Base oil prices surge as supply takes a dive
In recent years, a growing oversupply has allowed companies to secure competitive base oil prices and encouraged many countries to increase their reliance on base oil imports. A substantial oversupply in 2019 emphasised the benefits of a widening adoption of imports. However, dependence on base oil imports is not without risk.
The propagation of Covid-19 throughout 2020 brought with it a prevailing global theme of tightening base oil supply. The supply tension contrasted sharply with the oversupply of a year earlier and underscored the risks and costs associated with this strategy, says Jane Liu, associate editor, base oils, Asia-Pacific & Middle East, Argus Media. Liu provided an update on the disruption of Covid-19 on global base oil supply during a virtual Base Oils Forum hosted by Argus Media on 9 February 2021.
Global base oil supply tightness was unexpected and prolonged. The main driver was a reduction in base oil production — a trend that began in 2019 and continued throughout 2020. Lower production meant countries had trouble securing sufficient supplies and were forced to pay high prices to compete for available supply, says Liu. This also caused considerable trade flow disruptions.
Typically, base oils follow a regular seasonal pattern. In the United States, rising demand usually occurs in the first four months of the year with slower demand towards the back end. Seasonality ensures the arrival of supplies coincides with a pickup in demand.
In the United States, Europe, and India, base oil demand slumped during the second quarter of 2020, leaving producers and distributors in key markets with the prospect of a surge in base oil stocks, says Iain Pocock, global editor of Argus Base Oils. Demand in the U.S. and Europe typically peaks during those months.
Producers in Europe and in the U.S. responded by slashing prices to clear surplus through the export market, particularly in May and June, he adds. Asian refiners also responded by reducing supplies bound for the U.S. and European markets to avoid a supply glut and pressure on base oil prices in those markets. Pocock highlighted a sharp drop in shipments from South Korea to the United States. In April 2020, exports fell from around 60,000 tonnes per month to a shocking 22 tonnes. Pocock also detailed a sharp fall in U.S. Group II base oil exports to Europe from April onwards.
Base oil producers were largely successful in curbing the supply glut in markets like Europe, says Pocock. Prices still fell in Europe, however, but they fell less sharply in the second quarter, he adds.
U.S. refiners began strategically cutting base oil production to keep supply balanced and margins firm. In seven of the first 10 months of 2020, the utilisation rate was below 70%, a rate that is generally considered unsustainable, says Eva Molina, global deputy editor at Argus Base Oils.
Worldwide, base oil producers responded with a heavier focus on maintenance. Even before the lockdowns, planned and unplanned maintenance at several U.S. Gulf Coast refineries meant utilisation was already below 70%, says Molina. Several refineries were operating at lower rates to keep supplies balanced at a time of year when demand is seasonally weak, she says. As production rates recovered in July and August, Hurricane Laura hit the West Louisiana Gulf Coast, halting production for six to eight weeks at several U.S. refineries.
Latin America and India have a growing reliance on imports. One-third of Latin American base oil capacity has been shut, says Molina, and the remaining refineries are running at reduced rates. Supplies from many of India’s key sources fell sharply in 2020, leaving Indian buyers struggling for resources.
Saudi Arabia is a key base oil supplier to India. The Covid-19 enforced lockdown meant imports from Saudi Arabia to India collapsed in the second and fourth quarters of last year. This impact was exacerbated by a drop in exports from areas like Iran, South Korea, the United States, and Europe, says Liu. Lower import availability coincided with a rebound in India’s lubricant demand in the second half of 2020. Even though lube demand collapsed in the second quarter, full-year sales were only down 10% thanks to a healthy rebound, says Liu. Liu also highlighted a surge in Indian and North East Asia bright stock prices in the second half of 2020. Typically, North East Asia bright stock prices operate at a premium to India, says
Liu. Therefore, Southeast Asian supplies usually move to China. Indian buyers responded to the base oil supply shortage by sharply raising their bid prices to secure greater supply, resulting in a surge in imports from Southeast Asia. This resulted in a change in trade flows with supplies directed away from China, says Liu.
Globally, the revival in demand was earlier and stronger than expected, says Pocock. The Argus Media representative highlighted strong demand in markets such as India, Europe, and the United States, especially in the engine oil sector. However, a significant mismatch between rising demand in those markets and a reduction in supply from key sources like South Korea and the U.S. created a substantial supply/demand imbalance, triggering a price surge.
Clara Toellner, market reporter, base oils, Europe, outlined a real shortage in spot supply of Groups I, II, and III in Europe and unusually high prices. Recurring lockdowns are suppressing transport and jet fuel demand, forcing refineries to maintain a low utilisation rate, she says. Supply restrictions pushed European Group Iexport prices to the highest premium since Argus began tracking it over a decade ago. In addition, production of Group I base oils at Total’s Gonfreville refinery near Le Havre, France, stopped in December 2019 after a fire damaged the refinery’s crude distillation unit. Vacuum gasoil (VGO) procured from the market was prioritised for fuel production over base oils. The French energy major recently announced that it will permanently close the 240,000 barrel-per-day base oil refinery.
Toellner also emphasised a narrowing premium between domestic Group I and Group II pricing in Europe as Group I prices rose faster in the second half of 2020. Group II prices also increased due to low supply availability and declining regional production. Group III prices surged in the second half of 2020 moving to a premium to Group II from mid-2020, says Toellner. Group III supply is expected to remain under pressure until the second half of 2021. European blenders have endured supply cuts, and some have been put on allocation, leaving blenders considering ceasing production of some finished lubricants, she says.
Guo Harn Hong, senior analyst at Argus Media, outlined a narrowing of the spread between U.S. domestic prices and export prices for Group I/ II with the weakening of domestic pricing. Hong does not expect domestic pricing to remain at a discount as demand returns. Domestic prices for Groups I and II are set to revert to a premium to export supplies, he says.
In Asia, Group I/II heavy grade supplies have risen to a sharp premium over lighter grades. Hong predicts this spread will narrow from record-high levels. Group III CFR North East Asia supplies will remain at a discount to regional prices, he says. This trend is attributed to a significant rise in premium grade production capacity in China since 2018, and stricter emissions standards that have been implemented in India and China which require higher quality engine oil formulations.