Dan Szubielski sends: I am not a large scale trader, just a college student that enjoys trading and the energy complex and wants to make a career of it one day, but I hope this offers some insight. I made the prospects here based upon many investors who might not fully understand how the crack works.

Many of you are asking how to trade crude right now and the products complex. It can be interesting if one considers the fundamental points of the season. As of right now, refining margins are very low. Historically around this time of the year, they usually are somewhat depressed usually. Currently, the Gulf Coast Feb 3:2:1 crack is trading at less then $10. Refiners (such as TSO, WNR, FTO, VLO and SUN) still have to pay the higher crude oil costs in order to refine products, and right now are most likely using what is left of their stocks and hedging out on future month contracts that are less backwardated. As crude prices moved up in Q4, a significant backwardated curve occurred, often resulting in the heavy draws of crude we are seeing to make these refined products, at this time mainly distillates. This should continue for a couple of weeks with refineries utilizing about 91% right now. Soon, refineries will begin maintenance and will begin to slow their “cat crackers.” This happens as they switch from refining less distillates to begin creating more gasoline production before the summer driving season. It is a little early right now though. February is usually the time when this begins. Those refiners will push as much crude thru as they can before this time. As this begins to happen (and could take a few more weeks beyond this point) the crack will begin finding support and start stabilizing.

A few things to consider this coming year. Once again the question relates to refinery problems of aging infrastructure, breakdowns and disruptions. Reformulated gasoline demand is expected to fall and already has in face of a slowing economy, but in spite of this demand is still higher then last year due to tremendous demand from Asia. Also, this year was a far different stretch from last year, we have oil near $100 barrel of oil that was purchased by refiners that was hedged out in November, December when prices were above $90 that will be ready for delivery. What happens if we have oil at $100 as the dollar continues to weaken from a credit crisis? Either way, this will weigh tremendously on independent refiners more so then the intergrateds. Refinery stocks are also quite tight, and heating oil futures showed this recently.

The import situation will be sensitive. This year is going to be another year for imports to hopefully relieve the pressure of a tight supplied gasoline market. Many companies already have ordered gasoline refined in other nations to be shipped to help cushion higher anticipated prices in the spring. If oil prices stay high and larger imports relieve pressure usually put on ref. gasoline, then we could have just minor drawdowns into spring as well as the weakening consumer on top of that. Refiners would thus suffer and crack spreads would move just marginally higher (without geopolitical or unaccounted-for instances). Lastly, margins are expected to be alot lower then they were going into spring of 2007. Gasoline stocks are predicted to be around 208 million barrels entering April, above last year’s average according to the EIA. Countering this is if refinery production slows and inventories remain tighter then expected, then we will have to rely on imports at a greater rate.

Bottom line is, although refiners are cheap, for these stocks to move higher we will need wider margins on the 3:2:1 crack and oil to come down a bit. I still personally believe oil will come down some, but prices are likely to stay elevated. Gas prices will most likely average over $3.45 this spring. Because of the higher demand along the west coast and mandates in California mainly, the West Coast reform crack could be the widest of any spreads across the region. California’s refinery shortages and blends often cause the crack to trade at wider ranges at times. Thus, $4 gasoline could be seen in California once again.

As a disclosure, I am long TSO/VLO but have not added to my position that I put on earlier this week. I am interested in WNR, and it has the potential to move higher as well. Independent refiners will trade solely on the spread, and if oil stays high VLO and MRO will also be utilized in my trades. I will accumulate and have also maintained a MINIMAL short position on Mar 08′, Apr 08 and May 08′ crude while long front month gasoline contracts. A spread trade would work too if one knows how to do so - ask a broker or leave a comment and I’ll try to help if need be.

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