Forecasting oil price movements with crack spread futures

Abstract

In oil markets, the crack spread refers to the crude-product price relationship. Refiners are major participants in oil markets and they are primarily exposed to the crack spread. In other words. refiner activity is substantially driven by the objective of protecting the crack spread. Moreover, oil consumers are active participants in the oil hedging market and they are frequently exposed to the crack spread. From another perspective, hedge funds are heavily using crack spread to speculate in oil markets. Based on the high volume of crack spread futures trading in oil markets, the question we want to raise is whether the crack spread futures can be a good predictor of oil price movements. We investigated first whether there is a causal relationship between the crack spread futures and the spot oil markets in a vector error correction framework. We found the causal impact of crack spread futures on spot oil market both in the long- and the short-run after April 2003 where we detected a structural break in the model. To examine the forecasting performance, we use the random walk model (RWM) as a benchmark, and we also evaluate the forecasting power of crack spread futures against the crude oil futures. The results showed that (a) both the crack spread futures and the crude oil futures outperformed the RWM: and (b) the crack spread futures are almost as good as the crude oil futures in predicting the movements in spot oil markets. (C) 2008 Elsevier B.V. All rights reserved.