As demand grew, 2010 also saw less base oil than normal being stockpiled, leading to a tight supply/demand balance that has continued into this year.

Total production of paraffinic base oils climbed 8 percent to 49.6 million barrels for the year, after sinking to 45.9 million barrels in 2009. Naphthenic refiners reported an even stronger rebound from their dismal showing of 2009, and pumped out 10.4 million barrels in 2010 – a hearty bounce of 14 percent.

Base oil suppliers still have a ways to go to match the nearly 67 million barrels they manufactured in the peak year of 2006, yet signs of steady recovery are discernible. For both paraffinics and pale oils, output in the second half of the year was stronger than in the first half. (Total production in second-half 2010 was 30.8 million barrels, versus 29.2 million in the first half.) And U.S. refiners failed to better their 2009 monthly yields only twice in 2010, September and October, when several large plants were down for maintenance work.

Strong demand all year meant process oil sales, especially naphthenics, came back closer to normal, pre-recession levels, observed San Antonio-based consultant and process oil specialist Terry Hoffman. This was driven by, number one, the upturn in manufacturing in general and then number two, by the auto industrys recovery, he said. With the restructuring of GM and Chrysler, auto production was way down in 2008-2009 – and every car you dont build has four tires you dont need to make. In 2010 we saw that tire demand come back.

The appetite for electrical transformer oils was also healthier, remarked Tulstars Jeremy Kriska, in Houston. We saw transformer oil demand rebound as well, because the housing market picked up and that means more transformers are needed. The auto and tire sectors picked up a lot, too. The traditional base oil buyers like grease producers and lube manufacturers pretty much seem to be recovering, but maybe not at the same pace as auto and housing.

Base oil production in 2010 might have been greater yet, but if you look at the whole refining industry, the fuels margins in the Northeast U.S. were horrible, said Patrick Gribbin of Holly Refining, which makes API Group I base oils in Tulsa, Okla. Unable to profitably make gasoline, some refiners throttled back their crude units, resulting in reduced operating rates for all their downstream units such as base oil plants. Refiners have gotten a lot smarter on the incremental barrels. If the demand isnt there, they just wont make it, Gribbin commented.

Thats not optimal for base oil production, however. If you want to run a Group I plant at maximum production, you need to operate the crude unit at better than 90 percent, explained Hoffman, who formerly was with base oil refiners Valero and Sunoco.

Hoffman said gasoline margins were particularly weak in the first quarter of 2010, which held back crude inputs and as a consequence restrained base oil production. And by September-October, the gasoline crack spread was at or even below the refining cost. So right around Labor Day, as fuels demand eased up, we saw some refiners move their maintenance work up, to take advantage of a low-margin period when they werent going to run at capacity anyway.

Chevron, for example, took the opportunity to tune up its Richmond, Calif., Group II base oil plant, which had been seeing poor yields all summer, and Ergon moved to perform a turnaround on its Vicksburg, Miss., naphthenics plant that originally was planned for February 2011. Both were back on line by Octobers end.

First-half 2010 also saw a gradual drawing down of overhanging base oil inventories, but then demand began to rebound in earnest, Hollys Gribbin said. Ever since, refiners have had little leeway to rebuild their stocks, he added. Some were outpaced by the rising market, and couldnt get in front of it. Right now were in a similar situation again – and were just hitting the beginning of the spring driving season.

A look at inventory data from the Department of Energy confirms that stocks have drifted down to unusually low levels. With rare exception (such as after Hurricanes Katrina and Rita in 2005, and Gustav and Ike in 2008) the U.S. base oil stockpile during the past decade stayed comfortably above 10 million barrels, including material stored at refineries and in bulk liquid storage facilities.

Then, as production plunged in 2009, sellers worked off their inventories without hurrying to replace them. By late 2009, the United States had ending stocks of just 8.9 million barrels in storage. With demand resurgent six months later, June 2010 saw just 7.3 million barrels in the tanks.

The old rule of thumb for refiners was to keep 30 days supply inside the refinery gates, said Gerry Jackson of base oil marketer Renkert Oil, in The Woodlands, Texas. But as refinery capacities were creeping up over the last decade, I didnt see anyone building new tanks – so there isnt the same storage capacity relative to refinery capacity as before.

Also, when base oil refineries close, such as the Midwest plants of Citgo and Marathon, their storage capacity evaporates too, he noted. Regular reinspections of older tanks also cull the herd; unworthy tanks (so-called leakers) are forced out of service and not replaced. All this leaves less space to hold base oil barrels, and could account in part for the float-down in inventories, Jackson suggested. If so, the industry needs to adjust to it, he added.

Todays refiners expect quicker turns on inventory, and they cant get the cash to build more tanks, so they hold fewer days supply. Maybe this reduced level of inventories is the new normal, Jackson said. If so, its incumbent on all the blenders and refiners to manage their supply issues that much better.

Bright stock is one product that continues to be in very tight supply. Last summers closing of Shells Montreal base oil plant, which made bright stock, further snugged things up, and it now takes very little to create a shortfall in supply, noted Hoffman. North Americas two largest bright stock refineries are ExxonMobils Baytown, Texas, plant and Hollys in Tulsa.

API Group II stocks are another product seeing continued tightness. Motiva started advising customers last fall that one of its Group II hydrocrackers at Port Arthur, Texas, was facing a scheduled turnaround in late May. The company is working to build a cushion of inventory to get through the 30-day turnaround with minimal supply disruption, Motivas Mike Lewis in Houston told LubesnGreases, but a power outage early this year and winter storms stymied that goal somewhat. Last month, the company imposed an 80 percent sales allocation on its Star 6 base oil, to assure it reaches its inventory target before the turn-around commences.

Large capital improvements are under way at Port Arthur as well, Lewis pointed out. As part of that, were refurbishing a lot of storage tanks inside of Port Arthur, including replacing some older smaller tanks with new, larger ones, he said. That will help us in the long run.

This coming quarter could be a dynamic one, Gribbin predicted, with crude price volatility, rising inventory costs, and uncertainty over whether refining margins will stick or slip. Even so, 2011s first quarter has been better than last years, he stated. First-quarter 2010 was at least 30 percent better than 09, and our January and February this year were much bigger again. Last year felt fragile all year but things seem much more secure now. The scary thing will be if crude oil continues its march – that could shut it all down.

Hoffman too sees a very changeable market. First, there traditionally might be some turnaround work before the gasoline driving season kicks in. Then theres the events in the Middle East, which we may not have seen the worst of yet. Well need a few more months to see what the ultimate impact is on crude supply, and then on base oils.