Russian base oil producers are having a tough time. Prices were recently at their lowest in two years, but government support for plant modernization and tax breaks may see the country emerge as a vital source of API Group II and III base oils.

Forecasts project at least 500,000 metric tons of Group II and III base oil capacity will be commissioned by 2022. Gazprom Neft, Lukoil and Rosneft are investing in new base oil units that will increase exports and improve domestic lubricant quality.

Yet the Kremlins desire to boost exports could further disrupt global base oil markets amid fears of oversupply. In January, Group I prices dropped more than U.S. $150 per ton year-on-year, according to Denis Varaksin, director of base oils and waxes at Berlin-based commodity trading company DYM Resources GmbH.

Speaking at Februarys AMEA Base Oil, Lubes and Wax conference in Dubai, Varaksin said producers have ample availability of various grades and new Group III production is searching for outlets. This [new] volume will add to oversupply in the market and add pressure on prices.

Government support extends to completely lifting export duties by 2024, said Varaksin. Current levies are about $24.20 per ton, although they were as much as $277.60 per ton in 2013, effectively putting a brake on exports. Even with lower duty, exports fell by 12 percent last year, as refinery maintenance and plant optimization dampened output. The second and third quarters of 2018 were also the lowest export periods in three years, as that business was previously buoyed by a depreciation in the ruble and increases in Group II and III production.

Gearing Up for Future Exports

Rosneft is slated to add 250,000 tons of Group II capacity at its Novokuibyshevsk plant this year and by 2022 Gazprom Nefts Omsk refinery will add 220,000 tons of Group II and III. Meanwhile, Lukoil has planned for years to add 250,000 tons of Group II and III at its Volgograd plant and now says that project will be completed in 2022, too. But Varaksin cautioned against overoptimism.

[The] plan is 720,000 tons, but we think there will be some delays [and it would be] more realistic to expect two units out of three to be launched in next three years.

He estimated new capacity will be closer to 500,000 tons, with 50 to 70 percent earmarked for exports. Russia exports around 50 percent of current production, mostly Group I base oils, although further Group I plant closures could reduce that.

For now, Russias resurgent exports are led by Taneco from its Nizhnekamsk refinery in Tatarstan, a republic of the Russian Federation in the east-central part of European Russia. The base oil unit has a capacity of 100,000 tons per year of Group III and 90,000 t/y of Group II. Varaksin said Tanecos plant produces a high-quality, water-white Group III base oil with a viscosity index exceeding 130 but does not hold original equipment manufacturer approvals.

Price differentials between approved and non-approved base oils are as much as $250 a ton, Norman Sheppard of Bahrain Petroleum Co. stated in a presentation during the same Dubai conference, citing data from Lubrizol. Still, a lack of technical approvals has not hindered Tanecos export growth. From 2015 until last year, the companys exports grew from 4,500 tons to 118,000 tons, Varaksin said.

Meanwhile, Slavneft, a 50-50 joint venture between Rosneft and Gazprom Neft, looks well situated to supply Europe. The refinery at Yaroslavl is about 1,100 kilometers from Riga in Latvia, a main Baltic export gateway. The refinery can load trucks and isotanks for shipments directly to the European Union. Its new 100,000 ton capacity Group III base oil unit produces 2, 4, 6 and 8 centistoke viscosity grades. It also has capacity to produce about 300,000 t/y of Group I.

Varaksin said Gazprom Neft plans to market the product under the G-Base brand and is currently working on getting technical approvals from major OEMs. The company plans to offer up to 5,400 tons a month for export, comprising 57 percent 2 cSt, 29 percent 4 cSt and 14 percent 8 cSt. Slavneft also exports 40,000 t/y of Group I base oils in solvent neutral 80, 400 and 1200 grades.

With nameplate capacity of 2.54 million tons, according to data compiled by LubesnGreases, Russia is the worlds fourth-largest base oil producer after China, the United States and South Korea. The former Soviet republics of Azerbaijan, Belarus, Turkmenistan and Uzbekistan add another 881,000 tons of capacity. But it is still overwhelmingly a Group I region, with that grade accounting for 88 percent of capacity. Yet, Russia is not immune to the shifts in global markets. Since 2010, 1.1 million t/y of base oil capacity has been removed from the market, said Varaksin.

Lukoils two refineries at Volgograd and Perm lead current Russian base oil production with combined capacity of just over 1 million tons of Group I and III base stocks. With a 51 percent share, Lukoil is also Russias largest base oil exporter. It is followed by Rosneft, at 25 per-cent, Tatneft, the parent company of Taneco, at 13 percent and Gazprom Neft with 11 percent.

The enormity of the Russian Federation makes logistics a critical challenge, impacting both cost and efficiency. With base oil units located deep within the Russian heartland, distances to port can be thousands of kilometers.

Last year, the Baltic ports of Riga, Liepaja and Kaliningrad were the main exits for 522,000 tons of base oil exports to markets that included Belgium, Germany, the Netherlands, the United Kingdom and West Africa. A further 193,000 tons were exported through the Black Sea destined for Bulgaria, Turkey and Israel. Exports channeled through Ukraine amounted to 136,000 tons, while exports to Asia ceased in the second half of 2018, Varaksin said.

Flexitank shipments are routed through Riga and the Russian Black Sea port of Novorossiysk, but exports by rail via ports in Latvia were curtailed due to political tensions.

Majors Chase Swelling Lube Demand

Last year, Russias lubricant sector grew 1.2 percent to 1.56 million tons, and this year auto sales are expected to grow 3.6 percent to 1.87 million units after increasing 12.8 percent in 2018. Varaksin said the lubricant market is increasing because of higher quality products, newer cars and better machinery. Still, buoyant domestic demand could curb base oil exports, he added. Global finished lubricant companies including Fuchs, Shell and Total have commissioned lube blending plants in the last few years.

Their timing was crucial. U.S. and European sanctions against Moscows interventions in Ukraines Crimea region hit imports but rallied domestic lubricant demand. Locally produced products have an edge over imports, as the government requires foreign companies to comply with Russian standards and obtain a certificate of conformity.

With a population of more than 144 million and gross domestic product of about $1.59 trillion in 2017, according to the World Bank, it is easy to understand corporate interest in Russias latent lubricant market. President Vladimir Putins determination to bring the economy into the top five globally by 2024 could add impetus to demand for higher-quality engine oils amid worldwide regulatory pressure to reduce emissions. DYM Resources said Russia is now Europes biggest lubricant market and is ranked fifth globally.

Homegrown lubricant blenders have established an international footprint particularly in the global marine lubricant market. In February, Lukoil signed a three-year agreement with Oman Shipping Co. to supply its fleet of 39 vessels, ahead of the IMO 2020 marine fuel sulfur cap. Lukoil and Gazprom Neft are now ranked 12 and 16, respectively, among global lubricant producers. Lukoil has a lube blending plant in Austria and Gazprom Neft blends in Italy and has lubricants toll blended in the Netherlands by Kuwait Oil Co.s Q8Oils.

Tatneft has restarted production of polyalphaolefins at a plant in Nizhnekamsk, suggesting the market will undergo a qualitative shift to synthetic oils. Tatneft has been producing PAO since 2018 in 2 and 4 cSt grades and has capacity of 10,000 tons a year. The company eventually plans to produce 2, 4, 6, 12 and 20 cSt grades. PAO production was previously halted for several years due to a shortage of feedstock.

Wrestling the Bear

Compelling as it is, Russia is not for the faint hearted. The International Monetary Fund expects its economy to expand 1.8 percent this year, yet conducting business is complicated by international sanctions. While only a few Russian companies and individuals, mostly military officials involved in the Ukrainian conflict, are sanctioned, remarked DYM Resources, the knock-on effect has cut across the Russian economy.

Sanctions have slowed foreign direct investment, increased the cost of capital and delayed projects. U.S. sanctions on Iran also add to Russias convoluted business environment. Russian banks with U.S. assets are prohibited from handling transactions with Iran or Iranian products in euros or other currencies. Companies and banks are also banned from transacting with Iranian entities or goods in dollars.

DYM Resources says intermediaries can navigate the myriad issues facing companies attempting to do business with Russias budding base oil exporters, such as refiners demanding prepayment combined with complicated logistics, varying base oil quality and difficult communications can easily entangle buyers. One way is for intermediaries to offer credit lines, logistical solutions and helping to overcome communication and cultural barriers.

Varaksin also said the government is pushing oil companies to add more value to products and export less crude oil, substituting instead with higher-quality oil and petrochemical products.

Lower export duties will make base oils export more competitive versus domestic supplies [and] that should stimulate export loadings, he said.

Difficulties aside, Russia looks set to become a major force in Group II and III markets, and that is going to be increasingly hard to ignore.