At the moment the market is being torn between lagging demand on the one hand and a large increase in supply on the other. The demand weakness is the result of lackluster consumption of finished lubricants used in automotive and industrial applications.

These end-use sectors are in economic slow motion right now, not only in Europe but also throughout the Americas, the Middle East and the Indian subcontinent. These regions will rebound eventually, but the process will be slower than previously assumed and will not follow a straight line. There will be peaks and troughs of economic activity which will affect lube oil consumption, and growth will not be as dynamic as before the recession of 2008.

Another issue is that base oil prices remain under pressure from crude and feedstock levels. High costs for these commodities discourage production of base stocks by encouraging refiners to maximize production of other petroleum products, such as gas oil and low-sulfur diesel, which use the same feedstocks. Margins are much higher for these alternative products, so much so that some producers with flexibility are cutting production of base oils.

The effects of this squeeze are being felt most by traditional producers of API Group I grades throughout mainland Europe and into neighboring markets such as Russia, the Middle East and most of Africa. These operations have been around for a long time, and reinvestment in advanced new technology has been sadly lacking within the European refining fold.

The drop in Group I production has been rewarded by some excellent years of business after the 2008 slowdown, but dependence on that category is lessening, and the pressures are starting to tell.

Some Group I producers have cut back on production to align with a lack of domestic demand and few export destinations, but now there is a very real danger that these seemingly sensible quantity reduction precautions could hinder the market from picking up in the future. If base oil production is cut or indeed lost altogether, then this vacuum will be difficult to replace in the short or medium term.

On this very subject, Essar Oil (UK) Ltd., having completed one year of operation after purchasing Shells Stanlow, U.K., refinery, finally announced that it will seriously consider ceasing production of base oils after contractual commitments are fulfilled to current buyers. Among the reasons cited are poor base oil margins, but also limitations that base oils impose on the types of crude Essar can run through the larger refinery. This base oil plant, with its Group I capacity of 260,000 metric tons per year, may be just one of many considering this action.

Some players have suggested that declining Group I production in Europe could encourage lubricant blenders there to substitute Group II grades, thereby raising the quality of finished lubricants. This idea certainly holds water as a longer-term option, but with no indigenous production of virgin Group II as yet in the European mainland (several rerefiners have yields that meet Group II specifications), the market would be largely dependent on imports from the Far East and the United States.

There are new Group II facilities planned, such as a joint venture between SK and Repsol in Cartagena, Spain, which would also make Group III, and an expansion at Luberefs plant in Yanbu, Saudi Arabia, but these alone may not be able to fill the void left if Group I producers cut output to a minimum or in some cases scrap plants altogether.

The reliance on exports from the Far East is particularly significant given the current combination of low demand and high production in that region. Group II grades are long in that market so suppliers can export to Europe at competitive rates. But if the economies of China, Korea and Japan rebound, as will certainly be the case at some stage in the future, then Far East Group II and III production facilities will divert volumes to local markets or at least attempt to raise prices for Europe.

Similar patterns are seen in the Group III segment. When European lubricant manufacturers began using Group I-Group III base stock blends to make higher quality finished products, the latter material was in high demand and short supply. Demands were met by a combination of local production and imports. Now, after a large ingress of new Group III production in the Middle East and other locations, this market has become so diluted that prices and margins are falling to levels which were never contemplated some months ago.

We should also consider the possibility that a drastic drop in Group I availability could keep Group III demand from growing in line with forecasts. Not all Group III in Europe is used in conjunction with Group I, but a significant percentage is. If Group I is not easily available, what alternatives would blenders try?

More new Group III projects are planned in Russia and other members of the Commonwealth of Independent States, but with domestic markets unable to employ all the barrels coming from those facilities, some will certainly be exported to other parts of Europe.

Naftan announced in November that it had begun making 4 centiStoke Group III at its plant in Novopolotsk, Belarus. The company is looking to place relatively large volumes, perhaps 5,000 tons per month, into the saturated European market. The writing is on the wall!

The base oil market in Europe, the Middle East and Africa is in turmoil, with low economic activity, slow demand and, of course, problems stemming from turmoil in southern Europe, Syria and Lebanon. The Maghreb countries have not emerged from the Arab Spring unscathed, with Egypt and Libya still facing serious challenges.

All these factors, coupled with a global economic slowdown, brought rapid changes to the base oil supply scene in Europe, and they were coped with badly. Continued focus on Group I production in mainland Europe and North Africa, under-investment in new Group II plants and now the flooding of the home markets with untold quantities of Group III grades may all haunt the market for some time.