Crack. It kills. It’s also a high margin business. Not that I’d know.

Currently, crack’s in the macro-market news, or at least a term with the word “crack” in it. Specifically, crack spreads, which the layperson can just think of as refiner margins.

Right now, those margins are fat, and some argue crack spreads could kill the bull market in equities by pushing up inflation and, as a consequence, rates, curtailing discretionary spending and access to credit, to the eventual detriment of economic activity.

Or something. That’s a generic version of the crack spreads bear case and it was only right and proper that Albert Edwards should expound it, given his claim on being the sell-side’s longest serving, most committed bear.

The central concern is that maximizing refinery utilization to capture the historically elevated spread (i.e., to capitalize on this once-in-a-lifetime profit opportunity) is to increase the odds of unplanned downtime for maintenance.

Edwards quoted a colleague in commodities at SocGen: “Refineries are complex industrial systems, and sustained operation near full capacity places considerable stress on critical equipment.”

The figures above illustrate the point. Utilization rates in excess of 97% are followed by outages, almost as night follows day. As SocGen’s head of commodity research, Mike Haigh, put it, “while refiners can temporarily maximize throughput to capture strong margins or offset supply disruptions, operating at extreme rates is often unsustainable and ultimately results in higher levels of unplanned maintenance, reducing effective refining capacity in subsequent months.”

You don’t have to be George Soros to understand the role for reflexivity here. If you’re a refiner, you’re very likely to put off maintenance for fear of missing out on profits. That, in turn, puts even more stress on these “complex industrial systems,” thereby further raising the odds of failures. In the event of failures, margins will be even higher, as product becomes even more dear, further incentivizing refiners to push utilization limits, and so on.

“Refineries being run flat out and postponing planned maintenance almost guarantees capacity will soon go offline unexpectedly, further driving up crack spreads and increasing the incentive to continue driving (the remaining, still-standing) refineries into the ground,” Edwards wrote. “That all makes perfect, scary sense to me. It’s simply a case of making hay while the sun shines.”

As the figures above, from the same note by Albert’s colleague in commodities research, show, this is coming at a time when inventories are already very low.

Edwards tied this to the broader greedflation discussion. “The combination of imminent refinery outages pushing up the crack spread further and a change in aggregate corporate behavior in Q2 in using commodity inflation as an excuse to boost margins has led me to become much more worried about the near-term inflation outlook,” he said.

The figure below, which uses data from the BEA’s NIPA tables, is a reminder: The pandemic reset corporate margins higher, and they expanded back near the top of the post-COVID range in Q2.

As discussed in “Minting Money,” aggregate US corporate profit margins were 16.9% last quarter, second only to Q2 of 2021 in data back to 1947.

Although central banks can’t “fix” supply shocks with rate hikes, curbing demand (which rate hikes can accomplish) can indirectly address the issue.

“If Greedflation continues to take root, the Fed might have to end up hiking rates much more aggressively than I had thought previously,” Edwards went on. “And if this ends in recession and an equity bear market, then we will look back and say corporate greed has killed the stock market goose that was laying the golden eggs.”