31 August 2012 14:12 [Source: ICIS news]
By Carl Roache
LONDON (ICIS)--European base oil production margins are being squeezed by firm upstream costs and cuts to operating rates cannot be ruled out, sources said this week.
Group I base oil export prices have started to rise again, but increases have not kept pace with the feedstock movements of recent weeks.
This is raising the possibility of potential production cuts.
“The economics are not great, let’s say,” said a west European producer.
“There was some recovery [of prices], but not enough to make the margins attractive on base oils.”
The producer added that there was always the possibility of reducing base oil production rates for economic reasons.
It is not just producers who say this – several traders and buyers have said production cuts are a real possibility in the current market.
Base oil prices have been on a rollercoaster ride for the past 12 months, falling sharply during the fourth quarter of 2011, before reaching a plateau and then surging in late quarter one and early quarter two of 2012.
Prices then slumped from late quarter two and the weakness continued into quarter three.
However, the latest decline in Group I base oil prices came amid the beginnings of a steady resurgence in crude oil prices, which in turn pushed up the price of vacuum gasoil (VGO) – the primary feedstock for base oils.
Base oil prices are now on the way back up, but are lagging behind the rise that has occurred upstream.
For example, since 31 July solvent neutral (SN) 150 export prices have risen $10-20/tonne, whereas VGO prices have increased $73-87/tonne, according to the latest figures received.
According to market sources, $230-250/tonne over the cost of VGO is considered to be a breakeven cost for European Group I base oils production.
This value will vary widely by producer and whether they are integrated up the crude oil chain, but it is considered a good indicator level.
To illustrate the point that margins are being squeezed, the spread between the current SN150 FOB (free on board) Europe export low and VGO is $119-125/tonne.
Accordingly, some producers are losing money on base oil export sales.
“The raw materials [cost] for base oils production is extremely high at the moment and the refinery is under pressure,” said a northwest European producer.
“We will definitely try to increase prices in the coming weeks.”
One reason why production cuts have not yet been widely announced is because many suppliers commit substantial volumes under term contracts or spot sales to their respective domestic markets, for which they can enjoy significantly higher prices than for exports.
As you would expect, many producers are channelling as much base oil as they can into domestic markets because of the better returns available.
However, these domestic markets cannot consume all that is produced in the region.
Another factor that may see base oil output cut is the rising prices of possible alternative fuel products, such as ultra low sulphur diesel (ULSD).
This market has tightened in recent weeks because of reduced arbitrage opportunities from Asia and the US into Europe.
ULSD premiums to ICE gasoil have risen from the low-$30s/tonne at the start of August, to $44–47/tonne currently.
“Next month because of VGO prices, the margins are not very good, even if prices are higher,” said a central European producer.
The most common use for base oils is in lubricating oils for vehicles and industrial machinery. They are also used in process oils such as cosmetics and pharmaceuticals.
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