This puts most base oil plants into perpetual rivalry with the fuels side of their refineries for resources like feedstock, operating budgets and investment dollars, Eskew told last months ICIS Pan American Base Oil & Lubricants Conference, held in Jersey City, N.J. And it means that three fundamental inputs to base oil economics – feedstock supply, the ability to create value from byproducts, and operating costs – are all dictated by fuels refining economics, not vice versa.

The U.S. refining industry is in a bit of a pickle nowadays, said Eskew, who is based in Houston. When it comes to demand growth, almost all of it is happening outside North America. Asia is the biggest growth market, and Latin America is also growing, but the overhang of refining capacity, especially in North America and Europe, puts lots of pressure on those industries.

The United States is now a significant exporter of diesel fuel, especially to Europe, and it turns out that the economics for such exports are very favorable for U.S. Gulf Coast refiners. Unfortunately for base oil producers, diesel production is soaking up a lot of vacuum gas oil, and driving up the cost of this essential base oil feedstock.

This has led some industry analysts to suggest that base oil costs today are more closely linked to VGO than to crude, but Eskew demurred. Base oil generally moves with crude – not exactly in lockstep, but by and large, base oil moves up and down with other petroleum products. The feed is tied to crude, and base oil is tied to the feed.

Where might crude be headed next? Crude is now used more for transportation and petrochemicals, and less for industrial fuel, Eskew said. The value of transportation fuel to consumers, who are less price-sensitive than industrial users, has put a prop under the cost of crude. There is also a relatively little amount of cushion in crude production capacity, so prices have to support investment in exploration and production, he asserted.

The recent run-up in the price of North Sea Brent crude, which last year sold for a premium of up to $25 per barrel more than West Texas Intermediate was really an overreaction by the market, Eskew commented. A surfeit of WTI barrels in Cushing, Okla., contributed to this, but the glut was already being eased via truck and rail shipments when the announcement came that a new pipeline would start carrying WTI to the U.S. Gulf next year.

That snapped everyone out of that thinking, and narrowed the differential with Brent back to about $10, Eskew pointed out. I expect the WTI gap will close pretty rapidly toward the end of 2013.

Meantime, HollyFrontiers refinery at Tulsa, Okla., probably is the only base oil plant that is getting to enjoy the WTI price advantage, he said wryly.

Another issue in base oils is the extreme tightness of desirable barrels, such as API Group II and III. More Group II and III capacity is coming on, but there will not be enough to meet all demand for many years, he said.

And a well-run Group I base oil plant still can anchor the profitability of some refiners, Eskew added. Lots of refineries which would otherwise be unprofitable and would have closed have managed to stay afloat because of their base oil and specialties, he said. But if a fuels refinery is deeply under water, the base oil plant will sink with the ship.

A more melancholy view of base oil and lubricant demand came from Stephen Ames, managing director of SBA Consulting. He told the ICIS conference that global lubricant demand will be flat through 2013, with only moderate growth in following years. He based this outlook on lubes strong but lagging correlation to global GDP.

He also forecast that with enormous new capacity expected, over 9 million metric tons per year of older base oil capacity should close by 2016.

Generally, Ames agreed that lube demand is strongly linked to global gross domestic product – when GDP goes up, so does lube demand – but it lags GDP by about 3.4 percent. Based on the International Monetary Funds September projections for global GDP change, Ames forecast little to no growth in lubricants demand in coming years, despite robust economies such as Brazil, India and China.

In fact, there has been essentially no global growth in lube volume demand over the past 20 years, declared Ames, who is based in Pepper Pike, Ohio. In 1995, global lube demand was around 38.9 million tons; in 2007, it was 38.4 million tons; and in 2010, it reached 37.1 million tons at best, he calculated. Yet, industry pundits (and Im one of them) have regularly downplayed the many factors that are hobbling lube demand.

Numerous headwinds have worked against lubricant demand growth, he continued. These headwinds include:

Economic downturns, which are likely to occur regionally or globally within any five-year forecast period.

Lubricant efficiency, which can be seen most starkly in longer drain intervals for automotive engine oils, but also is affecting industrial lubricants such as gear oils, hydraulics and compressor oils.

Legislative changes, such as emissions and fuel economy mandates, are nudging consumers towards new vehicles with smaller oil sumps and often longer drain intervals – and not just in passenger cars but trucks, trains and ships, too. In many countries, governments are applying the brakes to vehicle demand growth by hiking fuel taxes, which restrains miles driven.

Lubricants trailing relationship to GDP growth. GDP growth doubled from 1995 to present – lubricants didnt, Ames said simply. Tracking the annual growth of GDP against growth in lube demand, the latter consistently lags the former. From 1996 to 2008, in fact, the GDP-minus-3.4-percent formula tracked actual lubricant demand exceedingly well, Ames said.

Looking ahead, this final headwind does not bode well for lube volume growth. The IMF in September forecast global GDP would grow 4 percent or less each year to 2016. Subtracting 3.4 percent from that, Ames estimated global demand for lubes would contract by 0.2 percent this year, and then tick up only 0.5 to 0.6 percent a year through 2016. Hence, in 2016 global lube demand likely would reach only 37.5 tons.

Given that gloomy outlook, Ames projected that global base oils will see no demand growth in the next five years. Base oil demand will likely be about 36 million tons in 2016, he said, little changed from prerecession levels.

Despite this, he noted, more than 9 million tons per year of new paraffinic base oil capacity and 1 million t/y of naphthenic capacity have been announced, and another 4 million t/y of new projects are under evaluation. In addition, retrofitting and debottlenecking will provide more than 2 million t/y of additional capacity.

If its all built, the worlds nameplate base oil capacity could rise to nearly 60 million tons by 2016 – well beyond what the market will require, even after accounting for a cushion of buffer capacity.

Consequently, Ames concluded, over 9 million t/y of older or high-cost capacity should close, and this will predominantly be API Group I. However, it will take time. People are reluctant to shut down an operating asset, so the shakeout may extend well beyond 2016.