The Continuing Harrowing Account of Coronavirus
When I was writing my previous column in February, the Covid-19 situation had yet to unfold. Although there was growing awareness of its effects, life went on almost as normal. A major annual industry conference in London went ahead and although a number of regular delegates from Asia and the Middle East were absent, most of us were largely oblivious to what was to come.
The base oil industry was ticking over, as producers looked to increase prices in regions such as mainland Europe and Africa. API Group l was in balance, since many refiners had cut output and looked to hold margins in place in the face of relatively weak demand.
Group II was in a stronger position, with positive demand and the European Union import quota system being the only major blight on the horizon for some major players. Group III sales were buoyant but with oversupply looming due to the large number of new sellers trying to establish themselves in Europe. And with the new ACEA standards implemented in late 2019, many forecast a rise in demand for these two groups that would soak up oversupply.
All that would change as the disease became a pandemic. There were restrictions on the movement of people and goods the likes of which had never been seen before. Factories were closed and millions of people were out of work.
Inevitably, these actions devastated commodity markets. In April, crude collapsed, with WTI falling to minus U.S. $40.32 per barrel. While it rallied back into the positive, the damage had been done.
A perfect storm of factors caused the fall. Squabbles about production levels between Opec and Russia sowed panic, while no demand from China spiked inventories across the globe. Where stock levels were already high, levels were pushed to the critical point. This prevented traders from benefiting from a “super-contango,” when the spot price trades for less than futures. Delivery has to be taken in the contracted month and the oil has to be stored somewhere, but the world’s storage was at tank-tops.
Production cannot be switched off at the drop of a well-cap, either. It is the last, very expensive defense against rising crude inventories. Governments tried to maximize strategic stocks and some agencies, such as Chinese buyers, purchased as much crude as they could physically handle at very low prices. To no avail.
Base oils did not escape the nightmare. As almost all economic activity came to a halt – crucially including car manufacturers switching off production lines – the factory and service fill markets dried up and sent demand for base oils through the floor.
There are a few blenders still providing a limited range of finished lubricants for key end-users, such as military, medical, food and essential goods transportation. But some of these blenders have found it difficult to access base oil, with inventories not being replaced from source for distributors. At the same time, other sellers have material in-tank but no demand.
What happened to base oil has fractured the industry by disrupting supply chains that had been taken for granted and stopping or delaying shipments from source refineries. Some producers have looked to cut production to a minimum and others have contemplated temporary or permanent closure.
Business decisions are still being taken amid the debate on the best course of action under the circumstances. They vary depending on the type of base oil and viability of operations. For example, refiners have reduced output at new or recently built plants producing Group II and III base oils to meet limited demand now present in the market. Those fortunate enough to be operating with regional hubs have been reallocating stocks to available tankage, freeing up vital storage space at the point of production to accommodate the minimal flow.
The ability to increase storage in third-party terminals has largely been removed by the latest and perhaps to most damning event to happen so far.
Ironically, in normal times this would have been an ideal situation in which to produce and sell large quantities of base oils. With feedstock prices so low, margins would have been fantastic. The problem is that there is virtually zero demand with few buyers to take quantities of base oils.
What demand there is comes from canny receivers like those in West Africa with capacity to store large quantities. They have taken advantage of sellers who need to free up tanks to accommodate future production and bought cargoes at knock-down prices. Deals have been done that would have been inconceivable earlier in the year, with “special” discounts, temporary voluntary allowances and other one-off offers.
Some thought this must be a win-win situation for all concerned, including producers who can buy feedstock at an all-time low price. The reverse is the case. Producers are cheaply selling off stocks that were produced when raw material costs were higher. Whilst these costs are presently low, the risk is that markets will crumble further, sending prices even lower and squeezing margins tighter. Traders are operating on the same margins as before, and while base oils can be bought at rock-bottom, the finished lubricants market is gone. Unless organizations have the reserves and the nerve to weather the lack of cash flow, there are few winners in this scenario.
What for the future? With the very tips of green shoots starting to appear in the region, there is much speculation as to how this will all pan out. Some predict a rapid bounce back to normal business once restrictions are lifted. But the reality may be that this pandemic will alter working practices forever and, to an extent, that returning to normality will not be an option. It may be months, if not years, until the economy returns to pre-pandemic levels and a vaccine is available to all.
Ray Masson is director of Pumacrown Ltd., a trader and broker of petroleum products in London, U.K. Send him comments or topic suggestions at pumacrown@email.com