What Goes Up Must Come Down


NEW YORK – Energy markets, including crude oil prices, base oil prices and refining margins, are cyclical, and tend to move together in response to common stimuli, an industry expert told last weeks ICIS Pan-American Base Oils & Lubricants Conference. Expect a soft landing from todays cyclic peak over the next three to five years, he predicted, with both crude and base oil prices likely falling 30 to 40 percent.

Today, were in a perfect storm for high energy prices, said Blake Eskew, Houston-based vice president of consultancy Purvin & Gertz, but a range of factors, including conservation, economic downturn, alternate supply, regulations and capacity expansions are poised to move the cycle off its peak.

The current crude oil price peak is far above any period since the early 1980s, said Eskew, with prices rising sharply since 2004. No single event triggered the current long-term uptrend; no single event took product off the market, he noted. And as crude prices went up over the past two decades, refining margins followed. Base oil prices moved together with crude and refining margins.

These are all symptoms, he said, of a fundamental change in product demand, lead by tremendous demand growth in China, which surged in 2004. That surge filled up worldwide refining capacity, Eskew said. Asia moved from low to strong refining capacity utilization, so any small issue, such as a refinery fire, has a big impact. And OPECs cushion narrowed markedly after 2004 – current spare OPEC capacity is mainly sour and heavy crudes.

Another factor drivingup refined product pricesis the escalation in petroleum industry capital costs, Eskew continued. Since 2003, project costs in the U.S. have almost doubled, and in the Middle East cost escalation is much more severe, he said. So were in a perfect storm for high prices.

Since the end of 2004, with relatively strong demand, capacity is constrained and the market is tight, so costs can escalate.

What will move the cycle off its peak? Consumers are already responding to higher gasoline prices, Eskew said. Historically, in the United States, consumer miles driven grew 2 percent to 3 percent per year. But that growth has disappeared since 2005. As a result, U.S. gasoline demand growth is slowing. Looking forward, vehicle travel growth will not return to past levels, and people will buy more efficient vehicles, Eskew predicted.

In addition, the U.S. Congress is likely to address climate change moving forward, Eskew continued. The push for comprehensive climate change policies will ultimately reduce growth of petroleum demand. At the same time, the world is increasingly efficient in its use of petroleum, a process that will not slow down.

Capacity overexpansion is another factor on the horizon, said Eskew. The total of announced global refining projects is far more than the world needs. Many are speculative, but some will go forward. Well see a shift in refinery capacity to the Middle East from North America and Europe.

Hydrocracking capacity will increase along with crude distillation, Eskew noted, creating opportunities to produce base oils.

Eskews conclusions for crude and refining margins: Energy markets are cyclical, moving together in response to common stimuli. Todays peak is the result of long-term trends in supply and demand, such as Chinas demand growth exacerbated by recent events such as hurricanes. Market and political responses now under way will move markets off the peak, but prices will remain above historical levels. And a soft landing is now the most likely outcome over the next three to five years – but risks persist in both directions.

What does this mean for base oils? Its a strong but delayed response, said Eskew. Base oil profitability is closely linked to fuels refining. Base oil capacity investments are also focused in Asia and the Middle East, with nearly 3 million tons per year of announced base oil projects by 2013 in Asia and another 2 million t/y in the Middle East.

Expect more integrated fuels/base oil projects, said Eskew. Stand-alone base oil projects are less likely. But project cost inflation has already resulted in delays and cancellations, especially GTL.

Will base oils also see a soft landing? We hope so, said Eskew, who defined a soft landing for crude as prices falling by $30 to $40 per barrel, putting them somewhere around $60 per barrel. A soft landing for base oil would fall by similar proportions.

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