Recovery’s in the Forecast, with Caveats


DUBAI, United Arab Emirates – Is the outlook for base oils and lubricants brighter? Speakers at the ICIS Middle Eastern Base Oils and Lubricants Conference said the global recession has ended and the worlds economy has begun a recovery that should begin to revive lube demand.

But that does not mean a return to the prerecession status quo, according to one analyst. Purvin & Gertzs Blake Eskew said the industry will face a new order that includes higher prices, an acceleration of base oil plant closings and new base oil trading patterns.

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The two-day conference kicked off Oct. 13 with an optimistic speech from Brad Bourland, chief economist and managing director of proprietary investments for Jadwa Investments, an investment firm in Riyadh, Saudi Arabia. He concluded that the global economy has begun to recover and speculated that the recovery may be stronger than expected.

Bourland said his views on recovery are based on indicators from the United States, the worlds biggest economy and the home of the crisis that triggered the recession. First-time filings for unemployment have started to fall, housing prices have started to rise and the ISM Manufacturing Index has climbed from negative territory into the positive – all of which usually signal the beginning of an economic expansion.

As Bourland noted, others are reading the signs the same way. The International Monetary Fund predicted that the U.S. economy will grow 1.5 percent in 2010 after contracting 2.7 percent this year. The organization also forecasted that the global economy will grow 3.1 percent next year, following a decline of 1.1 percent.

Bourland cautioned that economies global and national are still fragile and that the recovery could sputter.

We are on the cusp of a recession, he said, but its a patient that is still on life support and not completely healthy yet.

There is significant danger that the world will undergo a double-dip recession, that economies will contract again after government stimulus packages run out. Several of the most recent recessions followed this model, and the second dip is usually worse than the first, Bourland said.

But he argued that governments can avoid the second dip by undertaking more stimulus programs, and he thinks they will do so in this case. In fact, he believes the recovery may gain strength sooner than expected. He noted that a majority of economists predict a U-shaped recovery in which economic activity grows very little for a drawn-out period of time before picking up steam.

I think that if the consensus is wrong about a U-shaped recovery that it will be much sharper than expected, he said.

Blake Eskew, a senior vice president in Houston with energy consultant Purvin & Gertz, agreed that recovery has begun and predicted it will follow a normal cycle in 2010 and 2011. But he emphasized that this was a particularly severe recession – the worst the world has seen since the early 1980s – and that it will become a catalyst accelerating trends that were already underway in the refining and base oil industries.

For the refining industry, Eskew said, the more significant events occurred before the recession. Petroleum demand experienced a huge spike in 2004, leading eventually to the run-up in crude oil prices, which peaked above U.S. $140 per barrel in mid-2008. Those prices were high enough to change driving practices of U.S. consumers – a change that will probably be permanent and curb future petroleum demand in the West.

But the run-up in crude also lead the industry to invest in numerous refining projects, some which have since come into operation, some of which are still underway. Combined with the drop in demand, these projects are creating persistent over-capacity, Eskew said.

With this backdrop, Eskew said, refining trends that were in place before the recession will resume, but their pace will be accelerated. Most new capacity will be built East of Suez – in the Middle East and in East Asia, to accommodate growth in those regions. In contrast, the West will be the scene of most of the rationalization needed to balance refining supply and demand in the intermediate term. Purvin & Gertz estimates that the industry needs to lose 3.6 million barrels of capacity and that approximately 3 million of those barrels will be taken from Europe, North America and the Caribbean.

To put those numbers in context, Eskew noted that 110 refineries around the world closed between 1990 and 2005, with combined capacity of 3.6 million b/d.

As we go forward today, rationalization needs to take place, he said. And while much of it is expected to occur in the West, the Middle East will not escape completely, he added. The Middle East will have shutdowns.

Base oil capacity is also growing faster than demand, Eskew said, and this again will accelerate the well-established trend of rationalization in the West. API Group I plants with combined capacity of nearly 2 million metric tons per year will close by 2020, he predicted, while North America will close a bit more than 2 million t/y of capacity during that time frame.

There are many, many smaller, weaker plants that are vulnerable to rationalization, and we think we will see some more shutdowns, he said.

Eskew and Bourland both said that oil prices in the future will be generally higher than before the 2007-2008 run-up. While allowing that crude will continue to go through large price fluctuations, they agreed that the long-term price is probably in the range of $70 per barrel.

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