There is no escaping the fact that the Middle East is geographically well placed to supply the global shift in lubricant demand to Asia, as well to meet growth in Group III demand around the world. According to Thomas Guinot, base oils global marketing and technology manager, at Neste Oil (Suisse), Group III demand growth continues to exceed that of the overall lubricant and base oil sector.

According to Kline & Co., Asia-Pacific will account for 47 percent of global Group III demand by 2020, which Kline estimates will total 3.7 million tons. Compound annual growth rates for Group III in the period 2011 to 2020 are forecast to reach 13.8 percent, the bulk of which will be from Asia and will far exceed growth in the traditional markets of Europe and North America.

The Middle East is also expected to witness strong Group III CAGR over the same period of around 12.4 percent, albeit in a much smaller market that will reach around 215,000 metric tons in 2020. The figures support Nestes claim that Group III base oils provide optimum technical and marketing differentiation to the lubricants industry as it edges toward a global supply model.

Changing Market Dynamics

Nestes Guinot says a number of factors underlie strong demand for Group III, and there is no doubt of strong support from original equipment manufacturers in the market. They are pushing the boundaries in the search for better fuel economy and as a response to the pressure to improve emission standards in Europe and the United States.

Globalization has created an impetus for standard specifications across markets with a direct impact on the cost of ownership. Guinot said Group III base oils are essential to blenders primarily because of their performance benefits, and their importance in the value chain is increasing as new specifications are set.

He added that Group III base oils can meet the increasing demands of original equipment manufacturers particularly when it comes to quality and the prospect of single slate supplies with a major formulation partner. That brings about supply chain optimization and reduced operating costs that Guinot claimed only a few suppliers can offer.

There is also pressure on base oil suppliers to meet market demands that support global and regional blenders. Group III suppliers must be involved earlier in new lubricants development phases, and a new direct connection between Group III suppliers and OEMs must be developed. That is a sea change from the current situation where Group III suppliers work with blenders and additive companies when specifications are already set in stone.

Guinot said Group III supplies have historically come from Asia, which has been instrumental in creating a global market for Group III. New capacity in the Middle East is rebalancing global supply and demand. Not only will it support U.S. and European demand for Group III, but it also prepares the market [to recognize] alternative sources for India and Asia, and [eventually] Africa.

However, mounting concerns over a Group III supply glut are not diminishing, and, according to Ernie Henderson president of K&E Petroleum Consulting, new capacity could dampen prices in North America even further. With the startup of the Shell Pearl and Neste/Bapco projects, significant new Group III production has been moved into the North American market to compete with and, in some instances, replace former barrels supplied by the Asia-Pacific market. This does not come cheaply, as previous suppliers do not want to reduce their market share established over years of effort. Hence, competition occurs and prices fall.

Henderson said the trend will continue as more capacity is commercialized and will only stop when technical demands lead to an increased Group III demand to rebalance the oversupply situation. Given that there is currently little demand for Group III in the Middle East, new Group III capacity looks like a tactical ploy on the part of Middle East refiners to target key markets.

There is industry speculation over the marketing strategy Shell is pursuing for GTL base oils produced at the Pearl plant at Ras Laffan. One of the biggest questions remains whether the oil giant is marketing GTL base oils to external customers as well as the markets it supplies, but Shell remains tight lipped.

Nureddin Wefati, Shell spokesperson in the Middle East, said that information cannot be disclosed due to regulatory obligations. I am not able to provide the information [due to] investor legal constraints, he commented in an e-mail reply to a question. He also denied there were any lingering technical problems with Train 2, despite sources saying there had been issues. Pearl achieved full production at 90 percent or higher on both trains at the end of 2012, marking the completion of the ramp-up.

How to Compete Effectively

Nestes Guinot suggested four main areas that base oil suppliers will have to address to survive in a competitive environment. Security of supply, unsurprisingly, features highly. He also said it is important to have sufficient capacity for long term growth across a multiproduction platform.

Second, a global formulation partner will provide technical expertise as well as the ability to codevelop formulations and obtain the appropriate approvals from API, ACEA or JASO in passenger car motor oil, heavy-duty engine oil or driveline formulations. That leads to the need for enhanced quality that is consistently on-spec in different markets.

Guinot added that many customers now demand a firm but flexible global supply capability, which Neste and its peers offer. Global capability also reduces blending complexity and duplication of effort, but allows broader coverage that enhances technical and marketing differentiation, said Guinot.

As a blender with Group III base oils in your tank, you optimize your logistics and storage because Group III can be used in top tier automotive [and] certain non-automotive applications. On top of logistics consideration, product performance is higher versus Group I/II-based formulations; therefore, market positioning can be justified, he said.

Guinot added that Group III technical profiles could alter in the future as GTL, renewable and Group III+ base oils garner a larger market share. Regardless, he said, they will still need to meet the criteria demanded by existing refiners in the market, but that outcome is far from clear. Next generation base oils are important for differentiation in the marketplace, but will they fulfill what blenders need; [namely], sufficient volume, formulation versatility, product consistency and stability?

Middle Easts Evolving Importance

It is too early to say whether new Group III capacity from the region will be a game changer for the industry, but increasingly it looks that way. Yet, in part, that outcome is contingent on the U.S. and its allies reaching agreement with Iran over its nuclear program.

On the supposition an agreement is reached, expect a flood of investment into Irans decrepit refining sector and rapid upgrade to produce Group III base oils. Iran has long had the plans; however, sanctions and inability to raise the requisite financing have stymied the continuance of an otherwise impressive refining history.

In August, a report surfaced that Irans Tabriz Petrochemical had announced a long term plan to produce 200,000 t/y of Group II and III in five different grades and add a lube blending capacity of 30,000 t/y. But in the current deadlocked political environment, it is difficult to imagine how the company will source refining and additive technology.

Majid Safdari, chairman of Tehran based Vista Energie, said there is unlikely to be any short term development in the project. Now that the Tabriz refinery has partly privatized, they are again bringing up old [plans], but technology acquisition is still an unanswered question.

Since Tabriz Petrochemical is now a private company, it has every incentive to get back into global markets with higher quality base oils as soon as sanctions are lifted. Behran Oil also previously announced a desire to upgrade existing Group I production to Group III base stocks. According to Mehrdad Vajedi, a U.A.E. based consultant and formerly of Nynas, there is strong demand for better quality. The country needs high-quality base oil, and companies like Behran Oil had investigated converting their Group I plants in Arak and Tabriz, but nothing happened due to technology and investment [issues].

All of that of course is going to take time. For refiners in the Gulf, Irans re-entry onto the international base stock market is something of an existential threat. If refiners in the Gulf are in a geographical sweet spot, then Iran is arguably even better placed. It sits at the crossroads between the major markets of Eurasia and Western Asia and is an energy superpower in waiting. That is the dilemma for Gulf based refiners, many of which are subsidiaries of their national oil companies.

On one hand, they can compete with Iran when it returns to the energy fold, maintaining the status quo ante and continuing to view their neighbor across the Persian Gulf with suspicion. On the other hand, there is the enticing prospect of being able to invest in Irans refining industry, which would have a profound impact on the base oil business.

Some industry sources are suggesting investment in Irans refining sector by Gulf investors could be part of the nuclear agreement if governments are able to overcome intrinsic animosity. At the moment, major base oil producers in Bahrain, U.A.E. and Saudi Arabia seem opposed to that idea while Qatar and Oman have forged strong relations with Iran.

There is no surprise, then, about the spate of announcements signaling new Group III capacity from Gulf-based refiners. And there is likely the prospect of more to come.