For many years, players in the base oil industry have wondered about the phenomenon known as the Base Oil Price Lag, which occurs almost every time crude and feedstocks are affected by rapid and significant price changes. This issue is raised because the latest movements in crude and nearly all other petroleum product prices have been markedly downward, while base oils continued to maintain selling levels for a prolonged period following the market changes.
Many reasons have been put forward to explain the lag, but none satisfactorily answers the fundamental question of why the process appears to apply only to base oils. One idea is that API Group I oils were produced on a first-in/first-out basis, and refiners started to allocate costs when feedstock runs were initiated. Because many Group I grades were produced in batches, rather than continuous processes, costs were added in stages as the material came out of the refinery before moving into storage.
This system took time; hence, the final cost at which the base oils were produced was used as a yardstick for selling prices. This may have had little or no relation to recent crude and feedstock levels because the base oil remained in some form of limbo until sale and, ultimately, replenishment with a new set of costs. This argument also may be somewhat outdated because refinery runs, even for Group I, are now much more streamlined, and costs can be adjusted during the process to take immediate account of changes in the petroleum products market.
Another hypothesis is that base oils are sold less frequently than other products such as gasoline, kerosene and gas oil; therefore, the pricing curve becomes much gentler with fewer peaks and troughs. This may also be a function of other products being sold through exchanges where electronic pricing controls values at any given time, meaning that fluctuations are monitored on an exact scientific scale with no leeway for pricing delays.
This scenario perhaps leads to inaccuracies in reporting base oil prices, which could be overcome by posting all completed deals on an exchange platform – as outlined in a previous column – should the industry want to go down this road. The delays, coupled with the lack of pricing knowledge, perhaps extend the validity of base oil prices continuing to be offered at current or present levels rather than moving with the market.
Base oil is nearly always designated as a specialty, and never a commodity, because every refinery’s production is unique in one way or another. Each refiner produces material that has different characteristics and specifications, due to varying crude and feedstock input, in addition to process variations. This was certainly the case with Group I material, but when large corporations refining Group II and III base oils claim they can produce identical material from different refineries, are they not producing a commodity?
If they are producing a commodity that can be interchanged and co-mingled with production from their other refineries in a continuous process, it would seem that prices for these base oils should follow product markets more closely by immediately changing in line with crude and feed stock values. The producers defense is that these base oils are produced specifically as approved blend stocks in the production of lubricants for OEMs and other users of products and, therefore, don’t follow other price fluctuations.
Some commentators argue that commodities such as diesel and gasoline are produced to common standards, depending on target markets, and one grade from one refinery can be easily substituted for a grade from another. These products are not readily or often identified by refinery and are attributed values through the workings of exchanges.
The answer to these points comes simply as the market controls supply and demand. If demand is strong and supply is short, prices remain high. When demand falls, overproduction covers the markets and prices fall.
These simple rules should mean that at the moment Group II and III prices should have responded to the vast oversupply situation caused by new facilities being built in the Far East and United States. But this is not the case. Prices for these products remain relatively high and have actually escalated in the face of falling crude and feedstock levels due to perceived demand for some of the higher viscosity grades.
Extrapolated historical data on prices over some 10 years shows that base oil prices can be linked to crude and other petroleum product levels on a month-by-month basis throughout that period. Base oil prices hardly ever rise and fall in unison with those of other petroleum-based products, although downward movements are slower to adjust than upward moves. With Dated Brent crude at around $43 per barrel and ICE gas oil at around $430 per metric ton, the relative value of Group I SN 500 would be about $385/t.
Some comments have also been made regarding base oils being a small part of the refinery slate; therefore, the broader principles of daily pricing should not apply. However, close examination of bitumen, another small fraction from the overall production, shows prices closely aligned to fuel oil levels – perhaps not on a daily basis but certainly on a monthly average.
Similar comparisons have been drawn by various parties trying to correlate base oil prices with gas oil levels. But these are rather tenuous, as is the purely statistical claim above that base oil prices should be X when crude levels are Y.
Looked at objectively, the real control on base oil prices lies within the market itself, and the supply/demand situation is ultimately influenced and controlled by the various economies around the world. Accidents, shutdowns and turnarounds will have an effect, along with planned limited production of certain base oil grades. But, thus far, no one has been clever enough to control global production on a scale that could manipulate prices. Perhaps this is yet to come.