Base oil pricing was once determined by rather simple arithmetic. It has since become a much more complex set of calculations, with an emphasis placed on the return of capital and payback periods for new or updated refineries.

With the addition of API Group II and Group III base oils to the existing Group l portfolio, markets have had to adapt when setting prices for the many new types and grades of base stocks on offer.

When there were only Group l oils, the final pricing for these products was relatively easy. Sources of crude were limited to a small number of producers that basically set feedstock prices. There were a limited number of producers that owned refineries built around the same time after the 1940s. Base oil producers also faced almost identical costs, hence Group I prices were formulated on a cost-plus basis, which included overheads and margins plus an agreed markup.

Prices for all petroleum products were based on this principle and varied little from month to month or from year to year, in fact. Of course, supply and demand dynamics were present in the market, but these could be forecast with a fair degree of certainty – something one cannot say about todays market. Refineries could also calculate turnaround times with few spikes and troughs in either supply or demand.

But the complexity of pricing started around the oil crisis of 1973. It would change the petroleum industry forever, including the supply and sale of base oils. Crude prices became volatile and would fluctuate hour by hour. Some refiners could not calculate the costs of feedstock on a regular basis, and product prices tended to respond some time after changes to raw material costs. Different base oil producers used varying cost allocation procedures with the result that, when cost-plus pricing was used for the selling prices attached to base stocks, the market fell out of kilter, with some sellers able to undercut others by apparently losing money.

During the 1970s and 1980s, this situation led some refiners to pull out of base oil production altogether, mainly in Europe and the United States. (The rapid expansion of Far Eastern refining capacity had not yet started, at least not on the scale of the past 30 years.) A number of state-owned companies continued to produce Group l base stocks in Europe and South and Central America, resulting in regular periods of oversupply and shortage. In any one season, some producers would purchase material to import into other markets whilst in the next breath they were selling overproduction to new hungry and developing export markets in the Middle East, India and the Far East.

The question remains – what sets the price for a ton of base oil at any particular time? Is it simply a question of production cost, including feedstocks and the costs of new plant and equipment? Or is it the market that dictates what prices are achievable? These values are ultimately what blenders and other base oil users attach to the various types and grades available in any one market.

There is no single answer to the question, since many factors are at play, including the relationship between the different types of base stock, with variances in quality and specification that affect the relative value that can be attached to any one grade and type of base oil.

Should Group l be priced cheaper than Group II and Group III? Of course, since this material is inferior in almost all aspects, apart from having higher viscosities than the more processed types of oil. Instead of solvent extraction, a great many Group II oils are produced by de-isomerization, meaning improved specifications that deliver greater efficiency and ecological benefits in finished motor oils and industrial lubricant formulations.

Does the process cost more to produce these new-generation Group II and Group III base stocks, thus justifying premium prices? Possibly not, but the cost of setting up facilities in which these oils can be produced is enormous, and investors are certainly looking to achieve an acceptable return on any capital invested within a given time.

When these factors are added into the equation, the answer starts to become a little clearer. The more technology and investment, the higher prices are for the material being produced. Add these factors into higher-refined feedstocks and the numbers start to become apparent.

There is also the question of cost allocation. Not all producers account for costs in the same way. Multi-functional refineries that produce fuels from an in-house feedstock stream have an efficiency edge over standalone plants that have to rely on feedstock being bought in at market value for that particular product.

The relationship between base oil groups is also complex since, theoretically, Group II should be priced above Group l and below Group III. But there have been times when some grades from each group are priced above or below the generally accepted levels for the adjacent group. This usually happens because of classic supply and demand dynamics. Oversupply or shortages of one or another grade can cause prices to become synchronous and even inverted from time to time.

There is no simple answer anymore to what the real price of a ton of base oil is, although there are limits at the bottom end of the market, where refiners have the option to halt production and divert feedstocks into other more profitable refinery streams. This has taken place with some Group l producers in Europe, where margins became so tight that certain grades were removed from their slates, only to be reinstated when the economics improved later.

The debate on how prices are set and whether they are legitimate will no doubt continue into the future. The days of certainty surrounding base oil markets may be long gone.