CRAK: Lower Supply And Demand For Crude Aren't Great For Spreads

The VanEck Oil Refiners ETF (NYSEARCA:CRAK) is a relatively high maintenance cost ETF at 0.61% expense ratios capturing the major refinery exposures in the US. While the higher-than-average expense ratios are not helpful to CRAK's case, it ultimately comes down to the fact that the data shows the coming quarters are going to become difficult for refineries, with product inventories coming up, but crude staying pretty normal. Refineries aren't the bottleneck anymore, so CRAK's in an ambiguous situation.

CRAK Breakdown

CRAK value-exposed to major crack-exposed refineries, some outside the US like Reliance, the massive Indian refinery that has been benefiting from surging imports of cheap Russian oil. That's what most of the companies in CRAK do, take crude and make distilled products, lately a lot of diesel.

The present environment has shown continued growth in profits for refiners. The key element has been that refining capacity has fallen more than oil, at least in the Western bloc, as a consequence of sanctions against Russia. With sustained demand for consumer goods (although weakness is beginning to show) things like diesel have been putting utilisation to very high levels at refineries.

But markets recognise that for various reasons this is coming to an end. An initial market is that crude inventories are at pretty reasonable levels relative to long-term averages while distillates have been at pretty low levels, hence the current high crack spreads and profits for refiners. But while crude is more normalised, there is quite a forceful recovery of inventories for distillates as they revert to the mean. It has been consistent with distinctly lower levels of manufacturing and freight being reported around these products, as well as the cooling off of the goods boom, with container freight down 10%. Distillate inventories are still below the historical averages, but that is changing quickly and is affecting crack spreads. Distillate prices can come down but OPEC will likely keep that from happening to oil despite concomitant demand declines.

The PE is around 4.27x, reflecting a very late-stage cycle appraisal.

Bottom Line

Refineries tend to be very cyclical since the output prices tend to be more sensitive to the economic environment than the input, and the demand for the refinery process simply falls in times of economic hardship. Germany has shown a quarter of decline due to inflation impacting consumer spending, which means that we're definitely approaching the definition of a technical recession at this point, even though everyone already knew that the world economies were under pressure. We can already observe the compression in crack spreads. Money can be made investing in the down cycle of a cyclical, but it's probable that the economic pressures are just getting started. Moreover, the 0.61% expense ratio isn't too attractive. Best to avoid CRAK for now.

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