If you buy bottles at Walmart, c-stores or other retail outlets, its generally priced anywhere from about $1.50 to $15 a gallon. Typically, nationally recognized brands command the higher prices. In addition, there are a number of top-tier brands that enjoy prices much higher than $15 a gallon. But surprisingly, while there are significant price differences between the economy and top-tier brands, the content of the bottles are strikingly similar. Most have nearly identical viscosity and contain about the same levels of calcium, magnesium and other elements. In fact, assuming they meet standards, they are usually so similar its unlikely a consumer would realize meaningful differences. But no, Im not talking about engine oil.
Instead, the opening of this story is about bottled water. Why? Because some in the lubricants business believe the majors are working to change perceptions about the cost links between crude oil, base oil and finished lubricants. If so, they are pursuing a model reminiscent of the bottled water industry. This is a model that very successfully broke the link between the cost of goods and the price of finished products. Its manufacturers converted a commodity with relatively inelastic demand – one delivered to the taps in most U.S. homes at far less than a penny a gallon – into a specialty product fetching well over 3,000 times that price.
Although there is little chance finished lubricant prices could ever enjoy a bump even close to that attained by bottled water, some suggest lubricants could track a similar model by blurring or breaking the links connecting finished lubricants prices to the cost of crude oil and base oil.
As an example, there have been four rounds of finished lubricant price increases so far this year. The first two could clearly be tied to increases in the price of crude oil and base oil. The third increase, however, was more challenging to connect since the price of crude oil and base oil were relatively stable when those increases were announced. But it was the fourth price increase – imposed when the price of crude was trending down and the price of base oil was flat – that really raised some questions.
For many marketers, the last two increases, especially the fourth, didnt make sense, even after they heard the reasons why. And interestingly and somewhat ironically, one of the reasons was said to be tied to higher prices for crude. And here is where the lines between finished lubricant prices and crude and base oil prices get even more blurry.
Traditionally, most blenders have indexed base oil to West Texas Intermediate crude (WTI). When the price of WTI increased, the industry learned it was only a matter of time before the price of base oils went up, followed by increases in finished lubricant prices. But over the past six months, the price of base oil appears to have started dancing to the beat of a different crude oil drummer.
Why this shift? Some assert its because WTI is no longer a reliable index for U.S. base oils, due to the large supply of crude oil derived from tars sands now being pumped down from Canada into Cushing, Okla. With limited further outlets, the price of WTI at Cushing is far below that of tanker-based waterborne crudes such as Brent or Louisiana Light Sweet (LLS). So in a nutshell, the lower-cost WTI at Cushing does not help Gulf Coast base oil refiners (who represent over 60 percent of U.S. base oil capacity) because Gulf Coast refiners cannot take advantage of it. Why? Because most pipelines between Cushing and the Gulf Coast now flow north from Texas into Cushing.
This means WTI crude cannot be delivered south to the Gulf when inventories at Cushing rise. Even as high inventories in Cushing are depressing the price of WTI, this crude is not available in the Gulf. As a result, base oil producers in the Gulf primarily receive their crude oil in tankers, at prices aligned to Brent and LLS crude oils rather than WTI.
In addition to these issues, which are like candy to traders and those who live the linear programs that drive refinery economics, some believe cracks are forming in the link that connects crude oil to base oil. They sense increasing haze around such issues as refinery outages and turnarounds, inventories, and myriad other factors.
Adding to the fog is the fact that prices for Brent and vacuum gas oil were also flat-to-declining when finished lube prices were moving up. So its clear the relationships between crude, base oil and finished lubricants are becoming less clear. And according to some unhappy marketers, that seems to be just what the majors want.
But instead of fighting this, maybe marketers can learn from it by asking themselves, While it may be easy to pass on a price increase when the price of crude goes up, what am I teaching the customer to expect? Do I want my customer hounding me for a discount every time the price of crude drops?
If the answer is yes, you might be better off selling bottled water, because otherwise, the drinks will likely be on the house.