A Dynamic Model of Crack Spreads

Crack spreads are a central measure of refinery profitability, yet they are often treated as exogenous differences between crude-oil and refined-product prices. We develop a structural dynamic model in which crack spreads arise endogenously from refined-product demand, crude-supply conditions, convex utilization costs, refinery complexity, hard capacity constraints, and costly production adjustment. The model shows that crack-spread dynamics depend on the source of shocks and the degree of capacity pressure. Demand-driven episodes generate strong positive comovement between refined-product prices and crack spreads, while supply-driven episodes can produce weaker or offsetting relationships. Adjustment frictions further create negative short-run comovement between changes in utilization and changes in spreads. Numerical comparative statics from an illustrative implementation show how the model’s mechanisms operate under alternative volatility, adjustment-cost, and capacitytightness scenarios. JEL Classification: D21, Firm Behavior: Theory; D22, Firm Behavior: Empirical Analysis