Who Will Make Money in China?


KUALA LUMPUR, Malaysia – With 40 percent of Asias lubricant demand, and its lubricants industry growing 7 percent a year, China is on everybodys radar screen. But who can jump Chinas lube marketing, distribution, competitive and base oil supply hurdles to generate consistent earnings today, not in 10 years, an industry expert asks.

The integrated global lubricants business, including finished lubes and base oils, generates about $67 billion a year in revenues, Suzan M. Jagger, president of consultancy Suzan M. Jagger LLC, told the ICIS Asian Base Oils and Lubricants Conference here on June 21. Gross margins are about $29 billion globally, and the average return on sales is 12 percent.

Base oil manufacturing is a significant contributor, accounting for about 40 percent of those total gross margins, Jagger said. But industry-wide, value has been flat. Global lubricant demand is projected to grow just 1.2 percent annually over the next five to 10 years.

In North Americas and Europes mature markets, the lubricants industry continues to commoditize. Jagger ticked off some of the contributing factors: globalization of specifications; mass merchants; increase in do-it-for-me oil changes; enhanced competition; and consolidation of fuels and lubricants distribution channels.

In sharp contrast to Western economies, forecast real GDP growth in China is nine to 10 percent per year, said Jagger. Recent growth in on-road vehicles is 20 to 30 percent per year. Motor fuel demand growth is 10 percent per year.

So everyone, Jagger said, is looking to China. Chinas lubricant demand by 2005 approached 4.5 million metric tons, representing 40 percent of Asias volume. From 2001 to 2005, demand for automotive lubricants in China grew 7.9 percent annually, and demand for industrial lubes grew 5.3 percent annually. Total annual growth was 6.7 percent. But, Jagger cautioned, China lags in profitability.

Marketing Hurdles
Marketing and distribution hurdles abound in Chinas lubricants market. Half of the countrys lubricant volume is concentrated along a dense coastal corridor, she said, although coastal markets are now rapidly expanding inland. There are large price differentials between mainline and premium products, and between Chinese national oil companies brands versus multinationals brands.

Five thousand-plus distributors cover the market. There are long lines of distribution through multi-branded intermediaries to reach inland markets, and counterfeiting issues persist, Jagger continued. The route to market for automotive lubricants is mostly distributor based, while industrial is mostly direct sales.

Chinas automotive commercial segment – trucks and buses – is growing rapidly. On the other hand, the automotive consumer segment is relatively small, characterized by fragmented do-it-for-me repair garages and some do-it-yourself auto parts stores, said Jagger. The fore-court major oil companies, for example, ExxonMobil, Caltex and BP, lack strong branded service station channels. Branded service station networks are missing in China. And international do-it-yourself marketers like Valvoline lack a sizable mass merchant channel. Only about 4 percent of the consumer market for lubricants goes through the mass merchant channel, Jagger added.

Not least, she asserted, the government needs to curb counterfeiting by enforcing minimum quality standards and brand registration.

Competitive, Supply Hurdles
Since 1985, international lube marketers established positions in free trade zones. 1997-98 brought the Asian crisis, restructuring of PetroChina and Sinopec, and major oil companies began building lube blending plants in China. In 2000 PetroChinas lubricants company was formed, followed by Sinopecs in 2002. But the consolidation phase is not over, said Jagger.

The big step changes in position have been from acquisition and restructuring, not organic growth, Jagger noted. PetroChina and Sinopec control half of the branded lubricant market and all of domestic base oil supply, and they continue to consolidate brands, strengthen ties with Chinese OEMs, expand direct sales networks and service centers, and focus on commercial and industrial markets. The major oil companies, on the other hand, control about a quarter of the market, with a focus on premium automotive lubricants; their market share has doubled in the last decade.

The big step was Shells 2006 tie-in with Beijing Tongyi, Jagger said, giving Shell access to inland distributors and the Monarch brand, doubling Shells market position in the automotive market. The deal brought China a base oil supply and integrated supply chain. Now, all the major oil companies are linking lubes strategies with fuels strategies, with aggressive plans for service station investments.

Will other multinationals try to follow Shells acquisition of Monarch? Theyd love to, said Jagger, but there was only one Monarch.

Finally, said Jagger, Chinas base oil investment has been slow. She predicted that base oil demand will approach 9 million metric tons by 2015, while current capacity is less than half that – with firm additions adding little more, and most of that new capacity is naphthenic base stock.

China has a strong refining base, but investment is hindered by lagging margins because of controlled pricing, Jagger explained. Fuels and petrochemicals are the countrys highest priority. China could become a big importer of base oils, or changing crude supply and the need for hydrocracking could drive the country to invest in base oil refining over the next five years. China doesnt want to expand its base oil capacity, Jagger said, but I believe that will change in the future.

So, who will make money in Chinas lubricants business? The national oil company consolidations and major oil company investments will reduce the operating cost structure in China, Jagger asserted. Marketers with distribution scale and a low-cost supply of base oil can mitigate their risks. But theres nothing wrong in staking out a profitable regional or channel play within boundaries, Jagger concluded. You need to be profitable now, not in 10 years.

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