Group I producers have reacted to falling prices by implementing maintenance, run cuts and by increasing export volumes to overseas markets. Group I is also facing competition from rising Group II supply, with new domestic capacity coming on stream this year, Catherine Caulfield, associate editor for Europe at price reporting agency Argus Media, told LubesnGreases via email.

European plant maintenance in 2019 reached a five-year high, impacting 800,000 metric tons of Group I capacity, Caulfield also said in separate remarks at the 2019 congress of the Union of the European Lubricants Industry in Cannes, France, in October. There, she highlighted several challenges to base oil producers and traders in Europe and the factors behind Group I prices for all grades falling in the first half of this year.

Why did this happen? It is extremely unusual, when you look back over previous years, where in the first half of the year it was a price uptake in response to seasonal demand. The reason [is] oversupply … both in Europe and globally, she told delegates.

Falling European prices prompted Russian producers and traders to curb Group I exports to Europe, and volumes fell by 13 percent from last year and by 30 percent compared with 2017.

Rising fuel prices and weak base oil margins have encouraged refiners to direct feedstocks into fuel production and away from base oils. The premium of Group I SN 150 base oil over diesel narrowed to as little as $30 per ton in May 2019, Caulfield said.

Refining crude yields a range of products, from light gases to heavy base oils, and refineries are optimized to output certain products. Most refineries are maximized to produce fuels and may reprocess heavy bottoms to increase fuel output. Those with base oil units take heavy bottoms as feedstock for Group I, but when fuel margins are more viable, the availability of base oil feedstock can decline.

Weve often seen when fuel prices are particularly strong, base oil output is curbed in favor of fuel production, she said.

Efforts to reduce Group I oversupply through increased maintenance and run cuts have had little impact on prices, Caulfield said. We are seeing in the second half of 2019 some price support from reduced production levels. But its not enough to actually support prices. We are just seeing steadier domestic prices so far in the second half of the year.

European producers have been looking to reduce oversupply by exporting surplus to the United Arab Emirates, India and northeast Asia. But new domestic capacity and exports from the U.S. and Asia-Pacific are competing with these exporters.

At no point in 2019 was it profitable to move [Group I] SN500 into the U.A.E., India or northeast Asia. This is significant, as these three markets represent key outlets for Group I surplus from Europe, Caulfield said.

To make matters worse, Group I is competing with greater availability of Group II in Europe, which is encroaching into traditional Group I applications, such as marine lubes.

Were seeing competition for SN150 from [Group II] N150 supplies and SN500 from N600 supplies, she said.

Availability of Group II has ballooned in the continent in recent years, with majors Chevron and ExxonMobil importing more and new large-scale production at Exxons Rotterdam unit. Asia Pacific also contributes considerable Group II supply to the European market.

Currently, Group II prices are between 720 and 750 per ton. This is a significant drop when you look at prices early on this year, that were 60 to 120 per ton higher, Caulfield said.

Despite new domestic capacity, U.S. and Asian Group II imports into Europe have remained stable. This adds up to total Group II supply in Europe being 25 percent higher in the first seven months of the year than the same period in 2018. While arbitrage opportunities have narrowed on both streams, its still profitable for traders to bring these volumes into Europe, she said.

Since Europe is flush with material, this is applying downward pressure on Group II premiums over Group I, to about 100/t from 150.

This is a significant drop in the premium of Group II to Group I. But still, 100/t is significant, and this could be slowing down some of the blenders transition from Group I to Group II base oils, Caufield said.

She pointed to regulatory uncertainty in the Group II market, including a proposed 3.7 percent tax on quantities over 400,000 tons per year of Group II imported into the European Union, making imports that exceed the quota less competitive then domestic supplies.

European lubricant associations are lobbying member states to up the limits to between 700,000 and 2 million tons annually. Harald Boerekamp, senior advisor to UEIL, told LubesnGreases the European Commission will discuss the quota mid-November and that the European Council will approve the decision at the end of the month or in early December. If approved, the new quota will come into effect on Jan. 1, with the possibility of changes after six months.

Caulfield also discussed how capacity and the number of suppliers of Group III have increased globally year-on-year in 2019, impacting prices in the European market.

The growth of Group III supply sources into Europe opened up a 200/ton spread between the lowest and highest prices available in the continent, Argus found. However, the spread between Argus Group III 4cst price with and without VW504/507 approval has narrowed by 30/t to 100/t since the beginning of the year because of oversupply and competition between all Group III suppliers in Europe for limited market share. (Argus is the only agency that publishes different Group III prices, with VW504/507 as the qualifying criterion.)

Supply fundamentals are clearly diverging, demand fundamentals are changing and pricing is changing, Caulfield said.