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July 10, 2019

Volume 3 Issue 4

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Base Oil Capacity Overhang to Shape Market

It’s not an industry secret that the discrepancy between base oil production capacity and finished lubricants demand is growing, and that the current overhang is impacting the market as the bubble waits to burst. Insiders say rationalization within the industry is inevitable.

According to independent lubricant blender Fuchs Petrolub SE, global finished lube demand, excluding marine oils, reached 36.4 million metric tons in 2018. Meanwhile, nameplate base oil production capacity soared to over 60 million metric tons, according to Lubes’n’Greases’ 2019 Guide to Global Base Oil Refining.

Ernie Henderson, president of Oklahoma City, Oklahoma-based K&E Petroleum Consulting, agreed it is a big overhang. “And it’s been getting worse,” Henderson told Lube Report

This stark contrast isn’t news to the lubricants world. Vince Gillooley, senior vice president of base oil supplier Chemlube, said the overhang has been predicted for at least a decade. “It’s already existed for five, six, seven years,” he continued. “Just about every conference, somebody gives a presentation about the oncoming flood of base oil.”

A decade ago, Fuchs estimated that finished lube demand stood at 37.2 million metric tons, while base oil capacity reached almost 50 million metric tons. Base oil capacity dipped the following two years, but since 2011 capacity has risen every year as lube demand remained stable between 34.5 million metric tons and 36.4 million metric tons.

One driver of this trend is that plant closings haven’t kept pace as more capacity is added. That could – and perhaps should – change soon, but the question is when and at what rate, said Henderson. “It has to start at some point.”

This could particularly be a concern for API Group I producers. “You would think that the Group I refiners would be the ones that close down,” said Gillooley. Some refineries, however, may stay open because they are propped up by the state or due to their importance to the local economy. “In Europe, there’s a lot of pressure for refiners to keep going because of local unions and jobs that would be lost if they shut down,” he explained.

According to Lubes’n’Greases’ 2009 Guide to Global Base Oil Refining, Group I base oils accounted for 66 percent of all production globally while Group II accounted for 21 percent. This year, Group I fell to 37 percent and Group II took the lead for the first time, reaching 40 percent.

The difference between base oil capacity and finished lube demand has already led to obvious issues for base oil producers: lower prices and tighter margins. For oil majors like ExxonMobil or Shell, of which base oil production is a smaller part of their portfolios, this likely isn’t a large concern. Smaller producers, however, could potentially be squeezed out of the market depending on factors like location – as in how close they are to their major market – and unit costs for production.

“Now you’re getting into companies that really don’t have a demand for the base oils that they’re making and are now essentially operating as a merchant marketer and trying to place those barrels at whatever price they can get,” said Henderson. “With oversupply, that placement causes competition, reduced margins. That’s what we’ve been seeing in terms of the marketplace.”

Gillooley said larger producers with higher quality products force smaller producers to be more flexible in their pricing. “They have to get more negotiable on the prices, so the differentials between Group II and Group III or Group III and Group I are shrinking and will continue to do so,” he explained. “Already here in the United States and much of the world, the [price] between Group I and Group II, there’s hardly any difference. It’s more logistics that determine the difference that one guy can sell for versus the next, more so than their quality.”

Despite this, U.S. producers have managed to hold their prices higher than in other regions, making the domestic market tight lately, said Gillooley. “It’s hampered a lot of export activity from the U.S. that used to be there when the relative price here was lower.”

Opinions differ on whether the overhang will get larger. Gillooley said he thinks the increase in base oil capacity is accelerating, while Henderson expects rationalization of the marketplace.

“I think the majors will start to rationalize,” he said. “Shell, I think, has been closing some of its Group I efforts or selling them off. ExxonMobil just got out of the Augusta [Italy] side of things, I could see them continue to rationalize.”

Smaller majors could also decide to retool their base oil plants to support their fuels businesses, explained Henderson.

“You almost have to go back and look at this on a case-by-case or region-by-region basis and see who you think is going be around or not,” he said.

Otherwise, prices and profitability will continue to decrease. Companies with the ability to upgrade their facilities to either produce higher-grade base stocks or switch to making gas oil or other higher-margin products could do just that to safely navigate out of the base oil market.

Group I refiners in particular may also defer the low-viscosity 150 Neutral barrels and put them to fuels, or – either through feedstock adjustments or taking another look at yields – focus on heavier grades like 600N or bright stock if they can, said Henderson. Other possibilities, like getting into the slack wax or finished wax market, also remain. Henderson pointed out Imperial Oil’s transition in 2017 at its Sarnia, Canada, and Edmonton, Canada, facilities to fuels operations.

Others without these capabilities could feel the squeeze and be forced to shut down because of unsustainable profit margins.

“Most of the refiners, just because they have the capacity they don’t have to use it, and in some cases they can switch to making fuel products instead,” said Gillooley. “Others don’t have that flexibility, but they may produce less. You figure on aggregate they all have to produce less because they’re not going to drink it. There’s no reason to think lube demand is going to go up.”

ExxonMobil Baton Rouge base oil plant

Photo courtesy of ExxonMobil

ExxonMobil's Baton Rouge, Louisiana, base oil plant, which has 16,000 barrels per day of API Group I production capacity. Base oil production capacity largely outpaces finished lubricants demand globally, and the market could soon correct itself as a result.