INSIGHT: Europe's Group I base oil market declines as prices rise

20 March 2014 17:52 Source:ICIS News

By Ross Yeo

LONDON (ICIS)--Prices in the European Group I base oil export market have begun to firm over the past three weeks, and recent history suggests this trend is likely to continue over the coming months. 

Looking at the past three years, prices have followed the same general trend: weakening at the end of the calendar year before strengthening again from February.

This weakening of prices happens because many companies, producers and blenders alike, run down stock levels before the start of the new year for tax purposes. The result is that buyers show less demand and sellers have a greater desire to sell, and so offers are lower.

However, this latest round of price increases, and its likely continuation for a significant part of the year, belies a market under pressure. What’s more, this pressure is expected to grow as time goes on.

A closer look at prices in 2011, 2012 and 2013 shows that the peak price in each year was lower than the preceding year.

Europe brightstock prices“Prices have followed this cycle for the last few years, but every year it gets worse and worse,” said a southern European refiner, referring to fact that each recovery from the year-end slump is weaker than the last.

The refiner’s explanation was simple: “there is an excess of Group I; producers are under pressure.”

This pressure is not unexpected. The increasing presence of higher quality Group II and Group III base oils in Europe at competitive prices has been widely recognised as a game-changer for Group I producers.

The problem for Group I producers is that it costs less to make Group II and III base oils than it does to produce Group I, yet the first two have superior technical qualities.

This cost factor means that Group II and III base oils are likely to replace Group I in applications that do not actually require higher technical performance, as well as in those that do.

Several industry participants have voiced their certainty in recent months that some European Group I base oil refineries will be forced to shut down as demand for their products dwindles, with some even slating 2014 as the year this rationalisation could start to happen.

However, others feel the rush to condemn the Group I industry has been too quick.

“I think it’s exaggerated,” said another southern European refiner, in reference to the perceived impending doom. “In the long run, yes, the [Group I] market will be under pressure, but it’s hard to predict [how quickly this will happen], and I think for Group I there will still be opportunities, like brightstock,” the refiner continued.

Indeed, brightstock represents a potential saviour for many Group I refineries. Brightstock is the heaviest grade of Group I, and many applications that require such viscosities will not be able to use Group II or III instead, because their yields do not contain grades of comparable viscosity.

Sources have also noted that many smaller lubricant blenders may resist the switch away from Group I. One reason for this is that many lubricant formulations must be agreed with customers and OEMs (original equipment manufacturers), and to change these would require consultation, time and money.

Another reason is that smaller blenders are unlikely to have multiple tanks, or the practical capabilities, that would facilitate the change-over.

These mitigating factors notwithstanding, European Group I rationalisation is expected to take place relatively soon, certainly in the next few years.

Before that, Group I refiners are likely to squeeze every last drop out of a declining market.

“Right now, there’s room to improve; I sense there’s an opportunity to increase prices,” the first refiner said.

With recent export prices representing negative margins for many refiners, such an opportunity is unlikely to be squandered.

By Ross Yeo