Global base oils: Margin pressures begin to build

Author Iain Pocock, Editor, and Guo Harn Hong, Senior Analyst

Plant maintenance, run cuts and arbitrage exports have helped base oil producers to balance out the drop in demand over the last two months. But weakening margins reflect the still-muted strength of the recovery in demand and the market’s structural oversupply.

Global base oil prices have steadied amid improved supply-demand fundamentals. But base oil values have begun to slide relative to rebounding crude and diesel prices. The trend has left base oil values under rising pressure in the US and Asia especially. The premium of US Group II N100 over diesel prices has fallen to around $0.26/USG. The premium was the lowest since January and down from an over seven-year high of more than $0.70/USG in March.

US base oils feel squeeze from rebounding diesel

A large volume of surplus base oil supplies from the US market has continued to move to markets like west Africa, the Mideast Gulf and India. The shipments reflected competitive US Group II prices compared with prices in Asia-Pacific and especially compared with Group I prices in the Baltic region. US Group II heavy-grade prices fell in April-May to a discount of as much as $85/t to fob Baltic SN 500 prices, from a premium of more than $100/t in February. West Africa is typically a key outlet for Russian base oil supplies from the Baltic market.

US cargoes break in on traditional arb flows

European export Group I base oil prices also fell at a much faster pace than fob Baltic Group I prices as producers in Europe slashed their price offers to clear surplus supplies. The premium of fob Europe export SN 500 over fob Baltic SN 500 narrowed to just $10/t in May. The premium was the narrowest since 2018 and down from typical levels of around $100/t.

Baltic supplies face even more competition

European Group I export prices also fell at a much faster pace than European domestic Group I prices. The discount of fob Europe export SN 150 to domestic Europe SN 150 widened to more than $170/t in May. The discount was the widest in more than a decade and compared with typical levels of around $80-90/t. The wide discount incentivised regional blenders to re-import base oil cargoes that had been lined up to move to export markets.

Europe blenders eye unusual arbitrage

The strength of domestic Europe Group I prices relative to European Group I export prices was in turn overshadowed by even stronger regional Group II prices. Outright prices for Europe Group II base oils fell even more slowly than domestic Group I prices. The result was a widening of the Group II base oil premium to domestic Europe Group I prices in May to its highest level in at least seven years. The Europe Group II premium to fob US Gulf coast and fob Asia Group II light-grade prices also increased to its widest level in at least seven years.

Europe Group II prices outshine other markets

The open arbitrage to Europe provided Asia-Pacific producers with an opportunity to clear surplus Group II supplies and counter the ongoing slump in Indian demand, where a nationwide lockdown was extended to the end of May. India’s lube demand fell in April to its third-lowest level in more than five years.

Lockdown limits lubes

Producers throughout the Asia-Pacific region slashed their exports to India in response to the slowdown. Singapore’s base oil exports to India fell in April to their lowest level in more than eight years. Taiwan’s base oil exports to India also slumped in April.

Producers cut back exports to India

The outlier in the Asia-Pacific region remained the Chinese market, where demand has remained strong, especially for Group II heavy-grade base oils. Prices for Group II N500 in China’s domestic market have moved to a premium of more than 1,300 yuan/t ($182/t) to N150. The premium is the largest since 2017. The trend reflected China’s plentiful supply of light-grade base oils and structural shortage of heavy grades.

Heavy strength reflects China’s structural weakness

But the price strength of heavy grades has boosted interest in heavy-grade supplies offered by some of China’s new base oil plants. The gap between domestic N500 prices and cfr northeast Asia cargo N500 prices has also narrowed sharply, especially compared with Group I SN 500 prices. The narrowing gap dampens the attraction of importing Group II heavy grades.

Group II heavy-grade strength squeezes arbitrage

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  • Argus Base Oils Outlook forecasts that in the absence of further disruptions, global net nameplate production capacity availability for June is set to revert to average levels in the fourth quarter of 2019.
  • Supply is set to get a boost as an expected rise in US and European production offsets supply disruptions in Asia. Supply availability in Asia is set to fall, more than countering the impact of supply from a slew of new plants that came on line in the region in 2019. The trend reflects some of the heaviest round of plant maintenance and run cuts on record in the region.
  • Europe’s net base oils production in June is set to increase by 5.3pc versus month-ago levels.
  • US’ net base oils production in June is set to hold steady versus levels in May.
  • Asia’s net production is set to fall by 5.3pc in June versus May.
  • The trend will likely limit the size of any price rise as demand rebounds following the resumption of market activities and as restrictions to curb the spread of Covid-19 ease.

 

Supply set to recover from 2Q slump

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