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Still Over a Barrel

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Encouraged by robust demand and fat margins, U.S. refiners wrenched open the spigots and streamed 31 million barrels of base oil in this years first half. Much of it was guzzled as rapidly as it could spill out, leaving refiners with patchy inventories. And a startling volume went to thirsty customers outside the United States.

Despite outages and setbacks that dented operating rates at a number of plants, total base oil production in the first six months of 2011 was almost 6 percent higher than the same period last year, according to data released Aug. 31 by the U.S. Energy Information Administration.

The improvement was seen most emphatically on the naphthenic side of the business as suppliers produced 5.6 million barrels of pale oil, 8 percent above last years first-half total of 5.2 million barrels and their strongest showing since 2002. Industry sources credited Ergons expanded naphthenic capacity in Vicksburg, Miss., as the biggest factor on the supply side of this equation, and pointed to brisk orders from the tire, transformer and metalworking industries on the demand side.

In the far larger paraffinic segment of the business, base oil producers attained 25.4 million barrels in the January-to-June time frame, a gain of 5 percent over first-half 2010s 24.1 million barrels, but still somewhat shy of the 28-million-barrel peak they hit in the first six months of 2008.

It was shy of market demand, too. Many suppliers said they struggled to fulfill all customer orders throughout the late winter and spring, especially for API Group II and III base oils. The market early on was flooded with sales allocation programs by numerous base oil producers who experienced disruptions, including Motiva, Chevron, Petro-Canada, American Refining Group and Calumet; some of these remain in place. And in May the flood became literal, as the Mississippi River threatened to swamp some refiners and further suppress supply. It wasnt until August that some refiners could say with relief that they were staying abreast of demand.

This has been a good year, with demand steady on both the naphthenic and paraffinic sides, said John Banach, lube sales manager at Calumet Specialty Products Partners, which is headquartered in Indianapolis. Calumet makes both paraffinic and naphthenic base oils at two Louisiana refineries, and markets the pale oil from Houston Refining as well.

Looking back at this years first half, Banach said the gains were especially welcome after 2009s recession. In October 2008 when we sat down with our customers, they were all begging us for base oil, he recalled. Everyone was asking, where can I get more base oil? Then in November, it was like a light switch being turned off – everyone stopped buying at once. By December you couldnt give base oil away, and when the 2009 recession hit, we were holding large inventories. We slowed down and ran at reduced rates in 2009, just to keep the refineries running. Only after the first quarter of 2010 were operations able start ramping up again, he added.

Jeremy Kriska, director of sales and marketing for Tulsa, Okla.-based oil marketer Tulstar, seconded those comments. This year has been a good year. Were seeing some slowdown now in demand across all segments, but until now its been very good. Demand in the first half was strong enough to even outpace the rising prices due to crude cost increases.

Weve seen good demand for exports, but availability of supply has been tight there too, although we sold some heavy grades into North Africa and South America, Kriska told LubesnGreases last month, adding, Were hearing recently that refiners have a little more available now, too.

Exports Swell

Exports are indeed a bright spot for U.S. refiners, who shipped 13 million barrels of lubricant base oils to foreign ports from January through June, according to the EIA data. Thats nearly 42 percent of all the base oil they refined in the first half, and on track to hit a total 26 million barrels by years end. From only 15 percent in 2001, the share sold to foreign buyers has climbed every year. In 2010, base oil exports totalled 22.6 million, or 38 percent of U.S. production.

Exports account for a good part of this years high demand, said Calumets Banach, and the prices they are willing to pay overseas are higher than domestic because often they couldnt get oil at all. Weve seen good demand especially from China and India.

From Houston, David Hieronymus, international base oil sales manager at Motiva, also cited healthy demand around the world. There has been a push to use Group II base oils or better in a lot of the worlds passenger car motor oils, he said. Five years ago, some of those foreign buyers may not have taken it. Theyd ask, What do we need this expensive stuff for? Now that formulators elsewhere have embraced Group II, the flow from U.S. refineries is being taken up eagerly, he said.

Hieronymus noted that he was commenting generally; Motiva itself has not seen more direct export sales, because the domestic demand has been so strong and operational issues have kept the market tight-to-balanced. But we have a couple of key accounts that may be exporting it, he allowed.

U.S.-made Group I base oils are also finding their way to foreign hands, especially after Europes Group I refiners slackened their pace a bit, said Steve Ames, principal of SBA Consulting, Pepper Pike, Ohio. To minimize pain, those refiners located at the 3rd- and 4th-quartile fuels refineries ran lower throughputs, so there was less feedstock to send to the base oil units, he explained. Their loss was the U.S. exports gain.

Naphthenics as well went swimming on the tides of global trade. We export certain vis grades, and were seeing very high demand for those outside the United States, remarked Craig Busbea, who is marketing vice president, Americas, for pale oil refiner Ergon in Jackson, Miss. Overall our volume expansion was directed at increasing our export sales, and were now seeing a lot of our 100-Second oil go to transformer markets in China, India, Brazil and Europe.

Demand from Europes tire manufacturers for cleaner naphthenic oils boosted Ergons exports, Busbea added. Our goal was to be a larger exporter of product since U.S. need was stagnant, and the transition to clean oils has fulfilled that.

The U.S. market is ticking along well, too, he added, with bright spots like large high-voltage substations that buy transformer oil (These are still a strong market for us) and metalworking fluids. As the auto industry goes, of course, so goes the metalworking fluids market, Busbea said. That has been reasonably strong in the first half of the year.

Scanty Inventories

One effect of the buzzing demand is that refinery disruptions have more impact now than before, in part because refiners have been unable to fatten their cache of inventories, Busbea feels. With such low inventories, if a competitor or we have a production problem, you see the effects worldwide right away. Motivas Hieronymus echoed that sentiment: The outages in the last 18 months had a tremendous impact on inventories, no question about it.

The EIA statistics support these views. Monthly closing stocks of lubricant base oil held by refiners in storage in the first half of the year averaged around 7.7 million barrels. But for decades stretching back, closing stocks were more typically between 10 million and 13 million barrels. Todays stocks look awfully lean by comparison.

The change is partly philosophical, partly financial, indicated Kriska at Tulstar. The focus today is on keeping inventories at a minimum without running out. Now refiners have to better manage inventory, especially with the price of crude being twice as high as it was 10 years ago.

In our company, related Banach at Calumet, the mentality on inventories has changed over the years. When I was coming up in the sales department, the old managers said a 30-day inventory was needed, so if there was a glitch in the refinery unit or the rail system or in crude supply, you were covered. Now, any glitch at the refinery causes shortages. Theres more pressure on the refinery to run like its supposed to. And if theres a naphthenic plant outage, theres really not much inventory to get us through it.

Thats one reason I think pricing held in the first half – inventories are being kept low, Banach added. He also senses that most refiners today are quicker to trim operating rates if they see inventories begin to build.

Thats because inventory is simply too expensive now, said Hieronymus. Tanks are expensive, and the carrying costs are too. It ties up working capital, and companies want to put their money to work. Its a much different scenario today, with crude costing over $90 a barrel, than it was five years ago with crude at $50 or $60. It costs far more to carry the same inventory, and refiners want to minimize that. They have to reduce their exposure, and that means thinning your inventories.

At the same time, Hieronymus added, remember were not out of the hurricane season yet. So there has to be some amount on hand in case of need. While the majority of our products are around the Port Arthur area, we do locate some volumes at other terminals outside the region, to mitigate the risk of a Gulf Coast storm.

Eyes on Next Year

Looking ahead, Banach said refiners are thinking hard about planning their next move. Now is the time that our planners are deciding the rates theyll run, how much crude to contract to buy for next year. If theyre thinking to run higher rates for next year, they have to start planning for it now, and it can be scary for planners to see the economy slowing.

As crude oil prices began to twitch downward in mid-August, Ergons Busbea said he was starting to see customers hold back on placing orders, in anticipation that base oil prices must also be due to ease. They watch crude and anticipate the price will move with crude. Theres that pressure every time crude drops quickly. We also have seen some slowing down in some parts of the world.

Starting in August, we know large-volume buyers became very conservative in their purchasing, because they were thinking prices should come down because crude fell, observed Banach. They naturally expected price cuts, and that may have slowed down their orders in the last weeks of that month. But thats one of the most difficult decisions for a purchasing person: Should I wait a bit to buy, for a price decrease, or will I risk getting stuck without oil in the tanks?

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