Executive Vice President, Sonneborn, LLC
Originally Posted April 23, 2014
There has been a drumbeat of press in the past year telling of substantial overcapacity and oversupply of base oils. This in turn created an expectation that prices will dramatically decrease for at least the next five years. And then there’s the glut of “expert” talking heads on the biz channels telling us crude prices will similarly collapse and return to the $70’s per barrel. Sonneborn is not immune to the press and we also shared the same expectations, which may still turn out to be true in the future. I just don’t believe it.
The current physical market situation is just NOT conforming to expectations.
Crude oil pricing remains stubbornly high and refiners have, in effect, shut down or severely restricted base oil output while standing in place.
Let’s look first at refiners’ raw material pricing (mid-April)…OPEC Crude basket cost is at ~$103.60/BBL (weighted average, FOB Persian Gulf) and Brent is $107.40 (in the UK North Sea) while the WTI and Louisiana Light Sweet are ~$100 at the Gulf Coast. Also at the Gulf Coast, the cheaper fuels crude, including Venezuela, Ecuador, Mexico and Mars are ~ $95, whereas imported lubes crudes are ~$110 or higher.
Base oil outputs are down considerably due to maintenance stops and output restrictions. European and Russian refiners in particular are bordering cash negative status and have cut output to the 60’s%, producing barely enough to cover their internal demands and severely reducing merchant and spot barrel availability. They have turned one month maintenance stops into 2-3 month stops. The story in Europe is that the majors (including state companies) are outsourcing the closure of excess and uncompetitive refining capacity by selling to concerns that in turn fall over.
Current refining data shows that US refineries are running ~15.2 million BBL per day, which is ~86.7% of capacity (in a better market, refineries ideally operate in the low to mid-90%’s). It is difficult to make money refining at lower operating rates due to high fixed costs of refiners. Recent financial performance of major oil companies reflects operating at lower rates. So, even the big boys are scaling back capital and spending.
US refiners, while not in dire straits as in Western Europe, are acting similarly (in their rational, self-interest), and have reduced inventories and some of the large, Gulf Coast refineries are taking planned maintenance shutdowns. The much heralded arrival of Chevron’s new, Pascagoula, MS base oil refinery has from current estimates been delayed by six months (in addition to costing ½ Billion dollars more than the original estimates).
Meanwhile, global demand for crude oil is at record levels (>93 million BPD per latest IEA reports)….on the strength of diesel fuel demand in particular. Increased US crude production is preventing much higher crude prices, but is not sufficient to drive down global prices. Though demand in mature markets is essentially flat or declining, this is not so in developing countries. In 2013, vehicle sales of 22.1 million in China alone account for ~23 percent of the light vehicles produced globally last year. Global demand for crude oil is on the rise as these new car owners drive them.
Crude oil production from OPEC is flat (including Saudi Arabia, the world’s swing producer); North Sea, Mexico, Venezuela output is declining; Brazilian output increases have been anemic, contrary to expectations. And the increased US and Canadian output may be helpful in constraining further increases, but the increases are only keeping pace with increased demand.
The production of base oils is optional for all refiners (except the few specialists) and refiners have other things to consider. Base oil is 1% of crude oil on average and less that 5% of the output of refineries having base oil units. This means that >90% of refinery output is in fuels, since they can easily swallow the lubes feed stocks (vacuum gas oil) into their fuel streams. Ask any refiner, and they’ll tell you they make more money on fuels if they don’t have to worry about base oils. And refineries having cat crackers (FCC units) and/or a hydrocracker can produce fuels without having to produce base oils at all.
Here are four base oil refinery guarantees you can bet on…
- When cash negative, the base oil units will fall over (e.g. Marathon and Citgo in 2008; Shell and Sunoco in 2001)
- Operating rates will decline and the length of shutdowns will expand in an attempt to avoid #1
- A major refinery base oil unit will close because it can; the independents will not close because they can’t (lest they cease to exist), and lastly….
- When the tanks are full, production shuts down. They won’t pour base oil on the ground
All of this has created the situation of a tight physical market, stubbornly high crude oil cost, burgeoning export demand for fuels (especially diesel)….and surprise, higher prices when we didn’t expect it. At the moment, the next increment of volume for large volume buyers actually costs more than the first barrel.
And so you asked, where will pricing go? We can offer only opinions, which we know have in the past been wrong. And the market will decide without consulting us first.