In the literature on mergers in the refinery industry, several studies rely on analysis of the price
margin, which is defined as wholesale prices of gasoline less crude oil prices. The Government
Accounting Office (GAO 2004) models the price margin as a function of the crude oil price,
inventory ratio, utilization rate, and dummy variables representing a merger and acquisition
event. Geweke (2003) provides a comprehensive survey on this subject.
The degree of market concentration has been long recognized and analyzed in the literature
seeking to explain price changes and adjustment in the wholesale gasoline market. Focusing on
Gulf Coast, Los Angeles, and New York whole spot gasoline markets, Oladunjoye (2007)
investigates the effects of market structure on the pattern of price adjustment and finds that
market concentration has a significant asymmetric effect on gasoline price changes responding to
crude price shocks. The GAO (2004) concludes that mergers and increased market concentration
generally led to higher wholesale gasoline prices in the United States from the mid-1990s
through 2000. Examining wholesale price responses in 188 gasoline markets in the U.S.,
Borenstein and Shepard (2002) find that refinery firms with market power generally choose a
different adjustment rate and adjust prices more slowly than do competitive firms.
Background
The 3:2:1 crack spread is defined as
π = ~P + - Ph - Po
3G3HO
where PG, PH , and PO are the prices of regular gasoline, no. 2 heating oil, and crude oil,
respectively.
The 3:2:1 crack spread has been institutionalized over the years as a way to measure the refinery
margin. The use of the 3:2:1 crack spread is justified by the fact that among all finished products
converted from crude oil in the refinery process, gasoline and distillate fuel oil are the two
primary product classes. The relative proportion of these two products is approximately two
barrels of gasoline to one barrel of distillate fuel. Together, gasoline and distillate fuel comprise
about 80% of the refinery yield. The average refinery yield of finished motor gasoline is about
46% and has been stable over the 1993-2007 sample period (DOE).
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