Ten years ago, there were no shipments of API Group III base oils from the Middle East to the United States or Europe. Fast forward to the present, and Middle East-origin Group III/III+ base stocks now account for 50 to 55 percent of exports to those markets.

Blockbuster investments in premium base oil capacity in Bahrain, Qatar, Saudi Arabia and the United Arab Emirates have catapulted the Gulfs Johnny-come-lately refiners to the top of the base oil league table, redefining the global supply chain in the process.

Uncertainty is the Only Certainty

The regions early successes in penetrating markets traditionally supplied by refiners in Asia are in danger of being overshadowed by geopolitical uncertainty and worries about oversupply. According to one base oil trader, the region faces a supply glut of more than 3 million metric tons per year of Group II, III and III+ oils.

As competition for blenders business intensifies, traders are increasingly turning to arbitrage in a bid to compete with refiners. Arbitrage is the purchase and sale by traders to profit from an imbalance in prices between different markets.

Iran continues to be the Middle Easts foremost known unknown as U.S. sanctions squeeze the Islamic Republics all-important Group I base oil exports. Washingtons latest round of sanctions have fueled excessive volatility in the Iranian rial, making it difficult for traders to price and insure cargoes. Fledgling Group II imports into Iran have also been hit, prompting a move back to Group I base oils in the domestic market.

Speaking at Februarys AMEA Bitumen and Base Oil conference in Dubai, Amreen Rafique, GP Globals base oil trader for the Middle East, North Africa and Pakistan, said additional uncertainties, including the boycott of Qatar by Bahrain, Saudi Arabia and the U.A.E., has undermined investor confidence at a time when crude prices have come under pressure. Qatar has the highest installed base oil capacity and, together with Iran, Saudi Arabia and the U.A.E., accounts for 84 percent of the regions nominal capacity, estimated at 5 million tons per year, or 5.8 million if Turkey and Egypt are included.

Turkey has one Group I refinery, which has a capacity of 400,000 tons per annum, and Egypt has four Group I oil refineries with a total capacity of 382,000 tons per annum, Rafique told delegates.

Overall, Group I and Group III base stocks are split evenly, at around 40 percent of the Middle East market each. Group II accounts for the remaining 20 percent. Iraq, slowly recovering from years of conflict and rise of the Islamic State, has seen its operational capacity plummet to 45,000 t/y a year, according to GP Global.

Despite the tightening grip of sanctions, Iran was still able to export 435,000 tons of Group I base oils in the 2017-2018 fiscal year, underlining its pivotal role in global Group I markets.

Base Oil Indigestion

The ramp up in Middle East capacity means most of the new producers – Bahrain, Qatar, Saudi Arabia and the U.A.E. – are now net exporters of base oils, although Egypt, Iraq, Israel and Turkey continue to be net importers despite refining Group I base stocks locally. Meanwhile, the rest of the Levant – Jordan, Lebanon and Syria – as well as Kuwait, Oman and Yemen, are simple base oil importers. Yet the regions increase in capacity is part of a reshaping of market dynamics.

According to Rafique, the Middle East is increasingly exposed to arbitrage speculation amid conflicting market forces. Yet, it is not just about oversupply. Fifty percent of Irans Group I base oil exports are shipped to the U.A.E., India and Pakistan, and that has created a regional deficit requiring Group I imports from Southeast Asia, Europe and Russia. The U.A.E is the regions base oil hub and the deficit is partly due to the large volumes of base oil the U.A.E. needs for finished lubes that it reexports, mostly toAfrica, which has driven demand for Group I base stocks from local blenders.

But surplus capacity is also having a major impact on prices. According to Nikhil Agarwal, director of Napstar Global in the U.A.E., Group III prices have now become cheaper than Group II prices. A shortage of lighter Group II grades in the Middle East has seen blenders shift to Group III formulations. Such gyrations in prices are unprecedented in this region.

In the meantime, regional Group II imports from the U.S., north Asia and Southeast Asia have been checked by the shaky start of production at Luberefs Group II plant in Yanbu, Saudi Arabia. Still, there are ample quantities of local base stocks to supply the regions lubricant sector.

Overall, GP Global estimates the total Middle East finished lubricant market at approximately 2.8 million t/y and estimates it will grow between 1.2 and 1.5 percent yearly. With its aging vehicle parc and poor fuel quality leading to shorter drain intervals, Iran continues to have the largest lubricant demand in the Middle East, at around 700,000 t/y, followed by Saudi Arabia and Turkey.

GP forecasts that by 2021, the Middle East and Africa will account for 7.3 percent of global lubricant demand, up from 6.9 percent in 2015, and it is a rare growth market worldwide. Globally, there is approximately 50 million tons of installed capacity, but Rafique said plant utilization will probably average two-thirds of installed capacity in the medium term.

Stakeholders Perspective

The strategies of suppliers and blenders are increasingly shaped by changes in regulation and emission controls, which are driving demand for better performing engine oils. Rafique said the relationship between the supplier and blender is adapting, as surplus capacity in the Middle East impacts prices and consumption patterns.

Refineries will likely pursue base oil blenders, whether bulk or [flexitanks], and probably give them better terms than traders, she said.

Refiners are keen to secure long-term contracts to stem volatility in prices and supply. But that leaves traders dependent on spot markets, she added.

Base oils comprise 90 to 95 percent of finished lubricants, making base oil cost an important determinant of lubricant margins and profitability. To maximize margins, blenders are increasingly seeking deals where the supplier absorbs costs.

Blenders are likely to tap CFR [cost and freight] selling refineries and international base oil traders or utilize their own blending capabilities to drive down the cost-of-goods sold.

Aside from ongoing closure of inefficient Group I plants around the world, Rafique said new Group II and Group III capacity, together with regulatory creep, will quicken the move to higher quality base stocks.

And the Winner Is

Koreas Group II suppliers have been shaken by stiff competition from Adnoc in the U.A.E and Luberef in Saudi Arabia but, Rafique said, Korean approved base stocks continue to command a price advantage over Gulf-origin cargoes. Group III supply from Adnoc has opened up an arbitrage market for traders seeking to capitalize on the price differentials. But a new coal-to-liquids plant in China could dampen arbitrage trading of China destined cargoes from the U.A.E. The plant is at testing stage and is yet to begin production, she added.

Availability of new base oil supply will see a rise in technical demand and spur migration to Group II and Group III base stocks. Although the U.S. and Asia are major suppliers of Group II base oils, their supremacy will be challenged by the recent start-up of ExxonMobils Group II base oil plant in Rotterdam. For now, the Middle East looks set to remain the go-to source for Group III base oils, followed by Korea.

Still, the fallout from erratic supplies of Group I cargoes from Iran has squeezed base oil traders particularly those based in the U.A.E. at a time of rapidly growing supplies of Group II and III base oils. In February, the gap between Group I and Group III prices fell to just $40 per ton for bulk U.A.E. free-on-board cargoes, according Napstars Agarwal.

Abundant supply and constrained trading conditions are a toxic combination unlikely to produce winners anytime soon.