INSIGHT: Europe base oil prices disconnect from gasoil feedstock

18 August 2010 16:24  [Source: ICIS news]

By James Mills

LONDON (ICIS)--After witnessing a steady rise in the prices of base oils since the beginning of the second quarter, European buyers are slowly coming to the conclusion that supply and demand issues are now driving the market, rather than refining margins.

The conventional assumption that fluctuations in crude oil and product prices will ultimately be reflected in the base oils market is not supported by historical price evidence.

In fact, there is no direct relationship between prices for the main feedstock used in base oil production in Europe, vacuum gasoil, and the market prices of light solvent neutral paraffinic base oils.

A once comfortable rule of thumb – that base oils prices trend in parallel with the price of vacuum gasoil at levels roughly $300/tonne higher – has not been a useful guide for the market in recent years.

An analysis of price trends over the past five years shows wide variations in refiners’ gross margin on base oil production, both in absolute and percentage terms. Although gross margins for a common base oil grade, SN150, average around $300/tonne during this period, they have ranged between $110/tonne and $670/tonne, based on quarterly averages.

Expressed as a percentage over vacuum gasoil prices, SN150 prices have represented margins of as much as 180% and as little as 25%, again based on average quarterly prices.

It is true that the point at which vacuum gasoil prices were at their lowest in the past five years, in the first quarter of 2009, coincides with the lowest prices for base oils over the period. But this is insufficient to support the theory that base oils follow gasoil.

The experience of the past six months perhaps provides the best challenge. Base oil prices are shown to have been on a pronounced upward curve despite relative stability in crude oil and product prices.

What emerges from the analysis is the notion that vacuum gasoil prices establish a floor for base oil prices when the market is oversupplied.

This is shown most clearly with a change in the direction of base oils prices in early 2007. Prices fell steadily in the second half of 2006, even as prices for crude oil and vacuum gasoil rose. At the point where the two price curves seemed about to converge, base oil prices were lifted in tandem with the rising price of their feedstocks.

A similar situation was observed in early 2009, when base oil prices were plummeting: a gradual rise in feedstock prices put a floor under the base oils market and reversed the downward trend.

Increasingly, arguments that rely on a purported connection between base oil prices and the cost of their feedstocks hold little sway with producers.

“No refiner is ready to give away margin by linking base oils prices to gasoil,” a trader active in the market told ICIS.

Base oil vs feedstock graph

($1 = €0.78)

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By: James Mills
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