OUTLOOK '09: Base oil players use '08 lessons to prepare

07 January 2009 23:30  [Source: ICIS news]

By Heather Doyle

HOUSTON (ICIS news)--The ups and downs of US base oil pricing alongside volatile supply over the last year have been more dramatic than ever, but market players are hoping the lessons learned in 2008 will prepare the market for what will likely be one of the most trying economic times in history during 2009.

In 2008, US base oil buyers saw spot prices for 100 grade paraffinic base oil go from $2.55/gal ($765/tonne, €566/tonne) at the start of the year to a high of $4.78/gal in September, an increase of nearly 90%, according to global chemical market intelligence service ICIS pricing.

By December spot prices for 100 grade base oil fell to $2.80/gal.

But price drops did not come soon enough and were still higher than prices at the start of the year, buyers said.

At the same time, crude oil prices reached their peak in July at $147.27/bbl, up 44% from January, and then plummeted to 2004 levels.

Market players said the reason base oil prices increased more than feedstock was fuels refining.

“Vacuum gas oil, a feedstock for both base oil and diesel fuel, had a higher return for refiners going to diesel fuel than to base oil,” said management consultant William Downey of Kline and Company. “So the prices of base oils went up until base oils generated returns that were competitive with diesel.”

Downey said base oil players should expect the volatility to continue as crude oil prices rise and fall and the importance of diesel fuel margins for the refinery remain.

Early in 2008, base oil refiners chose to divert the feedstock to create more fuels than base oils, creating a tight supply scenario for several months.

For 2009, base oil players are equally concerned about supply not only due to refinery production, but also widespread speculation that another Group I base oils plant will shut down.

Hesitation over the future of Group I base oil plants in North America is leading to neglected refineries and more shutdowns to come, another analyst said.

“Uncertainty over Group I future is creating deferred maintenance and capital investment,” said Amy Claxton, owner of Hershey, Pennsylvania-based consultancy My Energy. “This will make Group I shutdowns a self-fulfilling prophecy.”

In 1998, there were 34 paraffinic base oil plants in North America producing a total of 200,000 bbl/day Group I base oils. Ten years later, the number has decreased to 11 plants producing 70,000 bbl/day, Claxton said.

In 2008, the US base oils market saw the shutdown of two Group I facilities, Marathon and Citgo, which represented 20% of the US Group I base oil market.

Group I facilities are closing as the Group II and III facilities expand and buyers switch to high-quality base oils.

“But there are still many Group I applications regardless of region,” Claxton said. “High-value by-products are already in short supply and getting tighter.”

Many Group I base oil plants are wired to produce fully refined paraffin wax, slack wax and bright stock - products the Group II and III facilities cannot make.

Although base oil prices were quick to rise with crude prices in 2008, prices were much slower to come down as crude fell. This trend is not over, analysts say.
No base oil decreases were announced until the end of October, with another two following in November.

Just when base oil players were ready to call it a year and many expected no more price movements for 2008 fresh announcements emerged in early-to-mid December.

US base oil buyers received word that major Group I supplier ExxonMobil would lower all grades of base oils by 50 cents/gal effective on 18 December.

The decrease marked the fourth decrease for ExxonMobil since posted base oil prices surged on high crude oil values in July. SN150 posted prices have now moved down by 31% since a high of $4.97/gal in July.

Group I suppliers Sunoco, Valero and Calumet also lowered prices in December for the fourth time in 2008.

US Group II base oil supplier Flint Hills on 8 December lowered its posted prices for the fourth time since July as demand diminished from all sectors, and buyers were hoping the announcement would fuel other producer initiatives before year end. Chevron and ConocoPhillips reduced Group II posted base oil prices the following week.

Just before Christmas, the largest Group II supplier Motiva told its customers it would lower posted prices from 50-60 cents/gal effective 22 December.

Prices from South America also dropped as Venezuela’s PDVSA lowered its paraffinic grades by 60 cents/gal effective on 15 December.

But the price decreases did not come soon enough for most buyers.

Many downstream buyers were unable to pass the high base oil costs onto consumers and were left with high-priced inventory just as base oil prices began to fall.

At the same time, demand began to plummet for all those sectors tied to the auto industry, including blending and transmission fluids.

“A number of those base oil buyers directly tied to the auto industry - such as those involved in the initial fill and the blenders - have had to cut production at their own facilities even before Ford and Chrysler announced they would extend their shutdowns,” a refiner said. “Those guys are worried about having a job more so than ever before.”

Given the volatility and the hard to predict increases and decreases in base oil prices, the profitability of base oil buyers can be very dependent on the ability to pass raw material costs along to customers, said Kline and Company’s Downey.

“Companies with a large portion of business in value-added segments - greases, metalworking fluids and other market niches - have more margin protection and more insulation from raw material price increases,” Downey said.

The December price drops came just after the market had absorbed a reduction of around 60 cents/gal for all grades, ahead of the US Thanksgiving holiday.

Several market players believe the decreases are not totally over.

A buyer said there would be several additional drops in posted prices since crude values are hovering at levels not seen in almost four years.

With imports arriving from Asia and Europe, the US would surely head toward oversupply and prices would have to come down further, another buyer said.

This was already putting pressure on the spot market, where heavy discounting was heard as inventories were quickly rising at the refineries.

The balanced-to-tight supply dynamics that were keeping US prices firm remain in place, but demand has plummeted as customers destock inventories to improve cash flow. Many were ending the year with lower than usual stock levels and continued to buy piecemeal, sources said. Producers speculated that demand would improve as tanks were emptied.

Some anticipated that demand would improve in January since the whole chain seemed to be operating with dangerously low stocks.

Others were not as optimistic and said that a return in consumption may not be seen until the second quarter as demand from industries tied to the automotive market is expected to be at all-time lows.

The largest Group II supplier, Motiva, would be entering a 45-day turnaround during the first part of the year, which would tighten the market.

Motiva produces 40,300 bbl/day of paraffinic group II base oil, according to the National Petrochemical and Refiners association (NPRA).

“It is clear that the lubricants business will continue to be essential to many sectors of the economy,” Downey said. “To ensure the buyers thrive, reacting to base oil volatility by covering downside risk and moving focus to high-value added space will be important.”

($1 = €0.74)

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By: Heather McGuire Doyle
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