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How to assess the logic of market value chain volatility through chemical price gaps?

Chemicals operate in an industrial chain mode, and the value chain transmission in the chemical industry chain is a key indicator for analyzing price fluctuations in the chemical industry, which is also known as “spread” in the industry. The concept of spread is very broad, including the spread of cracking unit, the spread of refining unit, and the spread between chemical products and raw materials. Due to the complexity and diversity of chemical production units, it is almost impossible to assess the actual cost of production, which emphasizes the importance of “spreads” in market analysis.

Cracking spread is an important analytical indicator for chemical production. Cracking spread refers to the price difference between cracking unit products and raw materials, mainly the price difference between ethylene and naphtha. Because the cracking unit is the main source of chemical production, and there are differences in the processing costs of each enterprise, the cracking spread is used in the industry to reflect changes in the profitability of the cracking unit. Where the wider the spread, the more profitable the production of the chemical, and vice versa.

As the concept of crack spread in chemicals continues to grow, the so-called crack spread also exists in the oil refining industry, where the price difference between refined oil and crude oil is also known as the crack spread, or refining spread. In addition, crack spreads are usually denominated in U.S. dollars, which need not be analyzed too much.

As crack spreads represent different meanings, there are differences in the factors affecting crack spreads in different segments.

In the chemical production chain, the crack spread reflects the price difference between the raw materials and products of the cracking unit, which is usually measured according to the market price in US dollars, and the industry mostly uses the US dollar price difference between ethylene and naphtha. Therefore, the factors affecting the change of cracking spread in its chemical chain are ethylene price, naphtha price, crude oil price and crude oil quality. The correlation between crude oil and naphtha is 90% and above, which is a strong correlation, so the price fluctuation of crude oil directly determines the price fluctuation of naphtha, and therefore has an impact on the crack spread.

In addition, different crude oil quality, out of the ethylene yield is different, such as light crude oil production of light naphtha as cracking raw material, ethylene yield in 35%-40%, while heavy naphtha output ethylene yield in 30%-35%, resulting in the cost of ethylene there are differences.

In addition, in actual operation, the feed structure of each enterprise’s cracker unit may change, in which, in addition to naphtha as the main feed product, by-products from crackers and refineries, such as ethane-rich gas, cracked C5, LPG, ethane, etc., will also be used. The change in the feed structure brings about a change in the yield of the output products, which in turn affects the profitability level of the overall cracker unit and has an impact on the cracker spread.

In the refining segment, one of the factors that has the greatest impact on refining spreads is the relative proportions of various crude oil refined products that a refinery produces, and since a refinery’s output varies depending on the configuration of the unit, the types of crude oil it refines, and its ability to meet the market’s seasonal product demand, there are different types of refining spreads that can help refineries hedge against the varying proportions of crude oil and refined products. Each refining company must evaluate its own situation and develop a crack spread futures market strategy that is coordinated with its specific spot market operations.

What do spreads represent?

1:1, which indicates that there is no price difference between raw materials and products, is usually reflected in the loss-making status of the cracking unit, and the loss is mostly in the processing cost of the unit. If there is a 1:1 cracking spread, chemical companies need to adjust the product production structure, as far as possible to avoid the output of chemicals with a smaller naphtha price difference, to narrow the loss amount.

When there is a 1:1 spread in the refining segment, it also shows its loss, so the refinery in order to hedge refining losses, will be through the futures market reverse manipulation, that is, for the frequent purchase of crude oil to sell refined oil products. If the price of crude oil is predicted to rise and refinery products fall, gasoline will be sold and crude oil will be bought to ensure the stable production of refinery units, i.e., to ensure the rationalization of the crack spread.

3:2:1, whether cracking unit or refining unit, its products and raw material production value ratio is 3:2:1, gasoline production is about twice as much as distillate fuel oil (including diesel and jet fuel part), so 3:2:1 is the participants of more than several kinds of optimistic about the theoretical crack spread ratio, they will be through the futures market for the theoretical proportion of the operation, such as each of the three crude oil futures contracts corresponds to two gasoline futures contracts and one ULSD diesel futures contract, so as to ensure a reasonable theoretical crack spread for the futures contracts in hand, and a reasonable theoretical crack spread for their production units.

5:3:2, however, if a refinery processes crude oil and produces a relatively low ratio of gasoline to distillate output, it will use its own actual processing ratios to determine a more realistic theoretical crack spread, i.e., 5:3:2, which crack spread ratio is determined by selling every fifth refinery product futures (i.e., three RBOB gasoline futures + two ULSD diesel futures) and buying five crude oil futures contracts to lock in a reasonable 5:3:2 crack spread.

It should be noted that, whether it is 3:2:1 or 5:3:2, the principles pursued have the following commonalities: First, all theoretical spreads are based on the actual operation of their own units to assess the judgment, each enterprise has a fixed reasonable spread, and some enterprises will also use the 4:3:1 ground spread. Secondly, the reasonable crack spread implemented here is to lock in the naphtha price level in the chemical production chain, thus locking in the profit of chemical production, and also locking in the refining profit. Third, the theoretical reasonable spread is based on the manipulation in the futures market, and for the actual operation of its own refining and chemical integration unit.

What is the logic of the spread’s impact on chemical market prices?

If there is a strengthening of the spread in chemical production, it is a strengthening of ethylene prices and a weakening of naphtha prices, thus reflecting the trend in crude oil prices, and the strengthening of ethylene downstream chemical prices. In such a status quo, it shows that the consumer market is stronger, and the stronger consumer market is the best form of chemical value chain conduction, which will bring about the strength of the broader chemical market, thus reflecting the strength of the chemical industry.

Another trend reflected is the weakness of the raw material market. Weakness in the raw material market will bring about the strengthening of the spread, and raw material weakness will cause the downward shift of chemical production profits, bringing about the strength of the chemical industry. However, according to the past fluctuations, the weak atmosphere of raw materials will be quickly transferred to the downstream chemical market, thus bringing the overall weak trend of the chemical industry.

Spreads in the refining segment have seen a strengthening, i.e., a widening of the spread between refined products and crude oil, a strengthening of refined product prices or a weakening of the crude oil market. The pricing logic of China’s refined oil market price is based on the rate of change of crude oil in three places, and the pricing cycle is 10 working days. Therefore, in a long cycle, there is generally no differential fluctuations in the spread between refined oil prices and crude oil prices, but differential fluctuations in the price adjustment cycle will be quickly transmitted to the refined oil market or futures market, in which the price fluctuations in the oil market for the price fluctuations in the crude oil market there is a rapid feedback characteristics.

It is important to note that the impact of crack spreads on the market cannot be assessed through a unified model, which also has the issues of operating time period, different core impact logic, and the differential rate of output products of the device.

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