Base oils: Group II plants lengthen supply

Significant amounts of Group II capacity are coming on-stream, making life difficult for Group I producers but also forcing prices down as supply lengthens

If you are used to buying a particular product and a supplier comes along offering a higher-quality alternative with improved performance and at lower cost then you are bound to choose it, right? That is the key issue in the base oils market, argues Brian Crichton, director of Crichton Consulting.

The SK Lubricants-Repsol plant in Cartagena, Spain, came onstream in October last year, producing Group II and III base oils

Most lubricant manufacturers can effectively have a free performance upgrade by switching their base oils supply from Group I to Group II, he points out.

With significant new Group II capacity added to the market over the past year, and more scheduled over the next 2-3 years, the challenge for Group I producers will likely become more stark. Last year saw huge base oil facilities come on stream in the US, Europe and Asia.

at Pascagoula, Mississippi, in the US, which exclusively makes Group II base oils, came on line in July, while the SK Lubricants/Repsol joint venture plant in Cartagena, Spain, started up at the end of September with a total capacity of 630,000 tonnes/year producing both Group II and III product.

Also in September, Hyundai and Shell Base Oil Co brought on stream a new base oil manufacturing plant in Daesan, South Korea. The plant has a Group II base oils capacity of 650,000 tonnes/year (see box story on following page).

Significant new capacities are also due on stream in 2015. Among them is the Abu Dhabi Oil Refining Co (TAKREER) plant in Abu Dhabi which will produce 100,000 tonnes/year of Group II and 500,000 tonnes/year of Group III base oils; CNOOC’s 600,000 tonne/year Group II facility in Taizhou, China, as well as expansions of existing Group II ExxonMobil facilities in Singapore and the US.

Furthermore, Luberef – Saudi Aramco’s base oils business – is expected to complete the expansion of its Yanbu facility in 2015, bringing on stream up to 500,000 tonnes/year of new Group II/III capacity.

GROUP I UNDER PRESSURE
In the light of all this net additional Group II capacity, Crichton sees life for Group I suppliers as increasingly difficult. “Group I base oils are more costly to produce than either Group II or Group III,” he says. “Group I base oil is also produced mainly in older refineries characterised by lower crude flexibility and furthermore there’s a higher alternative value for vacuum gasoil (VGO) as a fuel source.

“Group I producers are poorly placed to deliver the improved performance that lubricant makers and their automotive industry customers require,” adds Crichton. “They just can’t deliver the low viscosity performance the market needs, so it’s difficult to justify any investment in this sector.

“Group II base oil is much more competitive in terms of the cost of production, more flexible in terms of the feedstock crude and, crucially, can deliver the performance needs of most modern lubricants, apart from some niche low viscosity products, so it is not surprising that most new investments have been in Group II ­facilities. Group II production is also integrated into refinery economics much more efficiently than Group I,” he explains.

Considering all this, the future for Group I base oil producers, many leading ones of which are in Europe, seems rather bleak. However, while lower crude prices push down base oil prices and impact producers of all grades, it has not all been bad news for Group I producers. In their case, the collapse in oil prices has at least given them access to cheap VGO as feedstock.

Also, some industrial lubricant blenders may be resistant to switching from Group I to Group II as the cost to reformulate their facilities to take the new feed could be more costly than the potential benefits.

Furthermore, Group II and III base oil plants do not produce heavy viscosity oils, equivalent to Group I brightstock, and produce middle viscosities at lower yields. Therefore, certain Group I base oil plants may be able to reposition themselves as niche producers of heavy grades.

In fact, perhaps things are not that bleak after all, according to Amy Claxton, owner and founder of base oil consulting firm My Energy. “Low crude prices are projected to last for several years, with OPEC understandably vowing to not give up market share to less efficient producers,” says Claxton.

“As such, the future of base oil supply becomes more complicated. Although Group I solvent processing plants have somewhat higher operating costs than hydroprocessing plants, this is more than offset by the fact that they are fully depreciated assets and have no royalty and licensing fees.”

The significance of this last factor is demonstrated by the fact that, according to Chevron, over half of the world’s premium base oil is manufactured with its ISODEWAXING technology through licensing agreements with Chevron. This is exactly the same technology used at the company’s new  in Pascagoula.

Furthermore, Claxton adds: “Group I plants will continue to enjoy lower crude/feedstock prices while selling products such as solvent extracted brightstock (SEBS), heavy base oils, slack waxes and fully refined paraffins at robust prices.”

VISCOSITY INDEX IS KEY
“Group II and III base oil hydroprocessing plants will also enjoy the benefit of lower crude/feedstock prices, but must contend with lower base oil product prices into an oversupplied market, as well as lacklustre diesel prices linked to crude prices.”

Claxton contends that base oil refining profitability and supply cannot be adequately described as Group I versus Group II versus Group III. It is better defined by markets characterised by viscosity (VI) requirements, in other words the 95 VI market versus the 120+ VI market for low Noack (a volatility test which determines the evaporation loss of lubricants in high-temperature service) engine oils; by viscosity grade (light versus medium versus heavy); and the by-products from the base oil facilities.

“In a world of low crude prices combined with 95 VI light and medium viscosity base oil oversupply, base oil refining profitability has taken on a life of its own,” she says.

Claxton notes a further interesting aspect to lower crude prices: the impact on the refinery by-products from base oil manufacturing. “The economic boost of ultra-low sulphur diesel production from Group II and III hydroprocessing plants improves the cash flow as well as rate of return for Group II and III projects when crude prices are high. When crude prices plummet, however, diesel prices fall rapidly as well, reducing overall plant profitability. Group I plants, on the other hand, have products in short supply whose prices are minimally affected by falling crude prices.

“The tight market conditions and resulting high prices for SEBS, extra heavy base oil viscosity grades, slack waxes and fully refined paraffin waxes are keeping Group I plant profitability on solid ground,” she says.

“The industry focus on the higher saturate and VI levels of Group II and III base oils is understandable for engine oil formulations, but this represents about half of base oil ­market volumes,” says Claxton. “The remaining markets are generally satisfied with Group I base oil quality, and in fact, some applications require them and cannot use higher levels of saturates found in Group II and Group III base oils.”

Despite Claxton’s defence of the viability of Group I production, she agrees with the consensus view that this is in long-term decline, particularly in Europe but increasingly elsewhere too. The rate of decline, however, is where she differs, seeing Group I plants remaining in the mix much longer than early predictions a decade ago of their complete obsolescence.

Crichton argues that, traditionally, Group I product has flowed to less developed markets where the technical specifications required are not so stringent and the costs are lower. However, with the Group I cost advantage having now changed to a cost disadvantage and the product quality argument in favour of Group II, that trade flow is becoming harder and harder to justify.

“There used to be more regional markets in lubricants because the standards required in less developed markers were much lower,” says Crichton. “But now we have universal production and logistics. This means that a BMW or a Toyota is essentially the same car whether it is made in Europe, Asia or the Americas so it needs the same high quality lubricant wherever it is manufactured.”

Consequently, “there’s no reason for opting for a Group I production, when you can have Group II at better quality and lower cost. It’s a no-brainer because you can upgrade your lube quality at no cost.”

BUYERS’ MARKET FOR 2015

Chevron’s major project at Pascagoula has added heavily to Group II capacity in the US

For base oils, generally “it is very much a buyers’ market and is likely to become more so over the next year or two,” says Crichton. “A lot of significant capacity has come on stream over the past year, with new Group II and III capacity coming on to the market much faster than Group I is being taken out.”

With all the new capacity coming through, unless there is sufficient extra demand to 
absorb it, prices are likely to go one way: down. Base oil prices have dropped significantly over the past year, mainly in response to supply factors and the trend to follow falls in crude prices which have dropped by 60% in the past six months.

However, there has also been a fall in demand growth globally – with the most significant factor being the slowdown in China. We have all become used to double-digit GDP growth in China (now the world’s second-largest economy and already the biggest in terms of purchasing power parity, the measure of economic output 
favoured by many economists) and with growth of just 7.4% in 2014 and around 7% forecast for 2015, that erstwhile engine of global demand is no longer firing on all ­cylinders.

Growth rates for lubricant demand are not high – they have been about 1-2% a year over the last few years and there is a “general ­softening in demand,” according to Crichton. “The market will be long for quite some time yet.”

“I am an advocate of scenario planning,” says Crichton, “but in all the scenarios I looked at, regardless of the oil price or original equipment manufacturer (OEM) demand, I couldn’t generate a plausible scenario that was good for Group I producers.

“Only the most efficient Group I suppliers can survive,” he says. And even then they will probably need a significant internal market (such as the Iranian producers and Russia’s Lukoil), as well as the ability to exploit the few niche areas where Group I has an advantage, such as some marine ­lubricant markets and specific industrial ­applications.

However, in the main automotive markets, the move to thinner oils is irreversible and governed by automotive industry needs for incremental fuel economy improvement. This trend to lower viscosity oils will increase ­demand for lighter base oil cuts so “Group II can become the new Group I as the market upgrades.”

Crichton postulates two possible scenarios for the base oils world: Bright and Sunny, characterised by rising economic growth and flourishing world trade; and Tough and Testing, with limited growth, recessions and continuing political tensions.

Under the more positive scenario, mature markets remain attractive for lubricant ­marketers, the automotive industry invests heavily in new technologies with fast global rollout, OEMs and lubricant marketers work closely together and there is continued high competition in lubricant markets but healthy margins.

SHIFT TO HIGHER QUALITY
Even here, however, things are difficult for Group I suppliers. Crichton sees rapid penetration of lower viscosity oils in mature markets, China and more advanced developing markets as well as less developed rising markets upgrading quality with Group II replacing Group I in mainstream applications.

Furthermore, there will be an increase in Group III/III+/IV/V uptake as oil marketers compete on performance and service with Group III replacing Group II in some grades. There will be high demand for diesel pushing VGO to fuel use, Group I will be uncompetitive on cost and performance so there will be continued Group I rationalisations.

Meanwhile, Group II and III producers continue to invest in capacity (the latter to ensure light cuts and Group III+ availability) while Group IV and V producers will flourish as they compete for top tier and premium opportunities.

If that all sounds miserable enough, then Crichton’s Tough and Testing scenario is worse, seeing low oil prices, gross oversupply and refinery closures, with significant overcapacity in the automotive industry and ferocious competition in the lubricant market.

There will be a slow conversion to high-performance low viscosity oils in developed markets and China, limited quality upgrades in less developed markets and the automotive industry focuses on low cost solutions.

There will also be reduced lubricant marketer profitability in a highly competitive/low growth environment and intense pressure on base oil margins as lube marketers seek to reduce costs. There will be oversupply of Groups I, II and III, with Group I producers heavily disadvantaged as lower cost Group II suppliers push hard into their traditional markets. There would be further Group I refinery closures as producers take out their more inefficient units and no justification for new capacity investment of any sort.

Whichever scenario proves to be more accurate, “there are bound to be significant Group I shutdowns over the next 10 years,” he concludes.

Alan Tyler is a freelance journalist with many years’ ­experience covering specialty chemicals and base oils, and was until recently head of ICIS Training