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Hedge the margin between crude and its products
A refiner does not really trade oil — it buys crude, converts it and sells products, and lives on the difference. That difference is the crack spread, and it can be squeezed even when the outright oil price is flat. A crack spread swap fixes the spread rather than either price on its own, which is why it is the hedge that matches how a refinery actually earns money.
Open in the app · Commodity · advanced
A refiner’s profit comes from the gap between the crude oil it buys and the refined products it sells — the crack spread. A crack spread swap fixes that margin rather than either price on its own. Because a refiner is short crude and long products, it is naturally long the spread: it gains when the spread widens and suffers when it narrows, so hedging means selling the spread.
The swap settles on the difference between product prices and crude. The most common structure is 3-2-1: three barrels of crude against two of gasoline and one of distillate, roughly matching a typical refinery’s output mix. The spread is expressed per barrel of crude, so the three-barrel bundle is divided by three to give a single figure the two sides can trade.
One barrel is 42 US gallons, and NYMEX gasoline and distillate futures are quoted in dollars per gallon. A 10-cent move in gasoline is $4.20 a barrel.
Hedging crude and products separately takes two trades and two bid-offer spreads, and any mismatch in volume or timing between the legs leaves the margin exposed. A single crack spread swap hedges the economics the refiner actually cares about, in one transaction, at one quoted spread — and it needs no view at all on where oil is heading.
The crack spread itself, the 3-2-1 ratio, the reference price index for each leg, the settlement period, and the notional expressed in barrels of crude. The product volumes follow from the ratio: 300,000 barrels of crude implies 200,000 of gasoline and 100,000 of distillate.
3-2-1 is the common shorthand, but 5-3-2 is used where the yield is more distillate-heavy, and a single crack trades one product against crude one-for-one.
The standard ratio rarely matches a specific refinery’s real yield, leaving residual exposure. Fixing the margin also forgoes the gains when spreads widen, and each leg carries its own basis risk against the grades actually processed — a plant running a heavier, sourer crude than the index will not see its own margin track the swap exactly.
The crack spread is a gross margin. It says nothing about the energy a refinery burns, its labour, or a maintenance turnaround that can take a unit offline for weeks.
Total margin is $4,800,000 + $1,800,000 = $6,600,000, or the $22.00 a barrel the refiner fixed. The crude price rose by $6 and the swap gave that back — but had the spread widened instead, the refiner would have paid the difference away.
Independent refiners without an integrated crude supply use crack spread swaps to protect the margin a lender or a board has been promised, particularly before a maintenance turnaround when volumes are known. Trading houses and bank commodity desks quote the spread and warehouse the risk, often laying it off in the listed crack futures at NYMEX or ICE.
The app adds a twelve-question bank for Crack Spread Swap, drawn differently every sitting, and a review queue for whatever you miss.
A subscription adds 3 further sections on Crack Spread Swap — Why three, two and one, The spread has a time dimension, What the spread does not cover — and 12 more questions to its bank.
Educational content only. Nothing here is financial advice, an offer to trade, or a recommendation to buy or sell any instrument.