil, gasoline and distillates. These prices are typically taken from the New York Mercantile Exchange. The NYMEX has traded contracts for crude oil and gasoline but no contract for diesel fuel (the most-produced of the distillate fuel oils). In calculating the 3-2-1 crack spread, prices for heating oil futures are typically used instead. Below is an example of how to calculate the crack spread, using data from 2012.

  • Oil Price: $84.54/barrel
  • Gasoline Price: $2.57/gallon
  • Heating Oil Price: $2.79/gallon
  • (remember that 42 gallons = 1 barrel)
  • (2 barrels * 42 gallons/barrel * $2.57/gal of gas) +
    (1 barrel * 42 gallons/barrel * $2.79/gal of heating oil) -
    (3 barrels * $84.54/barrel of oil) =
    $79.44 profit / 3 barrels of oil.
  • The crack spread would thus be $79.44 / 3 = $26.48/barrel of oil

The crack spread, of course, is not a perfect measure of refinery profitability. What it really measures is whether the refinery will make money at the margin – i.e., whether an additional barrel of crude oil purchased upstream will yield sufficient revenues from saleable products downstream. In reality, existing refineries must consider their refining costs in addition to just the cost of crude oil. These costs include labor (though that is generally a small part of refinery operations); chemical catalysts; utilities; and any short-term financial costs such as borrowing money to maintain refinery operations. These variable costs of refining may amount to perhaps $20 per barrel (depending on conditions in utility pricing and financial markets). In the example above, the true margin on refining would be $6.58 per barrel of crude oil – much lower than the simple crack spread would suggest.

The crack spread tends to be sensitive to the slate of products produced from the refinery. In the example above, we used gasoline and distillate fuel oil (heating oil) because those are two typically high-valued products, and U.S. refineries are generally engineered to maximize production of gasoline and fuel oil.

The crack spread is also sensitive to the selection of the oil price used. In the example above, we used the NYMEX futures price for crude oil, which recall is based on the West Texas Intermediate blend - a fairly light crude oil. Many U.S. refineries, however, are engineered to accept heavier crude oils as feedstocks. If there are systematic differences in the prices of heavy crude oils versus West Texas Intermediate, then the crack spread calculation (while illustrative) may not be sensible for a particular refinery.

The Energy Information Administration recently published a couple of good articles describing how the U.S. refinery fleet has been adjusting to changes in U.S. crude oil production. Not only has the quantity of crude oil produced in the U.S. been increasing rapidly, but the oil coming out of the large shale plays (like the Bakken in North Dakota) is much lighter than the crude oils typically accepted by U.S. refineries.

The first article, published on 7 January 2015

The second article, published on 15 January 2015