Gasoline/Crude Oil Spread: Did This Bull Market Just Run Out of Gas?!

RBOB Gasoline/Crude Oil Spread

The price action of RBOB gasoline and crude oil are highly correlated.  This makes perfect sense as gasoline is simply a derivative of the crude oil.  It’s quite rare for the two markets to move in different directions.  Looking at the last three decades of futures data drives this point home.  Plotting the closing prices of gasoline and crude oil for every month from the mid-1980s through now will reveal an extremely high correlation factor.

Gasoline Crude Oil overlay monthly

Gasoline Crude Oil overlay monthly

The ‘Crack’ Relationship

Even though they generally move in the same direction, the degree to which gasoline and crude oil move can vary.  Seasonal demand during driving season can push both of the markets higher, but gasoline may drive up at a faster rate.  The increase in user demand places a premium on the finished product.  Conversely, a build-up in the RBOB gasoline stocks can leave a glut of supply in the market place.  This could cause the price of gasoline to spill faster that the crude.

Historically, there have been extremes on both the high side where gasoline went up much faster than crude oil and the low side where the crude oil held up much better than gasoline.  It is when these extremes are hit that trading opportunities manifest.

The Gasoline/Crude Ratio

Over the last three decades, there have been less than a dozen occasions when the ratio between the closest-delivery month contract of RBOB gasoline was at 1.4:1 or higher against the closest-delivery month contract of crude oil.  A 40% mark-up on the gasoline doesn’t seem to last very long.

Gasoline Crude Oil ratio monthly

Gasoline Crude Oil ratio monthly

On a monthly closing-basis, the longest period that the RBOB gasoline/crude oil ratio was able to stay above 1.4:1 was three consecutive months. Whenever the ratio has made a month-end close above 1.4:1 and then finally turned over, it continued to plunge. Historically, the RBOB gasoline/crude oil ratio always dropped back down to a more reasonable level of 1.15:1 or lower. This indicates that the recent excursion north of 1.4:1 is a setup for trading opportunity on the short side of the spread.

Trend Change Signals

Last week, the nearest-futures RBOB gasoline/crude oil ratio finished the month of March at 1.56:1. This was the second month in a row that the ratio finished above 1.4:1. Therefore, a major reversal seems imminent.

August Gasoline Crude Oil ratio daily

August Gasoline Crude Oil ratio daily

Both the August RBOB gasoline/crude oil ratio and the spread made bearish trend change signals last week. The ratio made a two-day close below the rising 30-day Moving Average for the first time since November. The spread made a two-day close below the rising 30-day MA for the first time since late January. This indicates that the expected reversal is underway.

August Gasoline Crude Oil spread daily

August Gasoline Crude Oil spread daily

Unless we see a breakout to new highs, the RBOB gasoline/crude oil spread now has a clear path to return to a more ‘normal’ level of $10.00.

Trade Strategy:

For tracking purposes, the blog will make a hypothetical trade by selling one 42,000 gallon August RBOB gasoline contract and simultaneously buying one 1,000 barrel August crude oil contract at a spread of $20.00 or better. Initially, the spread will be liquidated on a two-consecutive day close above $22.00.

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