Glass Half Full?

What optimists and pessimists can agree on is that the key risk for the base oils and lubricants sector in the region is the performance of the European economy, currently poised between modest growth and a potentially lengthy period of stagnation brought about by a possible political disintegration of the Eurozone. According to Jaap Kalkman, head of oil and gas and partner at Arthur D Little, Europes base oil capacity is currently 8 million tons per year, of which 95 percent is Group I, compared to only 50 percent in Asia-Pacific and less than 30 percent in North America.

Reliance on Group I puts European refiners at a disadvantage, Kalkman said, because demand for Group I base oil will fall gradually between 2015 and 2030. Overall, he estimates the annual average demand for Group I base oil in that period will fall by 1.1 percent per year, compared with growth of 3.6 percent per year for Group II, 8.6 percent per year for Group III and 2.1 percent per year for the other grades.

This explains why virtually all global capacity additions planned for the next 5 plus years are Groups II through V or GTL, he said. Thus, the long-term decline of Europes Group I industry is more or less guaranteed. What is uncertain is how quickly it will happen.

On the demand side, low growth across Europe has translated into poor demand for lubricants of all kinds. This negative trend was exacerbated for Group I producers because blenders and formulators are increasingly opting to use Group II and III base oils in place of Group I.

According to one leading industry analyst, European lubricant demand is set to decline in 2015, but this masks a significant degree of variance between the major consuming countries. Speaking at the ICIS World Base Oils and Lubricants Conference in London in February, Apu Gosalia, head of global intelligence and chief sustainability officer at Germanys Fuchs Petrolub, said overall European lubricant demand is expected to decrease by 0.5 percent this year.

However, demand among the chief consumers varies, and lubricant requirements are increasing in some countries. Lubricant demand in Germany, France and Poland is set to rise by 0.5 percent, 1.0 percent and 2.5 percent, respectively. However, average European growth rate will be pulled into negative territory by the U.K., Russia and Ukraine, where demand will fall by 0.5 percent, 3.5 percent and 2.5 percent, respectively. Total global lubricant demand has never recovered from the financial crash that began in 2008, with the average for the years since being around 1 million tons lower than in preceding years, said Gosalia.

A rosier scenario was postulated at the same conference by Arthur D Littles Kalkman, who said that Europe would experience a perfect storm, with lower oil prices and weak currency boosting exports and industry, leading to the rebirth of Europe. Everyone experiencing these lower oil prices will drive a lot more kilometers. Plus, they will be buying more new cars … so this will create more lube demand, he said. Another factor adding to greater lube demand would be drivers switching from public transport to more private transport, he added.

Or Half Empty?

Many analysts, such as Brian Crichton, of Brian Crichton consulting, suggest that the trend of Group I products being replaced by Groups II and III in Europe is likely to continue. Base oils from new global-scale Group II and III plants are coming into Europe, whether produced in the region or not, he said at the London conference. This is primarily because economics .have switched so it now costs less to produce Group II base oil than Group I.

For example, Group II base oils from Chevrons Pascagoula, Mississippi, United States, plant which started production last September, has flowed not only into Europe but also to some key importing countries – such as India – where it competes with European Group I exports. The SK Lubricants/Repsol joint venture plant in Cartagena, Spain, which started up at the end of September with a capacity of 630,000 t/y of Group II and III base oils, is also taking customers from Europes existing Group I facilities.

More is on the way. ExxonMobil is projecting to produce Group II base oils at its Rotterdam refinery in the Netherlands, the U.S. energy major announced in March. Esso Nederland BV, ExxonMobils subsidiary, has filed an environmental impact assessment with South Hollands regional environmental protection agency for the project, said the company. Were the Dutch authorities to give a green light to the project, its construction would start in 2016 with production forecast to start up in 2018.

Even the new plants in the Middle East will feature heavily in the European market. Multiple projects have been lined up for the manufacture of superior-grade base oils in the region, and the bulk of the Group II and III output is expected to move to markets such as Europe, where these grades are needed to help meet stringent auto-emissions regulations. One major plant due on stream fairly soon is Abu Dhabi National Oil Co.s (Adnoc) new plant, which will produce 100,000 t/y of Group II and 500,000 t/y of Group III.

Inevitably, all this new Group II and III supply will impact the viability of some Group I producers. While no Group I refiners actually closed in 2014, some closures have been announced for 2015.

The Colas refinery in Dunkerque, France, will shut its 260,000 t/y unit, while Shell will shut its 370,000 t/y unit in Pernis, The Netherlands. It is also understood that Total will rationalize some or all of its base oil production in Gonfreville, France.

Despite these upcoming closures, the market is expected to remain weak, with the closures balancing rather than tightening the market. So far this year, prices have stabilized, but not increased. With Brent crude having risen above U.S. $50 per barrel, from its January lows of $45, the pressure on domestic base oil prices has largely disappeared.

However, traders suggest that base oil price stability will be contingent on crude oil prices remaining around this level, which is very uncertain given the recent volatility. If crude prices are sustained above $50 per ton, there will likely be an eventual increase in base oil prices, although this would be seen first in the export market and then in domestic prices, said one trader. The general view in the market seems to be that domestic prices have bottomed out.

While falling crude prices have undoubtedly put downward pressure on base oil prices worldwide in the last six months, Group I base oil producers have benefitted from lower priced vacuum gasoil (VGO) for use as refinery feed stock, giving them healthy refinery margins. Apart from lower-priced VGO, another advantage for Group I plants may be their age.

Amy Claxton, founder of base oil consulting firm My Energy, said that although Group I solvent processing plants have somewhat higher operating costs than hydroprocessing plants, this is more than offset by the fact that the plants are fully depreciated assets and have no royalty and licensing fees. Furthermore, Claxton added, Group I plants will continue to enjoy lower crude and feed stock prices while selling products such as solvent extracted bright stocks, heavy base oils, slack waxes and fully refined paraffins at robust prices.

Politics May Interfere

Probably the key issue for European refiners and manufacturers for the remainder of 2015 and beyond is as much political as economic. The continent is at a crossroads, and the direction it takes will lead to either an upturn in prosperity or economic turmoil. The latter scenario could be brought about by a messy collapse of the Eurozone, the start of which would be a Greek exit, only narrowly avoided once already this year.

The year started uncertainly when Greeces new government sought to change the terms of its 240 billion (U.S. $250 billion) European Union bailout package, and the prospect of a default and Grexit looked imminent. However, a last minute face-saving deal was found in the form of a four-month extension to the bailout, until the end of June.

To persuade the EU of its credit-worthiness, Greece announced a series of reforms. But it also wants the EU to agree to new terms for the long-term repayment of its debts. If no agreement is reached, Greece risks being unable to meet its obligations, which could still precipitate the countrys exit from the Eurozone.

Greece added a new twist to the negations in March by resurrecting old claims against Germany for twentieth century atrocities committed in Greece by the Nazis. A Greek auditing office estimated damages at U.S. $340 billion, coincidentally enough to wipe out Greek debt.

At the start of the year, the European Commission upgraded the growth outlook for the Eurozone for 2015 to 1.3 percent, up from 1.1 percent three months previously. This is based on lower oil prices and the European Central Banks new quantitative easing program.

However, if things go badly in Athens, this nascent recovery would be threatened. Although Greece is a small economy, events there echo a wider anti-EU feeling that could undermine the whole EU.

In the U.K.s May general elections, the anti-EU Independence Party could win significant support and exert influence as part of a coalition government. The ruling Conservative Party has promised a referendum on EU membership if it is returned to power. Meanwhile in Spain, the anti-EU and anti-austerity Podemos party has been leading opinion polls ahead of a general election scheduled for before the end of 2015.

According to U.K. economic commentator, Hamish McRae, the fall in oil prices, the slight uplift in European growth and a drop in borrowing costs offer Europe a real opportunity for improved performance. Car sales in Western Europe were up 7.6 percent in February, after an equally strong January. And once a large sector like the automotive industry gets going, it pulls other chunks of the economy with it, he said. Since poor demand in the Eurozone has been the main drag on performance, any uplift is welcome.

Political uncertainty across the region does not bode well for Europes economic prospects or for its refiners and lubricant manufacturers. But if the politics remain stable, perhaps Kalkmans perfect storm could indeed auger the rebirth of Europe and brighter prospects for its base oil refiners.