The worlds energy markets have always been cyclical, noted Blake Eskew of Purvin & Gertz. But now the markets fundamentals have moved, with impacts seen everywhere, from crude oil, to refining margins, to petroleum product supply and base oil prices.

The first fundamental to shift was the global supply/demand balance. As this decade began, total refined product demand was growing at a rate of 500,000 barrels a day, Eskew pointed out to last months ICIS Pan American Base Oils & Lubricants Conference in New York. Then, from 2003 to 2004, demand growth surged, burning through 2.5 million additional barrels per day of petroleum products. This was completely surprising and unprecedented, Eskew noted, adding that 40 to 50 percent of the growth pressure came specifically from China.

That demand surge outstripped worldwide refining capacity – even in Asia, where capacity had been overbuilt and utilization rates had stuck stubbornly below 80 percent. That excess capacity now has been absorbed and Asias refineries routinely run at rates above 85 or 90 percent, in line with operators worldwide.

No Room to Spare

Too-tight capacity means the worlds refiners now have less ability to cope with disruptions and delays, Eskew explained. So the market now tends to overreact, with each change having a more pronounced impact. With no spare capacity cushion, every disruption – a strike in Norway, an attack in Nigeria, a fire somewhere – sends shocks through the market, Eskew said.

A second fundamental that saw upheaval in the past five years is capital costs. Back in 2003, we saw costs accelerating at breakneck speed, Eskew recalled. Estimates for refinery construction projects nearly doubled from 2003 to 2007. In the face of such uncontrolled costs, many capital projects were cancelled or put on hold – most notably the big-ticket gas-to-liquids (GTL) projects that had been proposed for the Middle East – until the investment picture brightens.

Crude prices are another source of turbulence. Last July, crude prices were around $70 a barrel. By December, they were significantly higher, and pressing up against the $100 a barrel mark. Yet, nothing significant has changed, Eskew remarked. We havent lost crude supply.

Overall, he said, were in a perfect storm for high prices. However, as refinery projects are completed and oil demand eases over the next three to five years, Eskew predicted the current cycle will coast to a soft landing. For crude oil, that will mean prices falling by about $30 to $40 a barrel, into the range of $60 a barrel. A soft landing for base oils would fall by similar proportions, he added.

More Gallons Coming

Eskew also pointed to some signs of relief ahead. Another 10 million daily gallons of new crude distillation capacity is expected to be built by 2015, and many of these projects will include hydrocracking capability. That makes them ideal to integrate base oil production with fuels production, and several such base oil projects are moving forward now. These include about 3 million tons of annual base oil capacity approved for construction in Asia by 2013, and another 2 million t/y planned for the Middle East. However, he conceded, it will be difficult to bring this capacity on quickly, due to construction constraints and costs. Expect to see project delays, he said. Projects once expected in early 2010, for example, will probably be done in late 2010.

Delays aside, theres still fear that when those projects come on stream, a flood of new supply could swamp base oil margins, observed William Downey of Kline & Company, Little Falls, N.J. Kline estimates current demand for global finished lubes at 38.5 million metric tons a year, or 770,000 barrels per day. Worldwide, about 55 percent of the total is used in automotive applications, with roughly 45 percent going to industrial and process oil applications.

In the past, base oil suppliers had a specific business goal for lubricants, he said. ExxonMobil, for example, is the worlds largest base oil producer, and also a global lubricants heavyweight. So its base oil decisions are informed by its understanding of the lubricants market. Some companies – such as Petrobras and Chevron – follow an integrated business model, balancing their base oil and finished lubes strategies, Downey said, while others (BPCastrol, Shell) follow a branded strategy for their finished lubes, separate from base oil margins. (There are also lubricant specialists, such as Kluber Lubrication and Houghton international, that compete in service-intensive market niches where owning a base oil plant is of no particular advantage.)

Its useful, Downey advised, to ask what model will be pursued by some of the companies now entering the base oil production scene. Formosa PetroChemicals and Bapco, for example, are among those adding large hydrocrackers with base oil plants (in Taiwan in 2008 and Bahrain in 2011, respectively), yet neither has a stake in the finished lubricants market, he pointed out. They dont fit in to the kinds of business models weve seen in the past, Downey said, and in fact, this new class of suppliers will be adding capacity without an eye to its impact on the lubricants business.

Group IIIs Conundrum

As more high-quality stocks come from Asia, the Middle East and elsewhere, refiners are also going to have to face up to Group III interchange needs, suggested Brian Crichton of Infineum International in Abingdon, U.K. He spoke frankly to the meeting about the need for wider and more open debate than there has been in the past on this topic.

Base oil interchange is useful because it allows additive formulations approved in one base oil to be used in another, without rerunning expensive engine tests. Interchange guidelines have been evolving since 1992, when the American Petroleum Institute first set up its Basestock Categories – the Groups I, II, III and IV used in engine oils today. The interchange guidelines were based on objective technical analysis of engine performance test data which was pooled by industry contributors, Crichton pointed out, and its important to note that there was a strong, collective industry will to do this.

So far, however, this collective spirit has been missing when it comes to creating interchange guidelines for Group III base stocks. Some limited Group III interchange is in place, but only where the data was available to make a sound technical evaluation. As Group III moves from only being used in top-tier products into more mainstream applications, and with an upswell of Group III production coming onstream in the next couple of

years, more interchange options are urgently needed. Current supply tightness is another argument favoring Group III interchange, added Crichton. Theres a desire for flexibility by marketers who cant always rely on a particular Group III to be available, he said.

Into the Pool

One major stumbling block is that few companies – especially the newer Group III sources – are stepping forward with the comparative data needed to allow robust guideline development, Crichton said. The test data are mainly owned by the base stock producers, who would have to make a substantial investment if interchange is to come about. But so far, Crichton observed dryly, they clearly see no obvious benefit in pooling data to facilitate base oil interchange.

Meanwhile, differences in Group III stocks are becoming more visible as their use spreads into mainstream engine oils. Crichton pointed to tests showing that Group III stocks which look similar in elemental ways – such as sulfur content – can actually vary widely when it comes to characteristics not covered by the API base stock category definitions, such as aniline point, wax content, viscosity index and saturates content. These differences come into focus when performance parameters such as engine cleanliness, piston cleanliness, wear control and oxidation stability are measured.

Clearly there is a demonstrated need for Group III interchange, declared Crichton. However, these stocks are different, and becoming more different as more refineries come onstream. So interchange guidelines for Group III may need to cover key performance areas and analytical issues beyond those used in the past.

First, he urged, industry cooperation is essential to develop a robust approach that is supported by all stakeholders. However justified we feel it may be from a technical viewpoint, in fact it wont be easy, Crichton warned.