Awash in a Sea of Group III


Demand for API Group III base oils, high quality refined mineral oil that can be marketed as synthetic, is growing at 10 percent per year, but will next years projected oversupply lead to severe competition and depressed prices? Or will production capacity find a balance with growing commercial demand, asked leading Group III refiner SK Energy at a recent industry forum.

There is a big shift in interest recently to Group III, J. Rock Lee, marketing manager on the base oil team at Seoul, Korea-based SK Energy, told the ICIS Asian Base Oils & Lubricants Conference in Kuala Lumpur, Malaysia, in June. SK Energy is the worlds largest Group III base oil manufacturer, with total capacity of 16,000 barrels per day (plus another 5/000 b/d of Group II). Another 7,500 b/d of new Group III capacity will come on stream in mid-2008, when SKs joint-venture refinery with Pertamina, in Dumai, Indonesia, starts up.

Total global base oil demand is growing 2 to 3 percent per year, said Lee, but Group III is growing 10 percent per year. Group III currently supplies 5 to 6 percent of world demand and will account for about 10 percent by 2015.

The key merchant players in todays Group III market are SK, Koreas S-Oil and Finlands Neste, Lee noted. Chevron, Petro-Canada, Sinopec and another 10 refiners also produce Group III today, but primarily or entirely for captive use.

There was no Group III merchant market before 1999, said Lee. We had to create demand, as a substitute for PAO and as correction fluid blended with Group I. But today, demand is pulling. Worldwide production of Group III reached 47,000 barrels per day by mid-2007, reflecting the development and approval of formulations using Group III. In fact, added Lee, demand is larger than supply in [the] short term, although demand differs by grade.

But a sudden oversupply may be waiting in the wings. Next year will see the opening of the SK-Pertamina joint venture, adding 7,500 b/d; start-up of the new Petronas refinery in Melaka, Malaysia, producing 5,500 b/d; and GS Caltex in South Korea streaming 3,000 b/d. Neste, in a joint venture with Bapco, is slated to produce another 7,700 b/d in Bahrain in 2009.Lee asked whetheraccelerating technical changes and increasing commercial demands for Group III can absorb that market expansion.

The prospect of gas-to-liquids base oils coming on stream around 2011 will create a Group III-plus merchant market, said Lee, but the question for todays merchant marketers is how Group III can compete with GTL.

Looking at global pricing trends, Lee noted that from 2004 to 2005, crude oil and fuel prices increased dramatically, resulting in a short supply of fuels and base oils. When fuel prices are higher than base oil, who produces base oil? he asked rhetorically. From mid-2005 to mid-2006, base oil prices continued to rise while crude prices fluctuated.

The latest period, from mid-2006 to mid-2007 may mark a regression, Lee said. Crude oil and fuel prices have increased, while base oil prices declined, and domestic and export pricing differed. It was a period, he noted, when base oil margins were squeezed, and the price premium for Group III over Group II-plus saw some narrowing.

There has been talk of posting [base oil] prices for Europe and Asia, Lee noted, But who will be first?

Turning to other issues facing the Group III market, Lee noted that the regional mismatch of supply and demand is a key factor, given the growing importance of logistics and the high costs of shipping and tankage. North America and Western Europe have the greatest appetite for Group III, while Asia Pacific will continue to be the dominant source of supply.

There are significant risks to further investment in Group III, cautioned Lee. Economic risks include feedstock costs, base oil price movements, competition against fuel, and severe competition in the high quality base oil market. The Group III [price] premium will be changed, he asserted, and full production is the matter. These risks combine with the cost burdens of high logistic costs, high research and development costs for formulation and approvals, and high marketing and operating costs.

As a Group III manufacturer, asked Lee, do you have enough captive use or a partner? Newcomers dont have either.

One essential answer to the anticipated oversupply of Group III will be increasing quality differentiation in Group III base oils, Lee said. SK is launching a new 4 centiStoke product, a Group III-plus, he said, with a viscosity index of close to 140 and NOACK volatility similar to PAO. Interchangeability is now being studied on the new Yubase-branded base stock, Lee acknowledged, and product formulations and approvals are still an issue.

In the short term, Lee concluded, oversupply could push Group III down into applications in lower performance tiers, but oversupply may push demand growth, and increasing demand of high quality base oils can put Group III in premium tiers in [the] long term view. Not least, he noted, more competition in the high quality base oil market will be good for blenders.

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