Kline also expects the European finished lubricants market to rebound at a slower pace after the recession, mainly because of the current uncertainty over the Euro zones financial stability.

Group I surpluses should soon turn into a huge deficit because demand continues to recover from the recession, and supply in Europe and North America continues to be rationalized, Geeta Agashe, vice president of Kline & Co.s energy research practice in Parsippany, New Jersey, United States, said in September during the European Base Oils and Lubricants conference hosted by ACI in Krakow, Poland. Global lubricant demand was promising in the first half of 2011, but the firm expects demand to tighten in the last two quarters. Considering all the problems with the debt crisis in Europe, people are worried about what might happen, Agashe stated.

Uncertainty in the industry is caused by the threat of default in Greece and the effect it might have on Italy, Spain, Portugal and Ireland. Another troubling factor is the slow economic recovery and continued high unemployment in the U.S. European car production in 2010 [including Russia and Turkey] approached 19 million units, Agashe said, well below the 2007 peak, when 23 million cars were produced.

Shift from Group I

Europe will face a Group III deficit in the coming years, according to Agashe. Group III production in Europe is too low to meet burgeoning demand. Refiners in Asia-Pacific and the Middle East will have huge Group III surpluses and will seek to export these base stocks to North America and Western Europe, where they are needed.

A Group III plant being built in Cartagena, Spain (a joint venture between South Koreas SK Lubricants and Spains Repsol) would ease the situation somewhat. But all other similar projects are either in Asia or the Middle East. Group III refineries are being built where you really dont need those volumes today, she noted.

Finished lubricant demand in Europe – excluding Russia and the Commonwealth of Independent States – was around 5.2 million metric tons per year in 2010. Germany is still the leader in finished lubricant consumption, followed by the United Kingdom, France, Italy, and Spain, she said. Kline expects volume in this market to shrink, but quality to improve significantly. This means growing demand for Group III base oils.

According to the firm, the top ten lubricant markets include only three European countries: Russia, Germany, and the United Kingdom. But if you look at the quality of lubricants consumed, Germany, for example, consumes much higher quality lubes than China or India, Agashe noted. This impacts the type of base oil and additives required to formulate the finished products.

Although Europe as a whole is not expected to increase base oil volumes, Russia is a different matter, she continued. The country might show strong recovery of its base stock output if the governments modernization program for the refining industry is successful. But there is still a big question mark about how successful the program will be.

If European base oil demand remains steady, the implications would be flat or declining regional production and a shift from Group I to Group II or III base oils. Due to high operating costs, Group I base oil plants in Western Europe are vulnerable to closure, Agashe remarked, adding that the most vulnerable plants will be those with a large component of merchant sales or sales to automotive lubricant blenders. These suppliers have to upgrade to lighter viscosity products, streamline their product portfolio to meet the requirements of their core customers, or shut down.

Imbalances Spur Trade

Kline estimated global finished lubricant demand at 36 million t/y in 2010, an increase of about 4 percent over 2009. It represents a recovery from the 2008 and 2009 recession, Agashe said. Group II/II+ base oil supply and demand are projected to move more or less in tandem. Increasing Group II supply increases availability, and this in turn drives its substitution into Group I applications. Because growth in demand is driven primarily by substitution, this market is expected to be in surplus through 2020, she said.

Regional supply-demand imbalances in various API categories and viscosity grades drive substitution and trade, and impact base oil prices. There is significant tightness in the market for bright stocks and some heavier viscosity grades. Group II/III markets are in surplus, causing Group II/III substitution in Group I applications. Similarly, North America and Europe are in surplus and export to other regions.

Regional supply and demand imbalances drive trade and make the industry global, according to Kline. We see a lot of movement of base stocks these days that we didnt see in the past. This is taking place because the base oils are produced in the parts of the world where they are not truly needed. For example, Group III is largely made in Asia and Group I in Europe. As a result, about 780,000 t/y of Group I surpluses flow from Europe to South Asia, 365,000 t/y to South America, 260,000 t/y to the Middle East and Africa , and an unknown quantity from Russia to China. North American Group II surpluses flow to South America (520,000 t/y), Europe (260,000 t/y) and the Middle East and Africa (260,000 t/y).

Kline projects global Group III/III+ base oil supply to grow by more than 130 percent by 2020. The top four suppliers will account for almost 80 percent of global supply. Greater concentration of base oil supply results in more product and formulation uniformity. This may lead to faster adoption of Group III formulations by the marketplace, Agashe observed. SK and another South Korean supplier, S-Oil, Anglo-Dutch Shell and Finlands Neste are the top four Group III base oil suppliers, according to Kline.

The future of the global lubricants industry lies in the Asia-Pacific region, Agashe continued. Around 42 percent of lubricants were consumed in this region in 2010, while North America is second, accounting for 27 percent of global lubricant demand. Europe consumed 15 percent, Africa and the Middle East 8 percent, and South America around 7 percent last year.

The largest market in terms of lubricant volume consumed continues to be the U.S., although a question remains for how long, Agashe said. In 2010, the U.S. was the leading consumer in the world, accounting for about 22 percent of global lubricant demand, followed by China with around 18 percent, she said, adding that only five years ago China was a significantly smaller consumer than the U.S. We expect China to overtake the U.S in the coming years in terms of lubricant demand.

Global base stock demand in 2010 was 33.4 million t/y. Although we have seen a lot of capacity shutdowns, Group I is still the primary base stock in the world, accounting for almost 60 percent of total demand, Agashe said. It is followed by Group II, which accounts for about 21 percent of global demand, Group III (7 percent), Group III+ (3 percent), and Group IV (2 percent). Naphthenics accounted for 9 percent of the global base oil demand in 2010.

Base stock demand is driven by a complex web of interconnected drivers, Agashe said. Countries like India and China are not following the same evolution in the lubricants market that took place in Europe or the U.S. she noted. They are leapfrogging in technology, and very soon many original equipment manufacturers will establish global specifications. Therefore, the motor oil used in the U.S. will be the same as that recommended for cars assembled or driven in countries like China and India.

Closures in Forecast

Kline estimated global base stock supply in 2010 at almost 36.5 million t/y. However, actual supply in 2010 is most likely lower due to unplanned outages not accounted for in supply buildup, and changes in production yields due to alterations in feedstock and product slates.

Group I accounted for 20.6 million t/y, or 57 percent of the total global supply, in 2010. Production of Group II/II+ accounted for 9.5 million t/y, or 26 percent of the total. Group III accounted for 3 million t/y or 8 percent of the total supply. The supply of Group I is in decline due to plant closures in North America and Europe, while the supply of Group II/II+ is concentrated in North America and Asia-Pacific. Group III supply is largely concentrated in the Asia-Pacific region We expect Group I base oil supply to shrink to about 37 percent of the total global supply by 2020. In turn, we expect a significant increase in Group II/II+ and Group III supply in the same timeframe, said Agashe.

The concern about plant closures is related to shifts in passenger car and heavy duty motor oils. Group I plant closures have occurred mainly in North America and Western Europe, Agashe declared. Recent Group I closures include a BP plant in Coryton in Essex, England; Shell plants in Grassbrook and Harburg, Germany, and Montreal, Canada; Cepsas San Roque, Spain, plant; a Marathon Ashland plant in Covington, Kentucky, U.S.; Imperial Oils Sarnia, Canada, plant; a Caltexplant in Kurnell, Australia; and Petrochinas plants in Yumen, Dushanzi and Jinxi, China.

A number of plants are under threat of closure in the future due to various other factors, including limited interest among new owners for the base stocks business, Agashe said. Agips plant was put on sale in 2009, but no buyer was found. In the current economic situation, it may be difficult for Italys oil major to shut-down and create unemployment. Also, given internal needs, it may continue operating.

Another candidate for closure is Imperial Oils plant in Vancouver, Canada. After the closure of Imperial Oil Sarnia, which also produces Group II, Vancouver is a candidate for closure, given its small size, Agashe noted. Whether or not a Group I plant continues operating depends heavily on business conditions at an individual plant, the owners business strategy, and the fit between the two.

Technical obsolescence, growing Group II/III base oil supply, and aggressive substitution in Group I applications are drivers behind Group I demand reduction, Agashe concluded. The Group II market is expanding with an increasing number of producers, many of them producing for in-house use.