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By Aaron Stone
Global demand for finished lubricants has essentially been flat over the past decade, only recently rebounding from pre-global financial crisis levels. In 2015, worldwide lubricant demand was estimated at 39.4 million tonnes, unchanged from 2014. At the Annual Meeting of the Independent Lubricant Manufacturers Association (ILMA) last October, Kline Group Director of Energy, Annie Tarquin, projects an increase to around 42.5 million tonnes by 2024. This equates to growth of less than 1% per year.
The destiny of the base oil industry is closely aligned to the success (or otherwise) of the finished lubricants market. A lack of growth in lubricant demand has exacerbated an already difficult operating environment. Presenting at the 10th ICIS Asian Base Oils & Lubricants Conference last May, Miland Phadke, director – energy practice, at Kline & Co. based in Pune, India, confirmed rapid new supply creation continues to outpace demand, causing a flood of base stocks around the globe. Navigating the next five years appears challenging for base stock suppliers as they attempt to place surplus production.
Unsurprisingly, this supply and demand mismatch has rendered the base oils and lubricants industry awash with change as manufacturers and importers adapt to a rapidly moving landscape. New trading patterns are emerging, regional demand is shifting, some former “rockstar” economies are struggling, and new markets are emerging — heavily influencing where molecules are produced and consumed.
Before we examine some of these regional movements it’s important to understand the trends contributing to lubricant consumption and the base oil supply and demand incongruence.
Limited upswing in the global economy
In essence, lubricant demand is an operational cost of an economy. A strong industrial output drives demand growth for lubricants. Stephen Ames, managing director of SBA Consulting LLC based in Pepper Pike, Ohio, U.S.A., suggests gross domestic product (GDP) can be a reliable tool to forecast lubricant demand. He spoke at the 12th ICIS Pan American Base Oils & Lubricants Conference in December. Where GDP growth is strong, lubricant demand follows. Alternatively, when markets remain stagnant, negative lubricant consumption results.
Unfortunately, the Economist Intelligence Unit forecasts no significant upswing in the global economy, and GDP growth rates in many major regions are expected to remain low in forecoming years.
Trending to efficiency
Technology is a key influencer of supply and demand. A trend towards greater lubricant efficiency is evident, and the Kline Group forecast a “long term trajectory towards lower volumes, higher quality and higher value.”
Much of this technical demand is focused on the automotive industry where an increase in automobile sales is countered with extended oil drain intervals and better fuel economy. The requirement for high performance quality lubricants is expected to accelerate in both developing and developed countries.
The increased prevalence of high quality lubricants in automotive and industrial applications requires higher performing base stocks. Fortunately, a proliferation of higher quality base oils exists worldwide, beyond the current technical demand.
OEM’s move towards global specifications
Original equipment manufacturers (OEMs) are increasingly shifting towards a global platform and specifications. In future, regardless of where in the world you purchase your vehicle, engine oil will adhere to these global standards — such is the influence of OEMs on the factory and service fill landscape. This technical demand is fast tracking opportunities for lubricant suppliers to sell high quality and synthetic lubricants.
Tightening emission norms
Changes to consumer attitudes towards health and safety and a need to reduce greenhouse gas emissions are driving tighter emissions norms. Regulations are accelerating change in motor oil standards and driving the usage of environmentaly benign lubricants that are compatible with emission control technologies.
These and other emerging shifts in the lubricants market are increasing the requirement for more sophisticated, high performance base stocks. The base oil industry is working to meet future demand as they strive to align quality output with technical needs.
Global demand for base oils
Statistics from Kline estimate the supply of high performance base stocks have increased tremendously over the last five to 10 years. Share of Group II and III has increased from 30% of overall supply to just under 50%. Group III and III+ accounted for 14% of supply in 2015, far in excess of demand. Kline suggests that the share of these groups will increase further to 16% following the addition of new capacity. PAO capacity increased by almost 20% between 2011 and 2014, and similar bio-based products have entered the market. Group I remains the “work horse” of the base oils industry; however its market share has dropped significantly in recent times, currently estimated at 44%. A surplus of Group II / II+ and Group III / III+ is evident at a global level, substituting for Group I in overlapping applications.
Despite an obvious supply overflow, Kline data acknowledges that the demand profile masks a growing shortage of high viscosity base stocks.
How will the market cope with this oversupply?
For the most part, there is a severe oversupply position in the base oil industry, despite a significant volume of refineries worldwide operating at a reduced capacity. However, Geeta Agashe, an industry consultant who spent 19 years at the Kline Group, suggests that “in spite of the fact that about 2.6 million tonnes of Group I capacity has already shut down” publicly made statements indicate “15 new capacity additions could still see dawn to 2020”. This has the potential to add an additional 10 million tonnes of capacity.
The Kline Group supports Agashe’s perspective, estimating a slightly lower 7.3 million tonnes of base stock capacity by API Groups. While this creates an extremely favourable situation for buyers of base oils, the question needs to be asked, “Why are we still building base oil capacity?” Surely this environment is untenable in the long term?
Phadke submits that plant closures are inevitable, as is the rationalisation of existing refineries. Bigger refineries typically provide better economics via the ability to spread cost over a larger operating base. Rationalisation is already underway (and even completed) in some regions.
Mothballing of some new plants will no doubt occur, various refineries will continue at redacted operating rates, and we’re likely to see the growth of further non-lubricant applications.
A regional perspective
Preliminary estimates from Kline attribute a lack of global demand over the past couple of years to demand declines in Brazil, China, Russia, Japan and low growth in India. Let’s examine regional variances in supply and demand and the potential for new trade flows.
Agashe refers to the Asia-Pacific as the “epicentre of the global lubricants industry,” currently supplying 46% of finished lubricant volume. While growth in traditional powerhouse China has struggled to keep pace with forecast, Asia-Pacific still represents a region for continued growth, particularly with new frontiers emerging. Kline’s 2016 market overview earmarked India, Indonesia and Vietnam as real opportunities, with compounded annual growth rates forecast in excess of 3%.
Asia-Pacific is also the largest region (by far) when considering global base stock demand (43%) with a total output of 15.4 million tonnes. However, Asia-Pacific, traditionally an exporter of Group II and Group III, is beginning to lose the tag of “Group III hub” as new supply emerges in other parts of the world such as the Middle East. In fact, APAC’s share of Group III is forecast to drop from 56% to 44% by 2025. Asian Group III capacity is likely to increasingly require placement within the region.
Kline Group suggests APAC has a significant surplus in Group II and III base stocks and a deficit in Group I. Irrespective of this position, a quarter of new capacity will likely occur in the APAC region, with most of Group II additions in China. This will seemingly exacerbate the current regional surplus.
Some of the surplus will be absorbed through quality growth (as Asian countries swiftly move to lighter grades with greater emphasis on emissions reduction and fuel economy) and increased regional demand, alongside more Group II substitution. The Philippines, Indonesia and Malaysia are also seen as potential markets for Group II.
Europe has traditionally been considered a frontier of regional strength, similar to APAC and North America. In recent times however, lubricant demand has declined significantly and Europe is losing ground on its rivals. Statistics from K&E Petroleum Consulting (KEPC) in Oklahoma City, Okla., U.S.A., indicate that Europe’s 27% share in 2000 has fallen to 17% in 2015, leaving Europe collectively a distant third overall.
Former shining stars Germany and Russia still enjoy strong lubricant demand, despite a weakening of the Russian market off the back of falling commodity prices. However, the United Kingdom and France have lost significant ground to developing countries and Italy and Spain are no longer part of the top 20. Ernie Henderson, president of KEPC, projects further declines of up to 10% until 2020.
Europe is a traditional source for Group I base oil exports – primarily to South America, Africa and the Middle East. Yet to transition to Group II, Europe is the largest remaining Group I region, a declining opportunity. The oversupply of Groups I and II, low base oils returns (well below the industry average), and limited investment in the region has created a need for rationalisation. The situation has seen Europe transition from a net base oil exporter to a net base oil importer.
The European industry has embraced synthetics. Henderson reports that they hold the greatest demand penetration based on share. Europe is also a Group III source and fulfills the resultant increase in technical demand for premium base stocks regionally. Excess Group III is typically exported to North America.
Agashe suggests that if you’re looking for opportunities in lubricant supply to consider the Middle East, Africa and Asia-Pacific markets. Many of these economies are “leap frogging” developed countries in their adoption of high quality lubricants by avoiding a prolonged lifecycle to achieve high quality. Car dealers in the region are driving high quality motor oil choices, regardless of sometimes severe climatic conditions.
The Middle East is a net exporter of Group III and a significant importer of base oils as a whole. However, local consumption changing from Group I to Group II has Agashe “guaranteeing” a change in demand in the region.
To complicate the current supply and demand mismatch further, the Middle East is in the throws of adding significant new capacity. Experts speculate they seek to reduce dependence on crude oil and move further up the value chain — producing more refined products for export and to satisfy internal demand, while delivering improvements to fuel refinery economics.
The South American region accounts for 12 countries, 420 million people and 5% of global GDP. The powerhouse in South America is undoubtedly Brazil, delivering 50% of the region’s GDP. During 2004-2010 Brazil enjoyed high prosperity. More recently, their economy has become battle-scarred by a GDP retracting up to 7%, eight consecutive quarters of recession, a plague of corruption, drop in vehicle sales and a slow pace of recovery.
Sergio Rebelo, from Factor de Solucao, purports a strong correlation between Chinese and Latin America growth. The Chinese boom had a flow on effect for Brazil, however the subsequent economic slowdown has really devalued currencies in South America.
CEO of Cosan Lubricants (now Moove), Ricardo Mussa, asserts that Brazilian lubricant trends are generally consistent with worldwide movements as they lean to synthetics and engine efficiency at record rates, much faster than anticipated; however no growth is forecast until 2020. Lubricant demand currently sits languishing at 2008 levels.
Brazil relies on a combination of produced, imported and re-refined base stock, with an increasing dependence on the import segment as demand for base oils shifts to high quality alternatives. Petrobras is Brazil’s main producer of Group I, and Mussa suggests they rely on Asia (Group III) and the U.S.A. (Groups I and II) from an import perspective.
According to Ames, North America supplies almost half of the global Group II capacity, alongside significant capacity in other base stocks. With almost 30 base oil refineries, North America has a total capacity of 14.5 million tonnes, 92% of which stems from the United States. U.S. exports predominantly service South America, Europe, Mexico and Canada; and they remain a big importer of Group III, mostly from Korea, Qatar and Bahrain.
The oversupply situation and the emergence of new capacity in places such as Asia-Pacific and the Middle East threatens to impact U.S. trade flows. However, Americans enjoy a structural advantage over many competitors through its five large base oils plants and integrated refineries on the Gulf Coast. These low cost, efficient coastal operations allow the U.S. to compete cost effectively worldwide; Ames even suggesting they have the ability to supply parts of Europe at a lower cost than from within the region.
North American lube demand is expected to remain stable moving forward, recent Kline data confirming that the U.S. is still leading China as the country with the largest lubricant demand, worth USD32 billion in 2015. While overall volumes will remain relatively flat, lower viscosity grades are growing with changing consumption patterns.
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