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Ike Saps Base Oil Supply

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Typically, U.S. refiners make about 13.5 million barrels of paraffinic base oil in the third quarter of each year.

Not this year.

Output was chugging along fairly well, despite the news that both Citgo and Marathon were exiting the base oil market. But in early September, Gustav and Ike delivered their one-two punch to U.S. Gulf Coast refiners. When the final tally is done, LubesnGreases estimates, the lubricants industry will be short more than 2 million barrels of paraffinic production. Closing the gap in supply could take until January or longer, industry sources say.

Gustav landed on Sept. 1, and many Louisiana refineries shut down in advance of the Category 3 storm. While no base oil units suffered major damage from Gustav, the 21,900 barrel per day Excel Paralubes Group II refinery, operated by ConocoPhillips in Westlake, La., could not ship product because its loading docks were impacted.

Word from Excels owners is that it could have been worse. Like other Gulf Coast refiners, ConocoPhillips took a lot of precautions with Hurricanes Gustav and Ike. Concern was focused around safety for employees, as well as for adequate time to shut or idle units, and to move critical equipment above threatened water levels. That precaution-taking paid off, and the base oil plant came up without incident – albeit at reduced rates for a week. Production at Westlake was interrupted again when Ike came through, but reports are that it restarted in less than a week. The dock has since been repaired and shipments have resumed.

Hurricane Ike, the more brutal of the two storms, pounded the Texas-Louisiana coasts on Sept. 13, bringing misery to millions. While it did not destroy any petroleum refineries or chemical plants, Ike did force many of them to shut down, including one-quarter of U.S. Group I capacity and over 40 percent of Group II capacity. The refineries came off line without a hitch, but getting them all back up proved challenging, as power outages dragged on and fuel, water and transportation woes mounted.

Units at ExxonMobils Beaumont, Texas, base oil refinery (10,000 b/d) shut down ahead of Ike, but were swamped when the Neches River surged over its banks. The company confirmed that the refinery sustained water damage, and it was still off line as this issue went to press. Beaumont is also home to ExxonMobil Chemicals polyalphaolefins plant, which took on water, too. The oil giants base oil plants in Baytown, Texas, and Baton Rouge, La., fared better and have returned to full operation.

Besides wind and water, the storms brought other frustrations, observed Steve Ames of SBA Consulting in Pepper Pike, Ohio. Base oil refiners had been enjoying the largest margins ever seen, he said, at around $500 per metric ton. Each day of lost production chafed painfully, as they had to forgo sales. By early October, Group I producer Houston Refining Co. was still operating at reduced rates, and ExxonMobil, Flint Hills Resources and naphthenics marketer Nynas were holding customers to strict allocations.

As was Motiva, operator of the worlds largest base oil refinery, a 40,300 b/d Group II facility in Port Arthur, Texas. Port Arthur closed shortly before Ike made landfall, and its base oil trains still were not operating at this writing. The entire massive refinery was down without power for about seven days, leaving the units stone cold, Motivas David Hieronymous told LubesnGreases. The refinery sustained no damage, but recovering from a hard, fast shutdown is complicated, and more so when the process units are cold, the Houston-based international base oil sales manager added. We took it down in a controlled manner, and bringing it back up safely and in a controlled manner takes precedence.

On Sept. 22, Motiva declared force majeure. Due to earlier processing problems it already was holding customers to 85 percent of prior purchases when Hurricane Ike hit. That allotment was further cut to just 50 percent, confirmed Hieronymous, adding that hes hopeful it will be soon lifted.

Hopefully it will be by the time readers see this, Hieronymous said. We dont enjoy this, just like our customers dont enjoy it. We want to get back up and running, and I hope that wont be long.

Meanwhile, he went on, a planned turnaround this fall was postponed until maybe mid-January. The exact date is not quite finalized, but itll be about 30 days of downtime, about a month. Our operations people have assured us that everything they need is lined up and ready for the turnaround at that time.

To get through the rest of the fall, said Ames of SBA, youll see the majors do what they did a couple years ago, which is to pull base oil and finished products alike from inventory – which helps in the short term but also makes it that much tougher to recover; it drags it out a bit. Unfortunately, U.S. base oil inventories were already quite tight, Ames said.

Terry Hoffman, base oil director at San Antonio-based Valero Refining, explained that base oils were short in part because refiners had been diverting vacuum gas oil feedstocks away from base oil and into higher-margin diesel production in the first half of the year.

It also is simply too expensive to hold much inventory now. I havent seen anyone out building inventories, Hoffman said. The goal is to make it, load it, and move it to a customer. Producing inventory today ties up too much cash, and the financial measures we live under mean that we have to show results every quarter, and justify the return on capital employed.

Seven years ago, he estimated, Valero probably had the ability to hold up to 90 days production in inventory; that has cinched up by about a third, as old bulk tanks were pulled from service and not replaced. Other refiners probably have made the same hard choice, Hoffman said. Its hard to put $2 million to $3 million into upgrading or repairing a tank, without a compelling business reason to do that.

Despite the tight stocks, suppliers said they do not expect a repeat of the long-term disarray seen three years ago, when Hurricane Rita severely hurt Gulf Coast refiners. One base oil trader, who asked not to be identified, said, Its rough, and you dont want to belittle the wind and the damage to power lines and refineries, but if we can make it to the end of October well not have had such a terrible blow. If everyone gets up and running, well have a tough October, yes – but November and December well see our usual seasonal slowdown, and that should help everyone recover.

Theyre starting to build inventories now, in part because demand is way off, Ames commented. This is not just seasonal, but is due to great demand destruction. With high prices and the economy really bad now, a lot of things are being postponed, including lube purchases. So I think youll see base oil production and inventories come up very quickly.

The irony is that people want to make base oil now. Margins are $500 a ton, so theyre certainly not diverting gas oil to the fuels side now, Ames said. Thats a very different picture today than we saw at the beginning of July. Back then, it was $250 per ton more profitable to make diesel. But that was with $145 per barrel crude. Now, base oil is $500 per ton over distillate fuels. The two prices passed rapidly in the night.

How quickly can the market recover from 2 million barrels of lost production? Motivas Hieronymous declined to speculate on that. Were just trying to get into position to rebuild inventories, but were also going into a slower period. Theres no question that with margins as good as they are now, that its frustrating to be not making product the way we want to.

ConocoPhillips has not declared force majeure, and is not on formal allocations, but the company said that customers in early October would get only their contracted amounts. Its time to refill the pipelines, a source there said. Supply will be tight, but maybe November and December will not be too painful. Despite the fact that supply was disrupted in a very big way, there appears to have been a lot of demand erosion.

Theres a strong chance well be in better shape after this season than we were in 2005, Hoffman suggested. One reason is demand. People arent driving as much, so weve seen whats popularly termed demand destruction. With less driving, folks arent changing their oil as much. Second, the auto industry is down too. If theyre not selling cars, theyre not making cars. And as manufacturing drops, the industrial lubes side of the business also goes down.

Another outcome of Hurricane Rita three years ago was that the American Petroleum Institute needed to establish provisional licensing procedures for blending engine oils when shortages threatened to choke off supply. Kevin Ferrick, manager of APIs Engine Oil Licensing & Certification System in Washington, D.C., said no one has asked for that accommodation – yet.

After Ike, we saw that a number of plants, even if not damaged, were without power and unable to produce. So weve been bracing ourselves for queries about provisional licensing, Ferrick said. However, since marketers can continue to draw on inventories for a while longer, he does not think provisional licensing will be required anytime soon, if ever. There tends to be a lag of several months, before supply of raw materials becomes too tight to make engine oil. Thats what we saw after Hurricane Rita three years ago.

Were seeing tightness, yes – including the closing of Citgos refinery, said one independent lube blender, who spoke on condition of anonymity. That really hurts. More unfortunately, thats letting refiners keep base oil prices at a higher level than is justified by the price of crude oil. Were still paying far over $4 a gallon, even with $93-a-barrel crude, this buyer complained in early October.

Supply is extremely tight, and prices are what they are because of it, commented another marketer. If demand declines 4 percent, but supply declines by 20 percent, that obviously means that were dealing with a very tight supply situation.

As October opened, Valero was enjoying strong demand from customers affected by the hurricane disruptions and the Citgo and Marathon closures. Right at the moment, our main problem is being able to load enough railcars, to cover others shortages. Were selling everything we can ship, Hoffman said.

When does that change? It will, he said wryly. It always does.

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