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After the Surge, the Slump

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Although U.S. base oil refiners opened 2012 on an upward surge, their monthly output started to wobble in the summer and then proceeded to lose momentum until the year finally drew to its close.

By then, U.S. base oil refineries had produced a total 57.6 million barrels of base oil, according to statistics recently released by the U.S. Energy Information Agency. Thats 7 percent below the 62 million barrel mark hit in 2011, and 4 percent less than the 60.2 million barrels refined in 2010. (Still, it was better than the low-tide year of 2009, when base oil output plunged to 55 million barrels.)

The 2012 total included 47.2 million barrels of paraffinic base oil, and 10.4 million barrels of naphthenic base oil (versus 50.6 million barrels and 11.4 million barrels, respectively, in the prior year).

From January to June, the countrys refiners produced 29.3 million barrels, but in the second half of 2012 they only managed 28.3 million barrels of output.

That second-half downturn in output was due almost entirely to worsening paraffinic production. After reaching 24.2 million barrels in the years first six months, second-half paraffinic volumes tapered off to 22.9 million barrels.

A big contributor to this million-plus-barrel decline, and one of the years most painful events, was an Aug. 6 fire in the crude unit at Chevrons Richmond, Calif., refinery. Richmonds 20,000 barrel/day API Group II lube unit was not damaged in the fire, Chevron quickly assured customers. But it did not operate at anywhere near normal capacity for the rest of the year.

Leading up to the fire, Richmond had been averaging about 520,000 barrels of base oil a month, the EIA data indicate; afterward, it averaged barely one-fifth of that volume.

Pressing Matters

Jeremy Kriska of Tulstar Oils in Tulsa, Okla., cited a number of additional factors that may have further depressed domestic base oil production. One thing may have been the slowdown in the European economy, he observed. That led European producers to become very aggressive on pricing, and we saw them exporting more base oil to North America.

Second, a large amount of rerefined base oil is now on the market, much of it API Group II quality, and we may be seeing some impact of that, he said. U.S. rerefiners nameplate capacity for making Group II has grown to more than 11,000 barrels/day, according to LubesnGreases research. Rerefiners do not report their base oil production volumes to the EIA, however, so their impact is not captured in the agencys data.

Third, new Group III base oil refiners in the Middle East – Neste-Bapco in Bahrain and Shells Pearl project in Qatar – began ramping up exports, too. So there was more competition here, and more choices for U.S. buyers, Kriska said.

Together, these factors helped to push down base oil prices significantly starting in July. And as values declined, Kriska said, U.S. refiners began to trim back their base oil units operating rates rather than endure unacceptable margins on their feedstock.

Refiners also tend to slow down as the year winds down, he added, to avoid carrying too much inventory at the year end.

The New Normal?

A base oil marketer in the Houston area, speaking on condition of anonymity, said the market has become quite cyclical as the year progresses. U.S. producers typically see rising sales from March to May, this marketer explained, as the prelude to the driving season. Then, they may continue to operate at high rates during the summer, building a cushion of safety stocks against the hurricane season ahead.

By the end of the third quarter, this source added, now they have to work off the hurricane stocks, so they may slow down production some. And then youll see destocking until the year end, to pull down their inventories for tax reasons before the year closes.

Industry consultant and base oil expert Terry Hoffman, in San Antonio, tended to agree. We seem to be on a cycle, where the first half of the year goes well, and people produce and buy a fair amount of base oils. Then, in the second half, the market takes a step change down, until finally, in November and December, we see people try to pull their inventories down, due to inventory taxes that Louisiana and Texas put on whatever refiners have in their tanks at year end. They want to avoid that tax.

Naphthenics seemed to be doing okay all year, Kriska pointed out. Although production was off 8.4 percent from 2011, the 2012 volume of 10.4 million barrels was right in line with levels that have been typical since 2004. Unlike paraffinic base stocks, pale oils did not see any slackening of productivity in the second half of the year; they actually moved at a quicker pace from July to December.

Incoming Tides

U.S. base oil producers also faced stiff headwinds from imports last year. Total imports rose to 10.7 million barrels, versus 10.1 million barrels in 2011.

Dallas-based Jamie Brunk, manager of lube studies at the research firm Solomon Associates, reminded that 2012 saw a number of new opportunity base oil plants begin to unleash large volumes of material. Opportunity plants are primarily built to produce base oil for the global merchant market, rather than to assure supply for the operators own finished lubricants.

Group II and III plants are cheaper to build and operate, too, Brunk pointed out, and all that new material got dumped into the global playing field. The bad news – or good, depending on your vantage point – is that more new Group II and III plants are under construction, including sizable ones in the United States, Spain, Abu Dhabi, China and Russia.

The largest sources of 2012s base oil imports continue to be South Korea, with 39 percent of the total, and Canada (21 percent), but they have now been joined by Qatar, home to the Pearl project, and Bahrain, where Neste-Bapco began operating last year. Pearl sent 1.5 million barrels to the U.S. in 2012, and Neste-Bapco brought in 603,000 barrels. Both Pearl and Neste-Bapco are Group III producers.

Hoffman said imports of Group III base oils have grown as we get into better-quality motor oils, like SAE 5W-20 and 5W-30, and 10W multigrade heavy-duty oils. All these are needed more and more for fuel economy benefits, and they need the same base oil viscometrics. So demand for Group III keeps going up.

Flowing Out

U.S. base oils also are part of a global trade, he emphasized. We suck in a lot of Group III now, Hoffman continued, and Shell seems to be pushing in a lot from Pearl. Meanwhile, more Group II is going out of the United States to enable the multinationals to produce their global heavy-duty engine oil formulations.

The export side was very favorable to U.S. material, and rose 9.6 percent. A total 27.3 million barrels were shipped in 2012, versus 24.9 million barrels in the prior year. In all, more than 47 percent of the total U.S. base oil production was shipped outside its borders in 2012, the EIA data show. Here too, though, the greater portion of shipments were made in the first half of the year, while the second halfs shipments were less robust.

By destination, the largest recipient of U.S. base oil exports was Canada (traditionally the largest trading partner); 5.4 million barrels went north in 2012, versus 3.2 million barrels in 2011. The next biggest buyer was Mexico, with 4.6 million barrels in 2012 (compared to 3.7 million in 2011). Third place as usual was Brazil, with 2.9 million barrels taken, versus 2.6 million the year before.

Exports have become something of an escape valve for U.S. oversupply, in fact. The two products most likely to hit foreign shores include Group II and naphthenics, said Hoffman, but substantial amounts of Group I ship out, too.

Heading now into spring, the current market is looking steady, and steadily better as each week passes, according to the unnamed Houston base oil seller. Sales look good, he indicated, especially for Group III base oils.

Demand seems fine, its not too low, not too high – just coming along nicely, said Tulstars Kriska. Were not seeing weakness on the demand side, at least not from our customers.

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