Base oils 2014: Group I prices come under pressure

11 February 2014 10:17 Source:ICIS Chemical Business

European base oil producers are facing soft domestic and export demand and the prospect of Group II base oils supplies from new capacities in the US and Spain

Prices in the European base oil market typically weaken during November and December, as participants try to lower inventory levels before the end of the year, leading to lower demand and discounting by refiners. This is usually followed by a resurgence from around mid-January as normal market conditions prevail once more.

Weak demand is putting a squeeze on prices

Copyright: D Sharon Pruitt

Although somewhat more muted than in years past, given the relatively low level of prices in 2013, export prices did indeed ­follow the usual downward trend and eased off from late November. However, as the second half of January approached, there was no recovery to be seen.

In the second half of 2013, many refiners reduced operating rates and output in January was low, something that should, in theory, support higher prices. However, there are ongoing concerns that demand, both domestic and export, remains too weak to support a sustained price increase.

In contrast with 2011 and 2012, when prices fluctuated wildly, prices in 2013 were stable, albeit at low levels. Rather than being the result of a healthy, steady marketplace, 2013’s stability was essentially caused by a stalemate between buyers with poor demand and refiners with narrow production margins.

Low buying interest resulted in an oversupplied market, but a narrow spread between feedstock vacuum gasoil and base oil prices meant refiners were reluctant to lower prices and squeeze their margins further. When faced with a choice between selling at, or near to, a loss and reducing operating rates, many in southern Europe opted for the latter.

This lower output helped to balance the market to a certain extent, and discounts were eventually offered in the export market from late November as certain refiners acted to lower stock levels. There are hopes that demand will improve as 2014 develops, yet there are also concerns that the levels of 2013 will be repeated.

To compound matters further for European Group I base oil refiners, 2014 will see them face a challenge from new supplies of Group II and Group III material. All eyes in the market are on the progress of US-based Chevron’s new 25,000 bbl/day Group II plant in Pascagoula, Mississippi, which began mechanical start-up in early January, and will make Chevron the world’s largest Group II producer (see page 9).

A significant proportion of the new plant’s output is set to flow into the European market, possibly in the second quarter, with Chevron building a new supply hub in Eastham, the UK, to complement its two existing European hubs in Antwerp, Belgium, and Hamburg, Germany.

Furthermore, the product is expected to be competitively priced relative to Group I material. Towards the end of 2013, Group II prices in Europe were only around $20-30/tonne higher than Group I prices. The influx of higher quality, similarly priced base oil is likely to put significant pressure on an already struggling market.

In light of the aforementioned concerns regarding the underwhelming demand seen throughout 2013, a recovery of the magnitude required to absorb the additional US material is unlikely.

Following in the wake of the Chevron plant will be a joint venture between Spain’s Repsol and South Korea’s SK Lubricants being built in Cartagena, Spain. The plant is scheduled to reach commercial production by September, and will have a total production capacity of 13,300 bbl/day, of which two-thirds will be Group III base oils and one-third will be Group II.

It has been noted that after years of formulating lubricants with Group I and Group III base oils, making an immediate switch to Group II is unlikely for many blenders. Nevertheless, there is a widespread acknowledgment that the effect of the new volumes will be to bring down the price of all three groups of base oil in Europe.

Observers have noted seriously the possibility of refineries closing down in Europe in 2014 amid the hostile economic conditions.

As mentioned above, a number of refiners in southern Europe reduced their operating rates during the second half of 2013 when faced with narrow production margins. Barring a significant decrease in feedstock prices, these margins appear unlikely to improve considerably in the near future.

“It will be interesting to see. Will refineries close? If they make specialties they will be OK, but those that make only the basic base oils, they could be in trouble,” said a trader and distributor.

Other refineries that are also likely to come under pressure are those in Russia. One reason for this is the EU’s decision to reclassify Russia as no longer eligible for its Generalised Scheme of Preferences (GSP), which allows developing countries to pay lower duties on their exports to the EU. The decision means that base oil imports from Russia will be subject to 3.7% duty from the beginning of 2014, up from 0% previously.

With the new Group II and Group III material likely to push down European Group I prices, Russian Group I material, which is generally of lower quality and therefore lower price, will come under pressure also, squeezing the margins of Russian producers.

At the same time, large question marks remain over the future of Turkish demand, normally an important buyer of both Russian and European material, because of new legislation that came into effect in 2014.

Under the new legislation, base oil importers will need to apply to the EPDK (Republic of Turkey Energy Market Regulatory Authority) for base oil cargoes planned for the country.

Licences will be issued according to buyers’ finished-lubricant production capacity, and the amount of base oils they already hold in stock. Only lubricant producers will be able to apply for the licences, but base oil traders will be able to use them on behalf of the buyer.

During the second half of 2013, the upcoming legislation severely depleted Turkish demand for base oil imports, largely because of uncertainty surrounding the situation. This uncertainty has persisted into the new year, and with it the subdued demand. European sellers have noted signs of returned buying interest; it remains to be seen to what degree this takes place, and whether Turkish base oil consumption will return to traditional levels.

In a further blow to Russian refiners, but a possible boon for European ones, Turkey also uses a GSP scheme, for which Russia and some other Black Sea countries no longer qualify. The result is that Russian base oil imports to Turkey are now subject to 4.5% tax, meaning many buyers are increasingly looking for European product.

All in all, 2014 looks set to be a challenging year for refiners. Consumers may not be seeing any marked improvement in demand just yet, but at least they have a second half of the year to look forward to with plentiful supplies and prices under pressure.

Ross Yeo is a markets editor in the ICIS office in central London, covering European base oils

Aerial view of the Le Havre site

Copyright: Le Havre Port

Odfjell Terminals is moving forward with its plans for a greenfield liquid bulk terminal on the Grand Canal in Le Havre, France. Basic engineering work starts this spring, with construction planned to begin in 2015. Onstream date is the end of 2017. The facility will serve as an export hub for European Group I base oils and as a French import hub for Group II and III base oils in future, says Carl Fredrik Odfjell, vice president business development and project management for Odfjell Terminals.

“Our plan is to construct a modern, state-of-the-art liquid bulk facility that will cater to the local cluster, ­giving flexible and efficient solutions for truck and rail loading and unloading, and ample waterfront for barges and sea-going vessels,” he adds.

Storage capacity in the first phase will consist of a minimum of 150,000cbm and tank size capacities of 1,250cbm, 2,500cbm, 3,300cbm and 5,000cbm.

The terminal will offer deep sea facilities. Three berth positions are planned in Phase 1, making the terminal easily accessible for sea-going tankers, coasters and barges.

The terminal will serve rail tank cars and road tank trucks and also provide a trans-shipment and intermodal platform.

By Ross Yeo