Those of a romantic bent may see base oil as the jewel in the refining crown, and it certainly shines in comparison to more prosaic products like gasoline, kerosene and asphalt. But the laws of supply, demand and gravity apply just as cruelly to base oil as to the rest of the petroleum stream, and have dimmed its semi-precious glow.
What took the shine off is no mystery, points out Jamie Brunk, manager of lube studies for Solomon Associates in Dallas, Texas. Paraffinic base oil demand is down, at the same time as new plants are being built, which is forcing out inefficient facilities, he summarized in December, at the ICIS Pan American Base Oils & Lubricants Conference in New Jersey. Yet even amid this turmoil, opportunities exist for refiners with low cost of production.
Through 2014 and into 2015, conditions favored refiners in the United States, he added. Low natural gas and crude prices in North America have revived its refining industry – and given a substantial advantage for refiners in this area of the world.
By contrast, European refiners are under intense pressure, Brunk said. They are squeezed between the energy cost-advantaged plants operating in North America and the new, more efficient facilities in Asia.
Karl Bartholomew, Americas vice president for ICIS Consulting, also spoke of the cost advantages of U.S. refiners, and the role that cheap crude and energy has played in their recent success. Thats why refiners are keeping a close eye on what will happen with crude and natural gas prices. Theyve also had a captive supply of home-based crude oil, which artificially kept prices low – but U.S. exports of crude will have an impact on that.
Bartholomew predicted U.S. refineries will run a lot more light, tight oil crudes, which isnt good for base oil. LTO crudes contain fewer of the heavy molecules that are needed to make the full slate of light-, mid- and heavyweight base stocks. When a refinery adopts LTO to make fuels – as many have – it risks getting less of the vacuum gas oil and resid needed to feed its base oil operations.
Besides crude, refinery utilization is another key factor in profits, said Solomons Brunk. Base oil refining capacity is fully utilized when you hit 85 percent [of nameplate capacity], he said. The other 15 percent gets spent over the course of the year in downtime, weather delays, maintenance work and myriad other slowdowns, planned and otherwise.
While 85 percent utilization would dazzle, were in the 70 to 75 percent utilization rate now, and its going down, Brunk said. As more plants are built, utilization has to go down to balance supply with demand. On a global basis, the worlds paraffinic base oil refineries saw utilization peak at 79 percent in 2011, but since then the operating rates have fallen steadily, managing only around 73 percent of their potential capacity in 2014.
Where utilization rates become interesting, he said, is if you look at the operating rates for API Group I solvent-extraction base oil plants versus the Group II hydrotreating plants. Group I has suffered a much bigger drop in utilization rates since 2011. On a global scale, Solomon calculates that hydrotreating plants generally have seen utilization rates stay at 79 percent or higher. Solvent extraction units, meanwhile, sank from 78 percent utilization in 2011 to a sickly 71 or 72 percent by 2014.
Geography triumphed here, too: U.S. and Canadian base oil plants operated at 75 to 80 percent of their capacity in 2014, while Central and Eastern European plants dipped closer to 70 percent, and Western Europes refiners averaged barely 65 percent utilization, Solomon found.
Turning next to crude slates, Brunk noted that in 2014, 27 percent of the worlds base oil refiners were running on Arab Light; 32 percent ran Russian crudes; 12 percent were using other Middle Eastern crudes, and 7 percent were fed a diet of Arab Medium. Other crudes, including local ones, were used 22 percent of the time.
In the U.S. and Canada, however, other crudes are now 51 percent of what refineries run. There are 42 crudes in this pool, which includes the best-known West Texas Intermediate, but also offshore Gulf crudes, those from Mexico, Louisiana Sweet, shale oils and more.
Flexibility is critical to refiners, Brunk emphasized. While some run only one crude, such as Arab Light from Saudi Arabia, others run up to 50 crudes. The number of crudes run in the typical refinery is now eight to 12, while back in the 1990s refiners used only four or five crudes.
A related issue is the use of LTO: light, tight oils, Bartholomew and Brunk agreed. These include crudes recovered from shale and clay formations, and some shale gas too, from the Bakken and Eagle Ford fields, the Permian Basin, the Marcellus shale formation, and elsewhere. LTOs are less expensive than West Texas Intermediate crude, but also tend to be less consistent in quality and lighter in API gravity.
Gravity is no laughing matter, especially for Group II refiners who use vacuum gas oil as their feedstock. Bakken crude, for example, has more naphtha and substantially less VGO than traditional crude. In a nutshell: The more a refinery uses LTO, the lower its yield will be of medium and heavy base oils and bright stock. Its a challenge for Midwest and Gulf Coast refineries, Bartholomew stated.
Crude is only one facet of a refinerys success, of course. To find what makes a leader or an also-ran, Solomon Associates gathers confidential data from refiners worldwide on their cost to produce lubricant base oils, waxes and specialties. It then can benchmark individual refiners against the global field. Its calculation includes each refinerys cost of raw material (crude, vacuum gas oil or other inputs), minus the value of the byproducts made, plus the refinerys operating expense.
When it comes to raw material costs, the U.S. and Canadian refiners are in pretty good shape as far as cost of production is concerned, compared to the rest of the world, Brunk stated. The question we always ponder is, why doesnt the guy at the other end of the scale, in the bottom fourth quartile, exit the market? In fact, over time weve observed that the plants that close tend to be the ones that are ranked in the third and fourth quartile.
Operators also have been adjusting their product slates to generate more of what customers demand – light neutrals at one end of the scale, and heavy neutrals and bright stock at the other. Unfortunately, the rush to add capacity to produce more light neutrals for making automotive engine oils has created a glut of these grades since 2010. The effect here is that light neutral margins are now the lowest margins within the base oils slate, Brunk confirmed.
The new plants did not make heavy neutrals and bright stock though, and several plants that did have exited the market. Thats made these products quite snug. So heavy neutral and bright stock margins are the highest margins within base oils.
The bottom line for many depends on how well they can manage their operating expenses. On a global basis, for example, energy costs represent almost 45 percent of base oil refiners operating expense. (The next largest cost is maintenance.) And on energy costs, Brunk showed, U.S. and Canadian refiners – hydrocracking and solvent extractors alike – were solidly ahead of their counterparts throughout Europe and the rest of the world, well into 2015. That difference went straight to their bottom line in the form of fatter margins.
Looking ahead, things appear less cushy. Bartholomew of ICIS observed that refiners are facing another round of costly regulatory mandates. More and more of refiners dollars will have to go to lowering sulfur in fuels and meeting new ozone standards, he said, rather than base oils. In fact, U.S. refiners earmarked only about $6 billion total for new construction this year and last. Thats not a lot of investment, when you consider that Chevrons Pascagoula refinery alone cost $10 billion. The future spend we see is going to be for regulatory compliance, not for capacity.
The lessons, Bartholomew said wryly, are that First, economics beats technology every time. And second, politics beats economics, every time.