Discounts Point to Trouble

The troubling market trends were signaled by the increased discounts on Russian base oil prices compared to European prices, Denis Varaksin, base oil trader at Geneva-based Integral Petroleum, told GBCs CIS Base Oils Lubricants and Fuels Conference in May in Moscow. Earlier this year, Russian base oil producers lost $40 per ton on base oil. After January 2014, the average discount grew from $120 to $140 per ton to $180 per ton, Varaksin said.

Additional reasons for Russias reduced base oil export volumes are a drop in car sales and sluggish industrial growth in Turkey and other European countries from 2011 through 2013. Turkey is an important market for Russian base oils, and its imports dropped 25 percent in the first quarter of 2014 compared to the same period last year. One factor in the drop is that Turkish regulators introduced stiffer sanctions and higher import duties for the countrys base oil importers due to an out-of-control illicit sale of base oil as diesel fuel in the last few years.

Another factor is the growing market for API Group II and III base oils in Europe, which Russia cannot satisfy. Europe imports 25,000 to 30,000 tons monthly of Group II base oils from the United States and over 40,000 tons of Group III monthly from South Korea, Varaksin said. He indicated that these volumes, especially from the U.S., will tend to grow after Chevrons 1.3 million t/y base oil facility in Pascagoula, Mississippi, is fully on stream.

Yet another reason for lower base oil exports to Europe was the regular technical maintenance being done at all major Russian refineries. During March and April 2014, they all underwent regular maintenance, Varaksin said. This particularly affected shipments to Turkey, which were filled by imports from Greece and Italy.

Twelve refineries in the CIS offer base oils for export. Besides eight Russian plants, Belarus, Azerbaijan, Turkmenistan and Uzbekistan are home to one plant each. The regions main transportation hubs for exports to distant destinations are Baltic Sea and Black Sea ports such as Riga, Liepaja or Kaliningrad as well as Novorossiysk and Feodosia.

The main transportation hub for exports to the CISs near abroad markets is the international railway terminal of Naushki on the Russia/Mongolia border. Around 10 percent of the total base oil volume produced in the CIS goes through Naushki. Ukraine and Kazakhstan transport an additional 5 to 10 percent of the regions volume, while the Baltic ports hold the biggest share, or 30 to 35 percent, Varaksin said.

Russia is the largest base oil producer in the CIS. Integral Petroleum found that monthly volumes through ports on the Baltic and Black Seas, as well as other railway terminals and border points, amounts to 80,000 to 100,000 tons.

Business Pros & Cons

Russian base oils provide some positive benefits for foreign buyers. They include a good variety of product and shipment choices. Prices also are low compared to those for producers from Europe and other countries. However, according to Varaksin, Russian oil major Lukoil is the only producer that can ship products to distant destinations abroad.

Unfortunately, foreign base oil traders and marketers encounter a number of negatives when dealing with Russia. These include low base oil quality, continuously rising transportation rates, the unavailability of Country of Origin Certificates (commonly called Form A) and 3.7 percent import duties in Europe and Turkey. Additionally, potential buyers should expect more postponements in base oil plant modernization projects as well as higher export duties, Varaksin indicated.

Base oil exports from Naftan in Belarus have been constant and uninterrupted at 5,000 to 7,000 tons monthly, and shipments from the countrys only base oil plant in Novopolotsk go through Baltic seaports. Benefits of base oils from Belarus include the availability of Solvent Neutral 500 and 1200 and hydrocracked HC-4 products. Varaksin indicated that West African customers are the main consumers of these products.

Novopolotsk base oils also benefit from low logistics costs, no export duties and the countrys transparent trade system. Negative aspects are the unavailability of Form A, the fact that not all banks are willing to service the contracts and that payment is accepted only in euros, Varaksin said.

Swiss traders hold long-standing contracts to export Turkmen base oils, and they currently buy 80 to 90 percent of all base oils exported from Turkmenistan. The country offers only two products – SN 180 and SN 350 – and the Turkmenbashi refinery exports about 60,000 tons annually to Turkey, the CIS and Iran.

Positives of dealing with Turkmenbashi products are the availability of river transportation from April to November, no export taxes, great base oil quality and availability of Form A, Varaksin said. Base oil from Turkmenbashi is sent to Astrakhan on the northern coast of the Caspian Sea. From there, it travels on the Volga River and Volga-Don shipping canal to ports on the Azov Sea, where it is shipped to Ukraine, Turkey, Bulgaria and Greece.

On the negative side, base oil marketers and traders dealing with Turkmenistan should count on unusual product specifications, expensive and complex railway logistics, long shipping time and fees for stock non-removal, vessel demurrage and idled cisterns.

Azerbaijan is characterized by low cost base oils, proximity to the customer base in Turkey and CIS and no taxes when base oil products are shipped to Turkey. The countrys Azerneftyag refinery is the only one in the region that produces naphthenic oils, but they have very low viscosity index and cannot be used to blend finished products, Varaksin said. Negatives include low base oil quality and inconsistent production volumes. Also, buyers can face price fluctuations because Azerneftyag alters its prices frequently to match those of premium fuel oil from the Black Sea region.

Uzbekistans Fergana refinery offers very risky supplies that can vary from zero to 10,000 tons per month. But companies dealing with Uzbekistan can expect discounts of $20 to $30 per ton compared to Russian prices. While the refinery provides Form A, product quality is low, shipping is expensive and lengthy, and purchasing and transportation procedures are risky.

What the Future Holds

Integral Petroleum expects exports of low-viscosity Group I base oil from Russia to decline in the near future, while high-viscosity grades such as SN 500 and bright stock will continue to be in high demand. Varaksin expressed the opinion that refining of SN150 or SN100 should be reduced or converted to SN500 to simplify export.

Additionally, he suggested that as long as Russia diversifies its means of base oil transport, it should expect continuous exports. In Russia, around 10,000 tons of base oils monthly (or 10 percent of the total exported annually) is exported in flexitanks and this volume is expected to grow, he said.

The trader also expects exports of Group II/III base oils from Russia to neighboring countries to grow after Tatarstans Taneko refinery commences production by the end of 2014. These base oils can be shipped at the farthest to Kazakhstan, Ukraine and Eastern Europe, and they cannot stand up to competition from U.S. and Asian suppliers to Western European markets and beyond. Construction of Group II and Group III base oil plants focused solely on the export market is unprofitable, and we expect modernization projects in Russia to be postponed, Varaksin concluded.