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Chasing China

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KUALA LUMPUR, Malaysia – With 40 percent of Asias lubricant demand, and its lubricants industry growing 7 percent a year, China is on everybodys radar screen. But China also holds substantial hurdles, in lube marketing, distribution, competition and base oil supply.

The integrated global lubricants business, including finished lubes and base oils, generates about $67 billion a year in revenues, Suzan M. Jagger, president of consultancy Suzan M. Jagger LLC, told the ICIS Asian Base Oils & Lubricants Conference here on June 21. Gross margins are about $29 billion globally, and the average return on sales is 12 percent.

Base oil manufacturing is a significant contributor, accounting for about 40 percent of those total gross margins, Jagger said. But industrywide, value has been flat. Global lubricant demand is projected to grow just 1.2 percent annually over the next five to 10 years. Not exactly glowing.

By contrast, forecast real GDP growth in China is 9 to 10 percent per year, said Jagger. Recent growth in on-road vehicles has been 20 to 30 percent per year. Motor fuel demand growth is 10 percent per year.

So everyone, Jagger said, is looking to China. Chinas lubricant demand by 2005 approached 4.5 million metric tons, representing 40 percent of Asias volume. From 2001 to 2005, demand for automotive lubricants in China grew 7.9 percent annually, and demand for industrial lubes grew 5.3 percent annually. Total annual growth was 6.7 percent. But, Jagger cautioned, China lags in profitability.

MARKETING HURDLES

Marketing and distribution hurdles abound in Chinas lubricants market. Half of the countrys lubricant volume is concentrated along a dense coastal corridor, she said, although coastal markets are now rapidly expanding inland. There are large price differentials between mainline and premium products, and between Chinese national oil companies brands versus multinationals brands.

Five thousand-plus distributors cover the market. There are long lines of distribution through multi-branded intermediaries to reach inland markets, and counterfeiting issues persist, Jagger continued. The route to market for automotive lubricants is mostly distributor based, while industrial is mostly direct sales.

Chinas commercial automotive segment – trucks and buses – is booming. On the other hand, the consumer automotive segment is relatively small, characterized by fragmented do-it-for-me repair garages and some do-it-yourself auto parts stores, said Jagger. The forecourt major oil companies, for example, ExxonMobil, Caltex and BP, lack strong branded service station channels. Branded service station networks are missing in China. And international do-it-yourself marketers like Valvoline lack a sizable mass merchant channel, Jagger said. Only about 4 percent of the consumer market for lubricants goes through the mass merchant channel.

Not least, she asserted, the government needs to curb counterfeiting by enforcing minimum quality standards and brand registration.

COMPETITIVE, SUPPLY HURDLES

Since 1985, international lube marketers established positions in free trade zones. 1997-98 brought the Asian crisis, restructuring of PetroChina and Sinopec, and major oil companies began building lube blending plants in China. In 2000 PetroChinas lubricants company was formed, followed by Sinopecs in 2002. But the consolidation phase is not over, said Jagger.

The big step changes in position have been from acquisition and restructuring, not organic growth, Jagger noted. PetroChina and Sinopec control half of the branded lubricant market and all of domestic base oil supply, and they continue to consolidate brands, strengthen ties with Chinese OEMs, expand direct sales networks and service centers, and focus on commercial and industrial markets. The major oil companies, on the other hand, control about a quarter of the market, with a focus on premium automotive lubricants; their market share has doubled in the last decade.

AUTOMOTIVE NEEDS

In 2006, demand for vehicles in China exceeded 7 million units, making China the worlds second-largest market. By 2010, a major automaker predicted, the market will reach 10 million vehicles sold annually. The countrys automotive lubricant industry is running fast to keep up.

Dai Fuming, manager of the fuels and lubricants department at Dongfeng Motor Co. Ltd. – Chinas third largest automaker by volume, and number one in commercial vehicles – offered the conference an overview of Chinas auto industry and the lubricants for those vehicles.

From 2001 to 2005, he said, Chinese demand for cars grew at the astounding rate of 24.2 percent per year, to a total of more than 5 million vehicles, far surpassing the 4.4 percent growth of the global market. In 2006, demand surpassed 7 million units, accounting for more than 10 percent of the cars sold worldwide and making China the worlds second-largest consumer of cars, after the United States.

It is expected that output and sales in the Chinese car market will break through 8 million vehicles, said Dai, and will reach around 10 million in terms of output and sales volume by the year 2010.

China is a vast country, with significant differences among regions, including a large gap in development between eastern and western parts of the country, said Dai. This means there is simultaneously a market for primitive vehicles for agriculture as well as sophisticated autos meeting Euro 3 and Euro 4 emissions standards.

ROOM TO IMPROVE

Quality problems abound, however, with poor being a much-used adjective. Poor-quality fuel is a common problem, Dai noted, on both the gasoline and diesel side. Poor driving conditions include poor road conditions and a lack of super highways, granular dust and other air pollution, overloading of both passenger and commercial vehicles, and poor driver maintenance practices.

Yet the combination of rapid growth of the industry and difficult conditions of use will surely bring opportunities and challenges to the car lubrication oil market, he said.

While factory-fill lubricants for gasoline engines are typically compliant with global standards, Dai said, in the aftermarket API SE to API SL oils are found. The most common viscosity specification is 10W-30.

On the diesel side, there are four families of engines. European joint-venture engines, such as the Dongfeng Renault DCI11, are used mainly for commercial vehicles, said Dai. U.S. joint-venture engines include the Dongfeng Cummins series and Zhongfa. The Japanese family includes the Hino 11L, while the fourth family is Chinese private brands, including Yuchai, Weichai and Dongfeng.

Imported diesel engine oils comply with current European, Japanese and U.S. specifications, said Dai. Domestic diesel engine oils range from API CC to CI-4, with CC, CD and CF-4 in most common use. Multi-grades are now common, with 15W-40 as the most common viscosity grade.

Dai highlighted his concerns with Chinas engine oils, including the large volume of oils below API CC quality in the marketplace. Any attempt to extend drain intervals for commercial vehicles is also a major concern. Because of bad road conditions, domestic intervals are 8,000 to 20,000 kilometers, Dai noted, while abroad 60,000 km to 100,000 km intervals are common; Dongfengs are set at 10,000 km.

PALE APLENTY

Despite the evident need for better lubricants, Chinas base oil investment has been slow, Jagger pointed out. She predicted that total base oil demand will approach 9 million metric tons by 2015, while current capacity is less than half that – with firm additions adding little more. Most of that new capacity is going to be naphthenic base stock.

A closer look at China and naphthenics came from Nynas Naphthenics. Overall demand for naphthenic oils in the Asia-Pacific region will grow from 600,000 metric tons per year in 2005 to 920,000 t/y by 2010, said Valentina Serra-Holm, senior technical coordinator with the Swedish refiner.

The trend is toward growth of naphthenics in the Asia/Pacific region, due to increased capacity and import, Serra-Holm said. But the situation differs by country.

Naphthenics, characterized by high solvency, high heat transfer properties, low viscosity index, good low temperature properties and good water separation, are preferred in three primary applications, Serra-Holm noted. These are transformer oils used in the electrical industry; base oils for lubricants, particularly metalworking fluids and greases; and as process oils in the chemical industry.

The Americas – particularly Venezuela – supply the lions share of the worlds naphthenics, but PetroChina is currently the worlds largest single producer, said Serra-Holm. The Chinese state-owned oil company produces nearly 850,000 t/y, followed by Nynas at about 750,000 t/y. (Ergons current expansion, however, will soon jump it to the lead, increasing its production to more than 950,000 t/y.)

China has a large and growing naphthenic production. Including two announced plants, Chinas output will reach 2 million t/y over the next five years, Serra-Holm said. Pale oils currently have a very high market share in transformer oils, and about a third of the process oil market. But there is still low use in base oils, she noted. They are mostly used in refrigeration oils and metalworking fluids, with limited use in greases.

Opportunities for naphthenics in China include rapid growth of metalworking fluid consumption to meet the needs of expanding automotive and metallurgical industries. The shift from neat oils to water based fluids, because of higher speed tools, will favor naphthenic oils due to better emulsion stability, Serra-Holm continued. In addition, expect increased use of naphthenics for textile oils, compressor oils and other specialty lubricants. And as more international metalworking fluid manufacturers start production in China, they will bring their global specifications calling for naphthenics.

Finally, Serra-Holm noted, Europe is banning aromatic extracts in tires, and China will be the biggest tire producer in the world in coming years, so demand will rise for naphthenics to replace aromatic extracts.

But the outlook for naphthenics in China is not without threats, she emphasized. Possible competition may come from hydrotreated paraffinics in transformer oil applications, and strong competition from Group I paraffinics in base oil applications.

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