A Little Perspective

Putting things in perspective in his February presentation, Ames said that lubricants are not the end product, lubrication is. Their quality is dictated by the original equipment manufacturer, and they are an operating cost to the user. Although representing less than 4 percent of total operating costs, lubricants nevertheless are an expense and a target for scrutiny.

Lubricants can provide the OEM and user with cost saving benefits, in the form of fuel economy, energy efficiency, longer drain intervals and greater durability, Ames added. Consumption or demand is a function of equipment use. Collectively, they have a strong correlation to economic activity; namely, gross domestic product.

In addition, base oils are not the masters of their own destiny. They represent 1 percent of all refined product and rarely constitute more than 10 percent of a given refinerys total output. Base oils impact overall refinery operations – some positively, some quite negatively, Ames said. At a minimum, they must add to the refinerys bottom line.

Base oil refineries operating at low utilization rates or depressed margins are being intensely evaluated as to their longer-term fit. But a technology paradox exists within base oil refining because the highest qualities have the lowest production costs, he explained.

This has resulted in most new base oil capacity being of API Group II and III quality, facilitating the development of higher specification lubricants that deliver better fuel economy and energy efficiency, longer drain intervals and increased durability. Importantly, they do not exist in their own right. Ninety percent are used to formulate lubricants, and their demand is inextricably linked to that end use, Ames said.

The Demand Scenario

For the past 20 years, global lubricant demand has closely tracked global GDP growth, but offset by about 3.8 percent. Using the International Monetary Funds 5-year GDP forecast should provide a reasonable estimate of future global lubricants growth, Ames explained. Thus, we should expect moderate declines in 2015 and 2016, easing in 2017 and weak expansion thereafter, as economies and GDP struggle to rebound. In other words, more of the same.

In recent years, lubricant demand has been held back by a weak global economy. Since 2011, succeeding global GDP forecasts have dropped, and the 1.7 percent cumulative reduction for 2015 correlates to about a 600,000 ton loss in lubricant demand and 500,000 ton lower demand for 2016.

Ames said that not all regions are experiencing the same rate of growth or decline. Organization for Economic Cooperation and Development countries in Europe and North America will see declines of 1.0 to 1.5 percent per year. Robust growth is still expected in the emerging economies of Asia, the Middle East and Africa, albeit at lesser rates than in previous forecasts, he noted. South America is being held back by the very weak economies of Brazil, Venezuela and Argentina.

By 2020, almost one-half of global lubricant demand will come from Asia Pacific. In contrast, Europe, including Russia, will consume only about one-sixth of total production. Ames cautioned delegates to expect little change in global lubricant demand over the next 5 years. So, any base oil additions must logically be met with closures or reduced utilization of existing capacity.

The Supply Scenario

On the supply side, there is some good news and some bad news, he said. About 1.5 million tons per year of capacity has closed over the past two years, and a further 1.1 million t/y will be shuttered in the first half of 2016.

A large number of previously announced projects have been postponed to after 2020, if then. Or they have been cancelled altogether, Ames reported. A multitude of issues prompted these decisions.

For example, low crude oil prices have sharply curtailed capital expenditure programs among integrated oil companies such as Petrobras, Pemex and PdVSA. In addition, the large oversupply of base oils shows little sign of abating in the near-to-medium term, affecting companies like Lukoil and SK-Pertamina.

Another factor is the sanctions against Russia that have limited access to capital and technology for such companies as Gazprom Neft and Zarubzehneft. Also, U.S. rerefiners have been affected by depressed prices and margins, especially for Group I and II light neutrals.

Finally, low crude oil prices led to reduced access to high-cost, waxy crudes that HollyFrontier had planned for Group III+ base oils production. And there will probably be more cancellations to come.

Over the past 2 years, over 4 million t/y of previously announced capacity additions have been delayed, some indefinitely, or cancelled altogether. Only 800,000 t/y of those may still be possible prior to the end of the decade and another 650,000 t/y of projects to upgrade Group I to Group II and III have been pushed back by a couple of years, possibly longer.

As a result of the delays and cancellation, the latest forecast shows a marked reduction of capacity additions from just two years ago, and the timing and size of the original 2014-15 tsunami has abated somewhat. Thats the good news, Ames reported.

Nevertheless, 17 major capacity additions are still possible by 2020. Five came on-line in 2015, representing 1.1 to 1.2 million t/y. Five more are awaiting start-up or are under construction for streaming during 2016, totaling 2.2 million t/y. Another four may add 800,000 t/y in 2018 or 2019. And three were announced for late in the decade, representing 2.5 million t/y.

Pulling it altogether and adding PAOs, naphthenics, some smaller projects and the retrofit grade shifts, and then throwing in the inevitable capacity creep, Ames said, We could end up with a further 9.5 million t/y of additions by the end of 2020, against a backdrop of little or no increase in demand. Thats the bad news.

This year will be another big year, with 2.7 million t/y of additions, he added. There will be a respite in 2017, and another surge is possible in 2018. Additions will be predominantly Group II in Asia and Europe for use in higher tier formulations and to supplant supply lost from Group I closures.

Today, the surplus is about 5 million t/y, Ames said, and the loss has been limited only by five recent closures and an industry plant utilization of about 70 to 75 percent. By the end of the decade, the surplus could grow by more than 6 million t/y, necessitating further closures.

Finally, some Group I plants are already operating near their lower continuous limits. The migration away from Group I continues, with Group II rapidly becoming the workhorse quality

Reviewing the regional production profiles likely in 2020, Ames said that Asia will become the largest producer of all three paraffinic qualities. Group II will more heavily dominate the North American and Asian regions, and South America will continue to be constrained to Group I.

All regions will experience declines in Group I supply, he related, but they will be most pronounced in Europe. But Europe and the Middle East should see their first major production of Group II. Project delays and cancellations will keep South America as a large, growing importer of Group II. North America and Asia will continue to be the Group II supply sources to the other regions.

Only relatively minor increases are expected in existing production of Group III. The Americas will remain almost wholly reliant on imports of this base stock, primarily from Asia and the Middle East.

Focus on Europe

Turning to Europe, Ames explained that the region comprises a highly developed economy with a maturing population and slow economic growth. The next 5 years should see a further decline in European lubricant demand of about 350,000 t/y, with each of the major product categories being impacted. Eastern Europe and Russia will be hardest hit.

Group I capacity could fall by 4.7 million t/y, while capacity for the other groups will grow. Collectively, there may be a decline of 2.4 million t/y, but that doesnt really tell the whole story, said Ames.

Output from projects planned in the former Soviet Union is not readily available to most Western or Central European blenders because of transportation issues. Similarly, Western European closures and changes will have nominal impact on Eastern Europe or the former Soviet Union.

Europe has been out of balance from a quality standpoint for many years, he related, with a heavy surplus of Group I and a substantial deficit in Group II and III. But the region has been moving in the right direction. The big unknown is the extent to which Group II will displace Group I for nontechnical requirements. About 2.4 million t/y is currently at stake, declining to 1.6 million t/y by 2020.

Lack of domestic Group II production had blenders relying on blends of Group I and III to meet their requirements, but imports from North America and Asia have now given blenders formulating flexibility. And the ExxonMobil Rotterdam project could materially change the landscape.

European blenders have had access to plentiful imported Group III and, more recently, to new domestic production, giving them a choice of suppliers. Future increases in demand for Group III will largely be met through additional imports, Ames concluded.