Middle East Supply Glut Weighs on Base Oils

DUBAI, United Arab Emirates - A dramatic increase in base oil availability from the Middle East is fueling a supply glut that could exceed 3 million metric tons a year, according to an industry executive.

New APIGroup II and III base oil production from Bahrain, Saudi Arabia and neighboring United Arab Emirates has led to Group II base oils increasingly displacing Group I amid a tightening in prices, according to sources. Total regional base oil production capacity for Group I, II and III combined has grown to just over 5 million tons a year, the executive said at the recent Petrosil Base Oil, Lubricant and Wax conference here.

Iran, which has historically dominated in Group I production, exporting up to 450,000 tons per year of Group I base oils. With a market demand of almost 700,000 tons, Iran is the regions largest lubricant market, but sanctions have effectively shut down imports of higher quality Group II and Group III base oils, forcing refiners to resort to local Group I base stocks.

Analysts say United States and European Union sanctions on Iran are radically reshaping regional market dynamics amid intensifying competition between producers in Asia and the Middle East Gulf.

Asia has emerged as an important battleground, with refiners competing for share in key markets as Gulf refiners grapple with flat domestic lubricant demand and falling auto sales. Mumbai-based Petrosil reported last week that China's base oil imports from the U.A.E. increased 30 percent to 80,000 tons between January and November 2019.

Wider uncertainty over stability of supply of Group I base stocks from Iran and a transition to higher quality finished lubricants in Asia has seen many blenders switching to Group II base oils as prices have eased.

Qatar is also a significant exporter of Group III and III+ base oils produced at Qatar Petroleum and Shells Pearl gas-to-liquids plant in Ras Laffan. Shell claims the base oil production is used exclusively for the oil giants internal consumption. Speaking at the conference earlier this month, Amreen Rafique, base oils trader for the Middle East, North Africa and Pakistan at GP Global Group, said the more than 3 million tons of excess supply in the Middle East consists of Group II, III and III+ base oils.

Rafique told delegates that Qatar, together with Iran, Saudi Arabia and the U.A.E., account for 84 percent of the regions overall base oil production capacity. Yet despite looming overcapacity, the Middle East has carved out a significant share of the North American and European base oil markets in the last few years. The Middle East continues to be a net base oils exporter, accounting for almost 50 to 55 percent of Group III and III+ exports to North America and Europe - this was nil 10 years ago.

But economic growth in the six-member Gulf Cooperation Council remains subdued and is forecast to be around 2 percent this year as geopolitical risk weighs on sentiment. Rafique estimates the total Middle East lubricant market at 1.9 million tons in 2020 against a backdrop of a flat or declining automotive sales sector and said demand may shrink by around 1.3 percent next year. New vehicle sales in major auto markets such as Saudi Arabia remain sluggish, with volumes in that country falling more than 50 percent between 2015 and 2018, according to GP Global.

Still, declining auto sales mask a wider picture of several competing factors that could be bearish for regional base oil and lubricant demand. Rafique said the shift from mineral based engine oils to semi- and full synthetics is favorable for margins but cautioned that longer drain intervals, which characterize synthetic oils, will result in lower lubricant sales volumes overall. Technical demand will rise, and migration to Group II and Group III is evident, she added.

National oil companies in the U.A.E. and Oman also benefit from government policy that mandates that lubricants from state-owned companies receive preference on government projects. Meanwhile, a broader market downturn as a result of falling auto sales has led to banks tightening working capital funding. This comes amid reports of a credit squeeze as channel partners experience delays in payments.

Despite active campaigns promoting total cost of ownership, the unit cost of lubricants still figures prominently among consumers, Rafique told delegates. That has spurred a rise in inferior products. Counterfeit and substandard lubes have made their way into the market, and that is harmful for genuine blenders, he said.

Nonetheless, the outlook for base oils from the Middle East remains promising, with big commitments from governments in Saudi Arabia and the U.A.E. to bolster investment in the downstream sector. Yet competition is heating up, and matching nascent volumes with technical approvals remains a key challenge for Gulf refiners, as South Korean Group II producers continue to hold their own, attracting premium prices for approved base stocks. Gulf refiners may have elbowed their way into international base oil markets, but it appears a lot of work still remains to be done.