I found the "recent work" that Jonathan Ferro is referring to in his introduction to Jeffrey Currie. Couldn't find a text version to summarize, but here's a longwatch video interview that has extensive details about the matters being discussed:
The essence of the interview is a question about why the price of oil (as reflected by Brent crude and WTI (West Texas Intermediate) has remained (relatively) stable despite the ongoing conflict in the Gulf. Those prices went way up when the "hot war" started, then moderated back down when the "memorandum of understanding" was executed, and now they are heading back up in a gradual fashion.
I have not previously been aware of Jeffrey Currie, but his reply (starting at the 1:15 mark of the second video) is exactly what I've been thinking - so I assume he is a brilliant genius. His Wikipedia page indicates that he is a highly-respected economist at the University of Chicago. Listen to as much of that interview as you have time for. I heard the same arguments presented live to Jonathan Ferro this morning on Bloomber's Surveillance program in the pre-market and I was blown away by the insights.
For the TLDR and TLDW crowd, I'll add some more nuggets. First the definition of "crack spread":
Crack spread is a term used on the oil industry and futures trading for the differential between the price of crude oil and petroleum products extracted from it. The spread approximates the profit margin that an oil refinery can expect to make by "cracking" the long-chain hydrocarbons of crude oil into useful shorter-chain petroleum products.
And before I move on, one note. Any juvenile salacious comments about "crack spread" will be instantly vaporized on review. The comment section here is for serious discussions of the world economy.
Here is an inadequate quick summary for those without the patience to watch the videos. The news media and the general public focus on the "price of oil," but nobody actually uses crude oil. People use gasoline, farmers and truckers and businesses use diesel, everyone uses plastic - but those are all products, not creude material. The only entities that use crude oil are refiners, who are now working at maximum capacity and unable to ramp up further production. The demand for these end products persists [unless demand destruction occurs - a separate issue], so right now the price for the products is huge. His rough example is that while Brent oil is USD70/bbl, the price for the products averages USD140/bbl - that "crack spread" is the highest he has seen in 30 years. Meanwhile, Ukraine has been hammering Russian oil reserves and Russia's refining capacity and the earthquake in Venezuela took out part of their refining capacity. Crude oil prices dropped when the "memorandum of understanding" was signed because a flood of tankers left the Strait of Hormuz, but without a continuing flow the price is edging back up and there is currently no reason for that to change. When this conflict started, the U.S. and other countries started to harvest their strategic petroleum reserves, which are now getting low (some other countries have exhausted theirs or have never had petroleum reserves in storage). If the U.S. continues to empty its strategic petroleum reserve to cover up the shortages of crude exiting the gulf, the potential scenario is catastrophic.
The long video also includes some discussion about how China (allied with Iran) also has control of much of the worlds critical metals, plus they are leading the world in energy storage (batteries) and in wind and nuclear technologies. IMHO the future belongs to China, which staffs their administration with scientists.
Addendum: Markets are now opening in Asia...
Addendum: A nice chart of transits through the Strait of Hormuz, showing the initial "hot war," the MOU period, and the resurgence of hostilities. I'll see if I can find an updated chart of strategic petroleum reserves.
Addendum: New data for August 14, 2026 -
I have a hard time following a lot of economics discussions. I understand gambling on the value of "the finished product" based on the current price of the crude "parts" of pre-production. After that, my eyes roll in the back of my head and I'm snoring.
ReplyDeleteBut I often wonder how much of the economy is manipulated by various individuals & entities "betting" on things that muck everything up: natural disasters, wars, epidemics, etc. as we have seen recently, those in the know have made a tidy sum betting on the crap this administration is up to.
I'll take this information on board
ReplyDeleteBut the truth is that I receive a pension, payback for all the tax I paid over my working life, and that pension doesn't quite cover my living costs.
For sure, I admit that I rescue cats and feed strays, and that takes money, and I still drink some alcohol, but only enough to make my guitar playing sound better than it is.
The idea of having enough money to invest in anything is a fantasy for me.
But still, I will take the information on board.
You don't have to "invest" in anything for the information to be important. Use it to consider the implications for the costs of things you may need to buy in the future.
DeleteI am always puzzled when people characterize commodity trading as either investing or gambling. It is neither. It is not like buying a stock or bond to finance the creation of something, nor is it a wager on a random event—or even on a skill-based outcome such as a football match.
ReplyDeleteCommodity markets exist primarily because producers and consumers need to buy, sell, hedge, store, or transport a physical product. Speculators—whom some dismiss as gamblers—often invest enormous amounts of time and capital trying to determine what that product is actually worth. Their participation provides liquidity, transfers risk, and improves price discovery. In principle, everyone benefits when a market is driven closer to its “true” clearing price.
Because energy and petroleum are embedded in almost everything we consume, the current tightness in physical product markets is genuinely alarming. If you live in the northeastern United States, Europe, Asia, or almost anywhere outside the relatively well-supplied parts of North America, this may be the new normal. It will remain so until we can move more Canadian oil-sands barrels to tidewater, deliver more Permian production to the Gulf Coast, or develop other secure sources of supply. Even then, much of the adjustment will probably have to come through demand destruction.
Well said. I quite agree. Having said that, I would note that there are ways to invest/gamble on commodities without going into the futures market. This year I discovered the JETS exchange-traded fund, which consists entirely of airline stocks (commercial, not military). Call and put options are available at modest premiums, so if one has expectations for significant changes in jet fuel prices, one can leverage one's investment that way. I have December 18 puts at a strike price of 30, which have risen 50% in the past week; I'm planning to sit on them for a while to see what happens.
DeleteUnlike some of my colleagues, I believe commodity ETFs can bring even more truth serum to the market. But be careful: some are closer to hemlock tea. Many are burdened by high transaction costs—whether from brokerage and churn in the underlying futures inventory or from repeatedly rolling into longer-dated contracts. Long-gamma trades can also be fantastic, but beware the theta burn and the other complications that come with them.
DeleteWonderful stuff. Happy alpha hunting.
The explanation by anon at 1117 does sound just like a stock market?
DeleteAddendum to my "JETS" comment above. One weakness to my strategy is that commercial airlines like Delta are reporting that their passenger revenues are in large part from commercial business travelers, not from the hoi polloi. Those trips are funded by corporations, which are still rolling in cash. So as jet fuel prices rise, airlines can raise their ticket prices accordingly. A jet fuel shortage would be a different matter entirely, of course.
DeleteBelieve it or not, I was the one who came up with the notion of "gold stock." Not quite as it is currently presented on the market, but still basically a way to not have a commodity exchange purchase expire on you.
ReplyDeleteThe key difference between commodities and stocks is that a commodity will ALWAYS be worth at least something (even if much less than what you paid for it). A stock can become completely worthless. Of course, a commodity OPTION can become worthless also, but not the contract itself.
As for "crack spread," I honestly thought it must mean some sandwich spread that was so good it was like crack.
As you can imagine, there is not much interest in allowing new refineries to be constructed in the US, so most of the capacity growth in recent decades has come from debottlenecking existing infrastructure.
ReplyDeleteInteresting thing on NPR the other day.... It said that the way they can track how much money a petroleum company is making is the calculate the more or less "fixed" costs--like refining oil--and then, accounting for the price of oil before the war with Iran and the price now, they can see how must money the company SHOULD be making (at least if they aren't trying to milk the matter for profits) vs. how much they ARE making.
DeleteThat is, if a barrel of oil costs $100 and refining a barrel of oil costs $20, then the sunk cost is $120. If out of that, you make a total of $240, say, then that means you made a 100% profit (paying back your sunk costs and then receiving the same amount in profit).
But say that a barrel of oil now costs $200. The refining still costs $20. So your sunk costs are $220. But if you make $600, you are making an even greater percentage than before.
I heard a cool term for it: greed-flation.
A couple of replies from Anon at 11:17.
DeleteAaronS, I think you have this backwards. A commodity—especially an energy commodity—is not always worth a positive amount. Electricity regularly trades negative in regional markets. Natural gas can go negative in constrained locations, and oil has even gone negative, though very rarely.
Agricultural commodities face similar issues with spoilage and storage, although usually to a lesser degree. Even physical precious metals carry insurance, security and storage costs. Stocks are different: their price cannot fall below zero, and shareholders have limited liability.
Anon at 11:03, I think your point about fixed costs gets into the different crack spreads, which is really what the original post is about. Every refinery is configured differently, often in an extremely sophisticated way, with multiple inputs and outputs. Crack spreads simplify all of that into an estimate of the value of the refined products relative to the crude used to make them.
A couple of things are worth keeping in mind. Oil is not one uniform product. Each refinery uses a particular crude slate or blend, and natural gas and other hydrocarbons are often important inputs as well.
The Gulf Coast’s need for heavy crude is a particularly interesting rabbit hole. Did Obama’s rejection of Keystone XL on national-interest grounds ultimately give an advantage to other suppliers of heavy crude and heavy refinery feedstocks, including Venezuela and Russia?
Finally, while there are certainly greedy actors in monopolistic markets, particularly where demand is inelastic, commodity prices often need to rise enough to create some pain. That pain either reduces consumption or creates an incentive to produce more.
In commodity markets, greed is often good—or at least useful.