During the refining stages of crude oil, there are other byproducts that come about from the production of this black sludge. The most basic refining process separates crude oil into its various components. Crude oil is heated and put into a distillation column where different hydrocarbon components are boiled off and recovered as they condense at different temperatures. The molecular structure is further changed in processes using heat and pressure as well as catalysts that increase the rate of reactions without being consumed themselves. In one barrel of crude oil, 19.5 gallons of Gasoline can be made, followed by 9.21 gallons of diesel fuel, 3.82 gallons of jet fuel, and 1.75 gallons of heating oil (1).
The type of gasoline that is produced is dependent upon the type of crude oil that it used and the setup of the refinery where it is made. Gasoline is also effected by other ingredients such as ethanol that comes from corn that is grown here in the United States. You might remember the massive spike we saw in ethanol over the summer that may have caused upward movement in corn and wheat prices and influenced the price of gasoline. The largest single use of ethanol is as a motor fuel and a fuel additive.
These products can be traded together on the floor of the New York Mercantile Exchange. They are all energies that come from crude oil so you can use heating oil (HO) or reformulated gasoline (RB) as a hedge against the main product. These trades are what are as known as “cracks”. If crude oil is positive you may see RB and HO in the green as well. If you are long crude futures and you think prices in RB or HO will come down first, you can sell the Heat or Gas crack as a hedge. You now have a crack on where you hope the price of RB or HO falls to make a profit on your position. You are long crude futures and short Gas/Heat. To get out of the position you just have to buy the crack spread back which is to buy the Gas/Heat and sell the crude futures. Remember whatever you are doing to the product (buy or sell) you are doing to the crack. Many traders use this as just another way to speculate and hopefully make money, but it is great for hedging as well.
(1) http://www.eia.doe.gov/bookshelf/brochures/gasoline/index.html
Trading in futures and options involves a substantial degree of a risk of loss and is not suitable for all investors. Past performance is not indicative of future results.
