Supply and Yet More Supply

The trouble is that the basetock industry is battling a static lubricants market. Klines preliminary estimates for 2013 put global lubricant demand at 39.2 million tons, a growth rate of just 1 percent over 2012 with heavy-duty engine oils at 22 percent of the market and passenger car/motorcycle motor oil segments at 21 percent. On the industrial side, process oil accounts for 15 percent, hydraulic fluids 9 percent, industrial gear oils 8 percent, industrial engine oils 7 percent, metalworking fluids 6 percent and grease 2 percent.

Given the shift from West to East, it is no surprise Asia dominates regional demand at 43 percent, while North America continues to languish at 25 percent, as does Europe at 17 percent. Africa, a nascent albeit low-quality bright spot, and the Middle East together account for 8 percent, while South America represents 7 percent.

Worldwide lubricant demand closely tracks global GDP growth, Agashe said, and has almost returned to the heady levels last seen prior to the 2007 financial crisis. Even so, the headline figures belie fundamental changes in lubricant demand, notably in North America and Europe whose combined share of the global market has fallen from 50 percent in 2007 to 40 percent in 2013.

Similarly, industry predictions of a reduction in API Group I basestock demand have proven accurate, and Group Is share of the global demand has fallen from 70 percent to 50 percent. Group I is increasingly replaced by Group II/II+ and Group III/III+ stocks. Group II/II+ currently accounts for around 24 percent and Group III/III+ and naphthenics each account for between 9 and 11 percent of total global demand.

Better performance characteristics should have resulted in some premium over Group I prices, but Agashe said that excess supply of Group II/III stocks has all but eradicated pricing differentials. Indeed, analysts in the Middle East already point to parity pricing of Group II and Group I stocks.

In 2012, Kline said underlying basestock demand for the finished lubricant market was 36 million tons. Nevertheless, substitution of Group I basestocks by Group II/II+ and Group III/III+ conceals the increasing shortage of high viscosity basestocks.

Against the backdrop of flat demand, oversupply is being driven by the global proliferation of aggressive low-cost Group II/III suppliers using the latest hydroprocessing technologies. Agashe argued that this is where the biggest impact is being felt. There is definitely a lot of substitution going on and in product applications where you do not need to use Group II base oil. You could do with a Group I, but formulators are switching to Group II. It is a similar picture with Group II to Group III switching, she added.

Asia Pacific and South America are in a net deficit position where demand for base oils exceeds what their domestic refiners can produce. That is in stark contrast to North America, Europe, Africa and the Middle East, which produce more basestocks than they can consume. As a consequence they have morphed into export hubs.

Basestock Industry Outlook

Predicting the future of any major industry is fraught with difficulties, but Kline contends that the basestock industry is vulnerable in several areas. One of the major factors will be the size of lubricant demand, itself a function of global economic performance. Brazil, Russia, India and China (BRIC countries) are exhibiting some signs of growth as are the newly defined MINT countries (Mexico, Indonesia, Nigeria and Turkey), which show promising potential.

Another important consideration is the quality of future lubricant demands in the wake of changing performance requirements brought about by OEMs targeting fuel efficiency, increased durability and emission standards. Additionally, high quality base oils are available in all lubricant formulating countries, meaning almost every country is capable of producing high quality lubricants. That was not the case 15 years back, said Agashe.

Changes in supply dynamics are also altering markets, particularly with the several planned Group II/III capacity additions, as is growing activity from some niche basestock suppliers, including the rerefining and biostock sectors. However, Kline said that although these latter two basestocks are important additions to a formulators toolbox, they remain niche segments for certain applications. Finally, Group I supply is not dropping at the rate the industry requires, creating significant oversupply.

Automotive OEMs focus on fuel efficiency, and this is expected to increase use of lighter viscosity engine oils such as 0Ws and 5W, supported by a modernizing vehicle park. The heavy duty market will not see any the same move to lighter viscosity oils while many parts of the world still use monogrades such as SAE 40s. In developing markets such as India, the switch has been faster in contrast with the U.S. where the cycle of rotation started with a switch from monogrades to 20Ws, 15Ws, etc. India leapt from 20W viscosity grade to a 5W, and that is probably the shape of things to come. This will be seen even more as mass marketers of cars like Toyota and Honda have gone to a 0W viscosity grade specification for their engines no matter where they are sold in the world, noted Agashe.

Whats Behind the Shift?

As reported in last months issue of LubesnGreases, Kline believes there are three key issues to consider as the basestock market evolves. First, lubricant quality requirements no longer govern basestock blends. Historically, formulators have looked at the demands of automotive/industrial OEMs and blended a product to match the specifications. Increasingly, that logic no longer holds true, largely due to the growth in the availability of Group II/III base oils. Between 2004 and 2012, Group II/III share of total supply has risen from 22 to 40 percent, an average annual growth of 9 percent. With the downward pressure on prices, Kline thinks viscosity is now more valuable than VI or other performance characteristics.

Second, how suppliers behave will influence basestock blends, particularly in their reaction to the long speculated decrease in Group I supplies. However, despite living under a cloud, Group I currently accounts for around 54 percent of global basestock volumes. And it is unclear how suppliers will react to new Group II/III production in light of the fact that some have now postponed production as a result of current oversupply.

Third, the behavior of blenders will affect the market, particularly with respect to where they place their product. Close to 10 million tons of new Group II/III capacity is planned according to estimates by Kline. Refiners who have announced extra Group II/II+ capacity include Chevron, Lukoil, Petrobras, Lubref and Hyundai Oil Bank. The figures include rerefiners whose technical expertise has improved markedly. Group III/III+ announcements include HollyFrontier, Sasol, Takreer and Russian producers. There are also capacity expansion announcements for naphthenics notably from Chinas CNPC, CNOOC and Northern Asphalt.

Group I Producers Under Pressure

With such an increase in Group II/III stocks, it is inevitable that some Group I producers will struggle to be profitable. This is particularly the case when older solvent technology is used, which results in higher production costs, lower product yields and lower plant utilization.

The historic preoccupation of basestock producers was optimization of formulation costs but that mantra has changed, said Kline. Today, the wider concern is with optimizing supply logistics costs to avoid arbitrage, assuming there will be enough Group II/III supply in most regions.

These factors are putting immense pressure on Group I refiners. Many of them are operating at a loss, and how long can they afford to run loss making refineries remains to be seen, Agashe said.

Kline forecasts a sea change in the regional share of Group III/III+ basestocks, which have traditionally been the preserve of Asia Pacific producers. By 2022, the Middle East will emerge as a supply hub on par with Asia Pacific with around 30 percent of all base oil coming onto the market.

Understanding Blenders

According to Kline, blenders want lower formulation costs, less complexity in the business and data to support their advertising
and marketing claims. More and more in our industry, lubricant formulators are finding it difficult to differentiate their product from competitors, said Agashe. With substantial commonalities among base oil supplies and additive packages, blenders are desperate to make sure their product stands out.

It is also important to understand how each segment of blenders makes basestock decisions and the range of blending options available to them. Equally, blenders may be susceptible to peer pressure or industry fads that could impact how they decide to blend their formulations. Some blenders are more risk averse than others, which will also determine formulation strategy. Nevertheless, Kline says identifying early innovators can be very profitable for basestock suppliers because the basestock selected can experience a virtuous cycle of increased availability and usage.

And the Future Is?

Some analysts say the market is headed toward commoditization, which is ringing alarm bells in some quarters. Extra basestock capacity suggests a future of low levels of effective capacity utilization for some time to come. In 2012, plant utilization was in the region of 80 percent said Kline. Come 2017, they claim that figure will be in the range 73 to 76 percent and by 2022, 72 to 82 percent.

The precise figures depend on the growth in the global market, and Kline outlined three scenarios: no growth (+0.1 percent/year), low growth (+0.6 percent/year) and business as usual (+1.4 percent/year). All of these scenarios will heap pressure on producers already under strain; so, it is clear the industry needs to prepare for extensive capacity rationalization this decade. Most at risk are Group I producers, but the sweep could also hit smaller high cost Group II and naphthenic refiners, Agashe said.

Overcapacity will dilute already weak industry margins, and a substantial reformulation of traditional Group I technical demand will continue for low and medium viscosity grades Kline predicts. As if that is not enough, it is possible there may be a global realignment of basestock players to regain profits.

The question remains whether the industry is ready for a wholesale redefinition of the basestocks business. Time will tell.