[white paper] how spot markets influence rack prices

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


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 out lets.

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?


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?



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?


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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.

[white paper] how spot markets influence rack prices

Economy & Finance