UK imports of Group II base oils are set to enjoy a tax advantage over EU imports from the start of next year. But UK exports of finished lubricants to the EU face the prospect of steep new tariffs if a free trade deal with the bloc is not agreed.
Under the new UK Global Tariff system that comes into effect from 1 January 2021, the Group II tariff of 2pc is suspended. In contrast, EU imports that exceed the bloc's current Group II base oil quota are subject to a 3.7pc tax.
The divergence in the tariff rates reduces tax costs for UK blenders relative to their EU competitors for Group II base oils imported directly from North America and the Mideast Gulf. As the UK currently has no quota in place, it also reduces uncertainty over any change in costs for UK blenders.
The change in tariffs will make it attractive for Group II producers in North America and the Mideast Gulf to move more supplies to the UK, whereas EU blenders face uncertainty over higher costs if and when imports from those regions exceed the current import quota.
The EU Group II quota is set at 200,000t for grades N150, N220 and N600 for each half-year period from countries that do not have a free trade agreement (FTA) with the EU. Imports above the quota from countries without an FTA are subject to a 3.7pc import tax.
The current Group II quota will remain in place for the first half of 2021, but it may be revised for the second half of next year. A reduction or abolishment of the quota would further increase the incentive for exporters in the US and Mideast Gulf to ship directly to the UK.
These tax arbitrages are a result of the upcoming implementation of the UK Global Tariff system, which will come into effect following the end of the Brexit transition on 31 December. UK imports of base oils from countries without FTAs are subject to a 2pc tariff. But this tariff is suspended, which means no tax will be due.
Until now, UK blenders have covered their Group II base oil requirements with US supplies shipped from storage tanks in northwest Europe. Since last year, they have also covered some of their requirements with supplies from the Netherlands, home to Europe's sole Group II refinery.
US base oil supplies from northwest Europe to the UK would continue to be included in the EU's Group II import quota. But cargoes moving directly to the UK from North America would be excluded from the quota and its import tax. Any significant pick-up in direct shipments from North America to the UK would mark a major change from current trade flows. Some 89pc of total UK base oil imports in 2019 originated from the European countries where refineries and storage tanks are located. Imports from North America accounted for less than 1pc of the total.
The UK market has become increasingly reliant on base oil imports as a result of falling domestic Group I production and rising demand for Group II and Group III base oils over the past decade. The growing dependence on imports increases the impact of any change in import tariffs. Domestic Group I production in the UK has fallen sharply since 2017. Last year it amounted to 293,460t, less than 65pc of UK production capacity. Output has continued to slide this year. Production was 200,000t in the first nine months of 2020, down from 253,590t during the same period in 2019.
But the tariff advantage that UK blenders will enjoy on feedstock supplies will be more than reversed when it comes to exporting finished lubricants to European markets if there is no trade deal with the EU before the end of the year. EU imports of finished lubricants are subject to a 3.7-6.5pc tax, depending on their application.
Under the UK's new system, Group III import tariffs are also set at 2pc, but they too are suspended. The tariff on additive components has been revised to 4pc, down from the EU's 5-6pc rate, and that has also been suspended.
