Term Paper on "Keystone Pipeline Has Some Critics"

Term Paper 5 pages (1781 words) Sources: 1+

[EXCERPT] . . . .

A second method involves purchasing crude oil call options and sell product put options. (Murat & Tokat, 2009, p. 88) These strategies involve complex actions and the requirement of the hedger to lock up funds in margin accounts.

The most common ration refiners' use for crack spread is the 3-2-1 ratio. This ratio estimates the real-world ratio of refinery output. 3 barrels of crude oil generate 2 barrels of unleaded gasoline and 1 barrel of heating oil. (Haigh & Holt, 2002, p. 270) Margin requirements are the main concern for buyers when it comes to the crack spread contract. They limit dealing with individual margins for the basic or hidden trades.

The common 3-2-1 ratio uses sweet crude and may not be suitable for all refiners. OTC, or over the counter, market grants access to contracts with better reflection on the conditions of individual refineries. Some refineries specialize in gasoline, with specializing heavy crude oil. Regardless of what type of product refiners sell, the best practice for them to minimize economic risk is through the use of crack spreads. Refinery crack spreads allow for refiners to effectively buy and sell futures along with having more control over the price of their products, providing stability in their market.

References

Inkpen, A.C., & Moffett, M.H. (2011). The global oil & gas industry: Management, strategy & finance. Tulsa, Okla: PennWell.

Haigh, M.S., & Holt, M.T. (2002). Crack spread hedging: accounting for time-varying volatility spillovers in the energy futures markets. Journal of Applied Econometrics, 17(3), 269-289. doi:10.1002/jae.628

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