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Hanging on to Hope

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U.S. base oil production in the first half of the year sank to its lowest level in more than two decades – the worst volume in fact since 1983, according to data from the Department of Energy. Nevertheless, producers, traders and pundits say the picture is brightening – and some even warn that snugness may be the next big thing.

Refinery output of base oils in the years first six months totaled just 25.3 million barrels, versus 32.8 million barrels in the first half of 2008. Not since the deep recession of 1983, when first-half output plunged to 25.2 million barrels, has U.S. base oil production reached such a nadir. Paraffinic base oil producers saw the more severe drop, and cranked out only 21.2 million barrels in the half, versus 28.2 million barrels in January to June 2008. Thats a 25 percent decline.

Naphthenic producers, by contrast, managed 4 million total barrels in first-half 2009, for a decline of 11 percent. That may seem less harsh, but this was the second straight year of shrinkage in U.S. pale oil supply, following a contraction of 12 percent in the first six months of 2008.

An obvious factor in the overall decline was the closing of two sizeable base oil refineries, both of which were operating when 2008 began but were gone by mid-year, pointed out Terry Hoffman, director of base oils at

Valero Marketing in San Antonio, Texas. Citgo closed its plant in Lake Charles, La., and Marathon ended base oil production in Catlettsburg, Ky., he noted. Together, the two had capacity to make 16,300 b/d of API Group I base oils.

The market could have been even worse, if those two plants had been operating, Hoffman said. But things aregetting better now. Business does seem like its easing its way back. He added that export sales have opened up in recent months, which also is helping refiners to boost production. There are some opportunities out there that are not typically available, he said.

Most sources blamed the first-half setback on the general economic gloom and lackluster demand for lubricants. Back when we were in that November- December-January-February-March funk, base oil refiners really reduced their run rates and worked off inventories, recalled Gerry Jackson, vice president of Renkert Oil in The Woodlands, Texas. Then in April they began opening up a bit more, but buying still was off, and there even was a bit of a glut.

Another factor in the decline may have been Motivas big turnaround in the first half, he added, where they had two trains down at Port Arthur [Texas] for nearly a month – thats 30,000 daily barrels. That took out a lot of volume.

Most Group I producers cut back, because if you were making Group I base oil in the first quarter, you probably were making it at a loss, or at break-even at best, commented Stephen B. Ames of SBA Consulting in Pepper Pike, Ohio. Naphthenic producers had to cut back too, he said, because many of their customers were especially hurt by the recession. Rubber and tire manufacturing was down; the need for printing inks was down with newspaper circulation falling; grease manufacturing was way down; and metalworking fluid demand was off, said Ames. Even the transformer oil side of the business declined for a while, but that seems to be coming back nicely now.

Usually things in the naphthenics end of the market are slow in January and February, so thats when well do maintenance turnarounds for a couple of weeks, said Ryan Eberly, sales and marketing director at pale oil producer San Joaquin Refining in Bakersfield, Calif. But things were extremely slow in this first quarter, so we as well as many other refiners reduced our run rates. We made adjustments to not flood the market. We sold off crude instead of processing it, and dropped down 10 to 15 percent below our normal production rates. That meant we did not have quite as much material to worry about.

SBAs Ames saw that pattern – low crude inputs – repeated at other refineries throughout the first half. This was largely due to weak demand for fuels, he said, but also depressed the operating rates of base oil units. Operating rates for U.S. refiners from January to June ranged from 80 to 83 percent of operable capacity, according to the DOE – quite slack compared to the last few years, when they often ran at 90 percent or higher.

Explained Valeros Hoffman, Older Group I refineries are set up so the amount of base oil they produce is dependent on the amount of crude oil they run for fuels. Globally, the fuels business fell off a lot from the first quarter of last year, and got worse when crude oil prices skyrocketed. So if these refiners reduced their fuels operations 15 percent because gasoline and diesel demand was down, they also lost the same percent of lube production.

For other refiners, the fuels and lubes relationship is not so linear, and so it may not be quite so bad, Hoffman continued. A refinery with a hydrocracker for example may not need to be running its fuels refinery to make full lube production.

The DOE data show that the worst months (in case you didnt notice) were January and February. Thats when sales nearly stopped cold, as frugal customers drew down inventories to avoid carrying costs, said one Gulf Coast supplier, who spoke on condition of anonymity. Prices after that began moving up, which spurred some buyers to jump in to rebuild their stocks ahead of the price increases, he added. And many also stocked up ahead of the hurricane season, which also helped. Each month since has seen some slowly building evidence of recovery, this marketer said.

Base oil margins, sources agreed, have returned to positive levels, but theyre nothing great, as Ames put it. Mostly were seeing restrained production – and thats not necessarily a base oil decision, but something thats due to running less crude overall.

Hoffman said hes now looking ahead to recovery, and weighing the factors and product slates that will keep Group I producers profitable for the next five years. (Hell explore that topic more fully in a presentation to the upcoming ICIS Pan American Base Oils & Lubricants Conference, Dec. 3 and 4, near New York. Visit www.icis.com/panamericanbaseoils for details.)

For naphthenics, demand started rising in June, and now were seeing a definit uptick, said San Joaquins Eberly. Now Id have to say theres even a slight imbalance, and were considering speeding our runs back up again-not just yet, maybe in November. That would be great, because we dont like to slow down.

We never panicked, because we know the market will come back eventually, but the change from 2008 – when demand and revenue were just phenomenal – to this year just shows, you need to be able to be flexible in the short term, he said.

Jackson of Renkert Oil also is looking ahead. Things are in better balance now, and in fact, were seeing a little tightness on the bright stock and heavy neutrals. Plenty of light vis is available, and the mid-vis grades are even more available. And the naphthenics market – which was very long early in the year – has really gotten snug. Now its tighter than a tick!

Still, you look at a drop like we saw in the first half, and you cant help but think, somethings gotta give, Jackson pondered. Perhaps theres still just too much capacity in the market, and maybe one more good-size plant will have to shut down.

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