Base Oils Surge in China


China is in the midst of what may be the biggest, fastest surge of base oil capacity the world has ever seen, adding 3.4 million metric tons per year to what was already the worlds second-largest base oil supply base.

It is a gusher that undoubtedly reflects expectations that these projects will generate profits, but industry observers say they could also make business challenging for their operators and other refiners. The market they enter already has excess capacity and has yet to develop an outlet for exports.

From June of 2018 through April of this year, Chinese refiners brought online at least six new base oil plants or plant expansions, and three more are scheduled to be completed by the end of this year. Before the first of those projects opened, China was easily the worlds second-largest base oil producing country, with annual capacity of 9.1 million tons. If the remaining projects are completed at the sizes previously announced, the nations capacity at the end of 2019 will be 12.5 million t/y, approaching the global leader, the United States, which has capacity of 13.2 million t/y-twice as much as the number three producer, South Korea. Chinas capacity will have jumped by more than a third in a year and a half.

Industry observers say no country has ever added so much base oil capacity in such a short span of time.

The rate of new capacity addition underway in China has been unprecedented compared to any other market, Steven Zhang, a project manager in the Energy Practice of consulting firm Kline & Co., said in an emailed response to questions from LubesnGreases. The closest example he could cite was the Middle East adding approximately 3 million t/y of capacity between 2011 and 2018. In addition to covering a longer span of time, that supply came from projects in four countries.

The capacity added in 2018 and 2019 is a relatively even mix of API Group II and Group III stocks. Shida Changsheng Chemical, Junheng Industrial Group and Kaitai Petrochemical opened new Group II plants, while Sinopec completed a Group II expansion at its plant in Jingmen, Hubei province, and Feitian Petrochemical is scheduled to do likewise at its plant in Xinji, Hebei province during the third quarter.

Coal supplier Luan Group added Group III capacity to its coal-to-liquids plant in Changzhi, Shanxi province, which was already producing CTL polyalphaolefins. Hengli Petrochemical opened a plant at Dalian with capacity to make 350,000 t/y of Group III along with 190,000 t/y of Group II. Qingyuan Group reported completing an 800,000 t/y Group II and III expansion at its plant Zibo, Shandong province, and Handi Sunshine Petrochemical has said it will complete a Group II/III expansion of equal size at its plant on Hainan province, but neither company has disclosed the split between Groups II and III.

Three of the projects are in Shandong, an eastern province on the Yellow Sea, which now has six base oil plants. It now ranks among the worlds biggest base oil hubs along with the U.S. Gulf Coast and South Koreas ports of Ulsan and Onsan, which are less than 20 miles apart.

Chinas base oil capacity had already undergone significant change before 2018. In 2010, the country had 22 base oil plants, all but one owned by national oil giants PetroChina and Sinopec, and five-sixths of paraffinic capacity was API Group I. Over the next several years, PetroChina upgraded nearly half of its paraffinic base oil capacity to Group II, and Sinopec almost two-thirds of its capacity to Groups II and III.

At the same time, numerous independent companies began entering the market, as did Chinas third large, nationally owned oil company, China National Offshore Oil Co., which now operates three base oil plants. As Zhang Chenhui, a Guangzhou-based independent consultant, noted during an April presentation at Enmores China Lubricant Market Focus, PetroChina and Sinopec now account for just 43 percent of the nations base oil capacity, and only a quarter of its paraffinic capacity is Group I.

Operators of new capacity express optimism about prospects for their base oils.

We built the plant to meet the needs in Chinas lubricant industry, Shida Changshengs technical director, who identified himself only by the surname Yan, said in April after the company opened its 300,000 t/y Group II plant in Weifang, Shandong. He added that customers include lubricant blenders located around the country, including Beijing, Tianjin and Jiangsu.

But analysts say the large influx of capacity in 2018 and 2019 has an element of irrationality insofar that it goes beyond the markets need.

Weve heard some operators say that the fuel oil market is bad, and that this is pushing them to transition to producing base oil, said Yang Wei, director of specialty chemicals in the Beijing office of research firm IHS Markit. She added, though, that the firm is nevertheless very confused with the booming expansion of base oil capacity.

China has been one of the worlds largest base oil importers, which might imply a need for more domestic supply. But in-country capacity is now significantly greater than the volume requirements of the domestic lubricant market, which consumed 6.6 million tons of finished lubes in 2018, Zhang Chenhui said. Kline & Co. estimated the number at 7.4 million tons.

He added that the influx of capacity has turned out not to be a very good fit for the needs of Chinas lubricant industry, supplying way more low-viscosity Group II oil than the market needs and not enough heavy grades or Group III. He estimated that the country produced 1.2 million tons of high-viscosity base oil last year, about half as much as it needed.

The production capacity of light lubricating oil is seriously over-extended, and serious quality base oil is seriously insufficient, he said.

It is common for the profiles of base oil demand and supply not to perfectly align. Most of the worlds regions have significant surpluses or deficits of some type of base oil, but the surpluses are shipped to other markets and the deficits filled with imports from elsewhere. Its the reason there is a healthy amount of inter-regional base oil trade. Chinas base oil exports have been scant, though, because the government discouraged them by requiring sellers to enlist one of three national companies to serve as agents for overseas sales.

The surplus and mismatched capacity, combined with the lack of a good export outlet, has resulted in Chinese base oil plants running far below capacity. Zhang Chenhui said the average operating rate for 2018 was just 60 percent, significantly below the global average.

Analysts say the new surge in capacity could be an additional drag on operations.

It is very possible the operating rate will be depressed further after these capacities release, Wang said.

The new capacity could also pressure suppliers of Chinese base oil imports. South Korea, Singapore and Taiwan are among the biggest suppliers of those imports.

One fallout of the new capacity in China is a reduction in imports, Steven Zhang said. Some of the established marketers felt heat due to this new material hitting the market. He added, though, that new volumes have not penetrated the top-tier market, which is catered to by imports from markets like South Korea and Singapore.

Zhang Chenhui said China imported 2.71 million tons of base oils last year, a slight increase from 2.65 million tons in 2017.

At least some Chinese suppliers do plan to export in order to increase selling opportunities. The Chinese government relaxed rules on petroleum product exports in 2016 and 2018. Representatives of Hengli said the company plans to export base oils and has hired staff for that purpose, and another company said it has done the same.

Exporting is not a simple solution, though. The global base oil market is mired in a growing surplus, meaning most of Chinas suppliers would probably face significant competition wherever they tried to sell. In addition, some observers questioned whether Chinas new base oil producers will be well-prepared to sell to overseas customers. Steven Zhang noted that most have little exposure to merchant market sales.

He added that finished lubricant approvals could be a barrier to sales for some applications, such as top-tier automotive lubricants. Lube marketers in developed markets-and marketers of top-tier automotive lubes in developing markets-have a strong preference for base oils certified as being used in finished product formulations that have met the requirements of industry or original equipment manufacturer specifications. Those specs often include engine tests that are expensive and can take significant time to pass. Some new Middle Eastern base oil marketers have been working for multiple years to achieve European engine oil approvals.

We are not aware if these private companies producing base stocks in China have secured any approvals, Steven Zhang said. Securing approvals is important for developing a long-term market strategy. In absence of approvals,they will primarily operate in the unapproved market, where profit margins are lower.

Analysts agree that the big influx of supply will make business more difficult for new and existing suppliers.

Base oil prices and margins were also impacted, Steven Zhang said. This situation will become further stressed with more base stock capacity added in China.

After this year, the pipeline of base oil projects in China slows but does not stop. Shenghong Petrochemical has said it will open a 700,000 t/y Group III plant in 2021, and G-TiBase Oil Technology, a joint venture between Yitai Coal and base oil distributor Jiyang Petrochemical, plans to open a 200,000 t/y CTL Group III plant in 2022.

Finished lubricant demand in China has flattened the past couple years, but some analysts forecast that it may resume growth if the automobile parc continues to expand-at least until numbers of electric vehicles become a major factor. That could help ease business for the nations base oil suppliers, but overall it appears that the coming years will be challenging times for them.

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