[White Paper] How spot markets influence rack prices

792 views
590 views

Published on

Getting pricing right is a crucial function in the US refined fuels market whether a buyer or supplier, yet many in the industry are frustrated by its dynamics. This paper discusses the important features embroiled within wholesale refined fuels pricing, with the spot market the most significant factor in determining rack prices. There is a definitive correlation between spot and rack prices, and in order to better anticipate next-day moves it is imperative that marketers fully understand this relationship.

Published in: Economy & Finance, Business
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
792
On SlideShare
0
From Embeds
0
Number of Embeds
4
Actions
Shares
0
Downloads
4
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

[White Paper] How spot markets influence rack prices

  1. 1. How spot markets influence rack prices Executive summary Getting pricing right is a crucial function in the US refined fuels market whether a buyer or supplier, yet many in the industry are frustrated by its dynamics. This paper discusses the important features embroiled within wholesale refined fuels pricing, with the spot market the most significant factor in determining rack prices. There is a definitive correlation between spot and rack prices, and in order to better anticipate next- day moves it is imperative that marketers fully understand this relationship. By Brian L. Milne
  2. 2. How spot markets influence rack prices Page 2 Refined fuels have a long supply chain that begins when oil is first discovered and extracted, to refining, transport, storage and final distribution to retail outlets. Each leg is critical in the conversion of crude oil from a raw material to a finished, usable product, which adds costs along each stage of the supply chain. These multiple stages also expose the product to potential disruptions that can and do affect costs. The various stages along the supply chain can also cloud our understanding of how refined fuels are priced and can cause confusion for marketers. A spot price, sometimes called a cash price, represents the real-time value of a particular product with fungible characteristics. All commodities have a spot or cash price. For refined fuels, it’s the price received or paid when ownership of fuel is transferred in the bulk wholesale market – from refinery gate to terminal. It is the primary wholesale market, with spot price assessments regional, based on established pipeline cycles and prompt barge deliveries. Spot oil product values are bid (the buyer’s price) and offered (the seller’s price) at a discount or premium to a benchmarked futures contract. It is these market mechanisms that determine the real-time fair value for gasoline, diesel fuel, jet fuel and heating oil in the spot market. Spot prices are the primary driver in setting wholesale terminal prices, known as rack postings, which are offers by suppliers for their product. Introduction What is spot pricing?
  3. 3. How spot markets influence rack prices Page 3 A rack posting is the supplier’s asking price for fuel at a distribution terminal. Suppliers set posting values to recover product costs in the bulk wholesale market, and to remain competitive with other suppliers. A rack posting reflects the buyer’s cost to procure product at the terminal known when “lifting” supply. The name “rack” is used because fuel is loaded in a tanker truck under a rack apparatus. The rack market is a secondary wholesale market and the last market in front of retail. As previously explained, spot prices represent the real-time value of a commodity. What this means is a spot value is incorporating the various dynamics of the broad and regional markets, including fundamental factors such as the supply-demand balance, seasonality features including peak demand, RVP changes for gasoline and refinery maintenance, and geopolitical issues. As such, a supplier looks to a spot price as identifying these market features and then sets a posting value aimed at recovering real costs and to establish a profit margin. A supplier would also need to consider competition among other suppliers at the terminal in setting its posting, as well as the supply-demand balance at the terminal and locally. Yet, by working off a spot assessment, a supplier has already identified fair market value for the product, reducing the risk he or she would price product at the terminal below costs. In other words, by using a spot assessment in determining a rack posting, a supplier is less likely to incur a loss. Our three-part chart below offers an example of how closely rack prices align with spot values, with the middle histogram showing the same day difference between a spot assessment and rack price. The bottom histogram plots the difference between the typical same day spot-to-rack differential and that differential if the rack posting was established knowing a day ahead of time what assessment the spot value would hold. In other words, by employing a one-day time lag, we illustrate what a rack posting would be if determined alongside the spot assessment. The difference between these two variables demonstrates the closeness in which rack postings are influenced by spot markets. What are rack postings? How spot markets influence rack prices
  4. 4. How spot markets influence rack prices Page 4 Since the spot market for refined fuels is indexed against the futures market, why not simply use the futures market? In the United States, physically traded refined fuels in the spot market are indexed against New York Mercantile Exchange RBOB and ULSD futures, with monthly contracts for the two commodities listed out for 18 to 24 months. The financially traded contracts are fungible, and their terms do allow for physical delivery. However, spot assessments are for prompt delivered physical products whereas a futures contract is for delivery a month or more into the future, creating a timing discrepancy. Spot assessments are also regional while a futures contract would reflect national and global influences. Moreover, the futures market includes speculation that might increase or decrease its value more than what the physical market would otherwise warrant. Since spot price assessments trade in a differential to the futures contract; i.e. premium, parity or discount, national and global issues are incorporated in its value while the differential fine tunes the price to regional issues. In other words, a well-supplied regional market might trade at a discount to the futures market while a tight market might trade at a premium. As a supplier, in the first market you would likely lose business at the rack if you only followed futures prices because you’ve overpriced your product, while in the latter scenario you’re likely headed for a loss. Most of the time however, whether buyer or seller you would simply leave money on the table. Although many factors can and do influence rack prices, they are most closely correlated with the spot market. By understanding the influences in the spot market and following the price, marketers can better understand their position in the market, anticipate next-day moves and make profitable decisions. Figure 1 The chart plots the spot price for CBOB gasoline in the Chicago market with the rack price for E10 gasoline in Cleveland, highlighting the close correlation between the refined fuels in the regional primary and local secondary markets. Conclusion Why not use the futures market?
  5. 5. How spot markets influence rack prices Page 5 ©2014SchneiderElectric.Allrightsreserved. About the author Brian L. Milne is an Energy Editor, Product Manager, with Schneider Electric's Cloud Services. Milne manages the refined fuel’s editorial content, spot price discovery activity and cash market analysis for Schneider Electric’s energy segment. He is also the editor for OilSpot, a weekly newsletter for fuel marketers, buyers and sellers published by Schneider Electric. Milne has 18 years’ experience in the energy industry as an analyst, journalist and editor, serving as Managing Editor for Btu publications and journalist with Bridge Information Systems America before joining DTN in 1999. His industry and market focus include natural gas, NGLs, electricity during its move to deregulated markets in the late 1990s, biofuels, and the downstream petroleum industry. Milne graduated Magna Cum Laude from Monmouth University in New Jersey with a B.A. in History and an Interdisciplinary in Political Science.

×