Taking Another ‘Crack’ At It
Opportunities abound in the energy crack spreads, which are simply the spreads between crude oil and its derivatives of RBOB gasoline and ultra-low sulfur diesel fuel (formerly known as heating oil). When the products get too expensive or too cheap relative to the crude oil, a bet on the inevitable reversion to the mean can provide a high-probability trade.
Back in the summer, the IMC blog was stalking the RBOB gasoline/crude oil spread for a short sale opportunity. After a record duration of being in overbought territory (six consecutive months of the nearest-futures gasoline/crude ratio above 1.4:1), the spread peaked in August and plunged. Unfortunately, the reversal was so swift and volatile that the reward-to-risk ratio on the trade was no longer attractive. So after all that waiting, we pulled the plug on the trade recommendation. Sometimes, that’s just how it goes.
Driving North For the Winter
After posting a new low for the year in mid-October, the nearest-futures RBOB gasoline/crude oil spread started to recover. So far, it has gained about ten dollars as it rallied from $6.67 to $16.69.
What has our interest is the April RBOB gasoline/crude oil spread. This spread is priced another four and a half dollars higher than the nearest-futures spread. The premium is no surprise. The April delivery contracts are the first of the summer blend contract for the year, which normally trades at a premium to the winter blend contracts.
Technically, the April RBOB gasoline/crude oil spread is at a decision point. Then spread finished last week just above the mid-August high of $21.00, putting it at a fourteen-month high. Coincidentally, this also put it right at the major Fibonacci .618 resistance level. If the rally continues, there is no price resistance until it reaches the March 3, 2014 contract high of $24.90. Conversely, a reversal from here could send the spread several dollars lower.
A Read On the Ratio
As always, we like to take a look at the ratio of any spread that we’re stalking. This can help us clarify what’s going on and determine whether or not the spread is historically over or underpriced.
Last week the April RBOB gasoline/crude oil ratio posted a new contract high of 1.47:1. This slightly clipped the August peak of 1.46:1. Just like in the spread, the ratio may be at a make-or-break level where it needs to accelerate or it will be at risk of a sizable reversal.
Recall from previous posts that the nearest-futures gasoline/crude ratio is considered historically expensive anytime it is at 1.4:1 or higher. Then twist here is that the nearest-futures ratio is nowhere near that high. It is the summer blend April contracts that has surged ahead in anticipation.
With both the spread and the ratio of the April delivery contracts both just above their August highs, it seems that a sideways market is the lowest-probability outcome. We expect to see either a continuation or a reversal. Seasonal patterns suggest a continuation for the next couple of months. However, we want to have parameters in place to catch a reversal just in case it materializes. Consider us officially back in the hunt for the RBOB gasoline/crude oil spread.
For tracking purposes, the blog will make a hypothetical trade by selling one 42,000 gallon April RBOB gasoline contract and simultaneously buying one 1,000 barrel April crude oil contract if the spread closes below $20.00. If filled, risk a two-consecutive day close of 50-cents above the 2015 high that precedes the entry.