OUTLOOK '20: Europe base oils brace for myriad effects of IMO 2020, looming EU tariff

Author: Samantha Wright


LONDON (ICIS)--Supply and demand are usually king for Europe's base oils market.

When it comes to 2020, international regulations for shipping and European trade rules are big factors at play, which could insert themselves into the more typical push and pull of the supply-demand balance.

Players are steeling themselves for an uncertain year, be it the risk of rocky European economic performance or continued weak automotive demand (though forecasts are for a return to growth in 2020 for global automotive production), changes in refinery outputs or the impact of new global regulations and EU tariffs.

The major issue hanging over Group I in 2020 is the start of IMO 2020 rules governing low sulphur emissions for shipping from 1 January 2020.

Potential effects are numerous, including: access to feedstock vacuum gasoil (VGO); potential moves in price of that feedstock; the internal competition of the refinery; and changes in specifications in the downstream market for marine lubricants, which must alter to match the changing sulphur content of fuel oil.

What brings this even more sharply into focus is the wider dynamic in the base oils industry: doggedly low prices for Group I, especially lighter grades, are being prompted by an escalation in the shift towards Group II, III and poly alpha olefins (PAO) use for lubricants.

Margins remain pressured, with ongoing speculation about refineries cutting base oils output in favour of other products due to weak base oil values and comparatively high VGO prices. This may be compounded by preparation for IMO 2020 low sulphur fuel oil sales.

Speculation continues about the fortunes of Group I plants in Europe, and whether one could close after 2019’s relentless pressure on margins. Purchasing activity from a refiner in late 2019, some rather unusual buying for light grades for the export market, confused some in the market. There is speculation there may be shorter supply of lighter grades as refiners favour fuel oil oil ahead IMO.

The confusion underlines uncertainty about the impact of IM0 2020 rules, with talk of different approaches emerging from refiners’ sales strategies. Examples include - and this is not an exhaustive list - some reluctance to commit to contracts for the year due to uncertainty in the market, unless prices are fixed against VGO values, compared to a more aggressive attitude linked to protecting market share.

Concern about Turkey’s economy in 2020 is a factor watched by Black Sea market players. After 2019’s “tough” year, with an “all time low” for sales in Turkey cited by one trading firm, “most companies in the petchems sector are forecasting 2020 [to] be worse,” said the source.

While Europe’s demand eases, export demand should prop up the Group I market to some extent, with African markets in particular likely to be dominated by Group I for the foreseeable future as outlined by speakers including ExxonMobil at the ICIS African Base Oils & Lubricants conference in November 2019.

This explains the ongoing importance placed on tenders for African material, such as Egypt’s regular brightstock demand, in the eyes of northwest European and Mediterranean refiners.

Major African nations taking base oils in 2019 included Nigeria, South Africa, Egypt and Morocco (see interactive map).

As one trader said, “The African market, India, the Chinese market, [are] hungry for Group I. We're not able to cut our ties with Group I.”

2020 starts with the introduction of the new IMO regulations on very low sulphur (0.5%) fuel oil.

This could be very disruptive to distillate, VGO and fuel oil markets, particularly early in the year, according to ICIS Senior Consultant Michael Connolly, who added this will have the flow-on effect into base oil refineries in multiple ways.

Key effects may be variability in the value of feedstock for other uses, the price of co-products from base oil plants (distillates and extracts) and the overall effect on the refinery as a whole that could ultimately have a major effect on the base oil plant.

Generally, expectations are for Group I plants to experience more challenges from the change than Group II and III.

"As with most refining changes, the more complex refineries will tend to benefit and the least complex suffer, but with IMO, the local site and market specifics will result in a highly variable effect from plant to plant," said Connolly.

"As the year progresses, the markets should stabilise, resulting in a clearer picture of who has fared best through this highly uncertain period. Continued drive towards higher specs in automotive lubricant grades and the ongoing rise of electric vehicles, will continue to underpin long term change in the base oil market, albeit at a slower pace than IMO effects in 2020."

The European Group II market will be impacted in the main by recently proposed tariffs on material being imported into the EU.

Under new EU proposals, the current tariff waiver on Group II material would be lifted in favour of a quota on imports, expected to come into force next year.

Up to 200,000 tonnes per every six months would be tariff free, with duties of 3.7% applicable on any material above the quota.

Material of a viscosity between 150N and 600N will be counted in the quota. Market sources believe lighter Group II grades will still be fully exempt from tariffs.

A final decision on the quota is pending.

Players are anticipating some tightness in the market if the quota is enforced.

While a new plant started up in Rotterdam in February 2019, market participants expect that this material will not be able to cover current demand for Group II base oils.

US market players are likely to be heavily impacted by the quota, as most Group II imports into the EU are from the US.

The Lubrizol fire at the end of the third quarter dampened base oils buying interest for use in lubricants production.

Lubrizol produce additives which are used with base oils to manufacture finished lubricants.

While some Group II demand was hit as a result, a few players saw lubricants producers switch from Group I to Group Ii material when they could no longer get the necessary additives for Group I formulations.

There is no clear indication of when the lubricants market will return to normal, with demand for both Group II and Group III expected to be at lower levels for at least January.

In the Group III market, the length that has been seen at the end of the fourth quarter is set to continue into January.

Healthy production coupled with less demand from lubricants producers could see an oversupply in the market for at least the first quarter, particularly on 4cSt material.

There are some expectations of higher demand from the automotive industry in 2020, with players anticipating more switches from Group I material to Group III.

Outlook article by Samantha Wright and Vicky Ellis

Front page picture source: Bienvenido Velasco/EPA-EFE/Shutterstock

Interactive content by Samantha Wright