Viewpoint: Surplus hits NE Asian heavy-grade base oils

Northeast Asian base oil prices were mixed in 2018. Group I heavy-grade prices increased in the first four months of the year before a sustained slump. Group I light grades edged higher.

But Group II light grades rose in the first half of the year before giving back all of these gains in the second half. Group II heavy grades edged higher in the first four months of the year before a sustained slide.

Group II light-grade prices began the year at their highest level since the end of 2014 after rising by $80/t during the last quarter of 2017. Heavy-grade prices saw a smaller $60/t increase during the same period to their highest levels since mid-2017. Group I heavy-grade prices rose by an even faster $90/t during the same period.

Tight supplies support SN 500 Group I SN 500 prices then extended their surge during the first two months of 2018, with cfr northeast Asia prices rising as high as $870/t. The firm prices reflected steady demand as blenders replenished stocks and limited supplies during the first few months of the year. The arbitrage from Europe was shut. Several major Asia-Pacific producers were focused on covering term commitments. This left only a couple of producers with spot volumes in southeast Asia.

But these prices continued to rise at a faster pace than Group II heavy grades. Group I heavy grades by late January had risen to the same level as Group II prices and then to a premium to Group II. This boosted the competitiveness of Group II supplies versus Group I. These Group II volumes were also more readily available from a larger number of sources. The high Group I prices prompted buyers to switch over to the Group II supplies, curbing demand.

But the surge in Group I SN 500 prices destroyed demand and triggered a sharp reversal from the end of March. Prices slid to $800/t cfr by June, then to $750/t cfr by August and then below $700/t cfr in December.

Buyers switch to Group II heavy grades Group II heavy-grade prices initially got support from firmer demand as buyers switched away from Group I during the first quarter of the year. Demand for heavy grades also typically gets a seasonal boost during the summer months.

Spot availability also tightened. Plant maintenance in Taiwan during the third quarter also began to curb volumes from this market during the second quarter of the year. This combination of factors supported a rebound in the Group II heavy-grade premium to Group I prices to around $50-60/t by June.

But Group II heavy grade prices then fell at a faster pace than Group I prices during the second half of the year, even with a drop in supplies from Taiwan. Group II shipments from there slumped during the third quarter because of a prolonged round of plant maintenance.

Slowing Chinese demand pressures heavy grades The slowdown from Taiwan was more than outweighed by a seasonal slowdown in Chinese demand during the third quarter, as well as steady availability of supplies from South Korea. The sharp depreciation of China's currency versus the US dollar from June exacerbated the pressure. Steady to weak domestic Chinese prices and poor demand meant cfr northeast Asia prices had to adjust to reflect the weaker currency and to keep open the arbitrage to China.

The supply and price pressure then intensified from the fourth quarter of the year, following the resumption of base oil shipments from Taiwan. Some Chinese plants had been trimming run rates during the third quarter because of increasingly weak base oil margins amid surging feedstock prices. But these moves then reversed during the fourth quarter following the slump in crude prices.

The rising volumes and slowing demand triggered a drop in Chinese domestic and cfr northeast Asia N500 prices to their lowest levels since late 2016.

Bright stock prices stabilise after fall Bright stock prices followed a similar trajectory to SN 500. Prices rose strongly in the first two months of the year before steadying. Chinese importers by then had secured sufficient volumes even with the closed arbitrage from Europe.

A steady drop in domestic prices from March then put pressure on imported cargo prices. These then fell by more than $100/t in the four months to early July in the face of increasingly plentiful regional availability. Prices then held around the $850-870/t cfr level throughout the second half of the year.

Tax changes support light grades Light-grade prices were relatively firmer than heavy grades for most of 2017. Prices got support at the start of the year from firmer demand for supplies labelled as base oils rather than white oils. The move followed the tighter implementation of China's tax rules. These required proof of payment of the country's consumption tax. Base oils included this tax in their price, while white oils did not.

Under the previous tax system, domestic producers in China had been able to offer base oil supplies labelled as white oils at much more competitive prices than imported base oils because they avoided including the consumption tax in the price. To remain competitive under the new system domestic producers had to lower their white oil prices to increasingly steep discounts to base oils to reflect the unpaid consumption tax of around 1,711 yuan/t ($248/t).

The effect was to create three tiers of light-grade prices in China — imported supplies, domestic supplies labelled as base oils and domestic supplies labelled as white oils. The choice of supplies, and the wide price disparity between the choices, prompted buyers to maximise their consumption of domestic supplies. The limited availability of imported base oils also supported prices for these supplies. Prices got further support during the third quarter during the plant shutdown in Taiwan.

Buyers purchase less, more often Buyers continued throughout the year their pattern from late 2017 of buying smaller volumes on a more regular basis. The move reflected expectations that they could secure supplies as and when required because of rising availability of supplies and production in China's domestic market. A light round of plant maintenance in China in 2018 added to these expectations.

The move aided buyers' cash flow by reducing their capital tied up in stocks. It also curbed their exposure to currency volatility, which became a growing concern in the second and third quarters of the year.

A consequence of these changing market trends was a smaller rise in Chinese imports in late 2017 and early 2018 compared with the previous year. Imports then continued to slow throughout the year.

The firmer demand for light grades categorised as base oils pushed Chinese domestic light-grade prices to an increasingly narrow discount to heavy-grade prices. They also narrowed their discount to domestic Chinese prices of Group III base oils without approvals. The Group II discount to Group III narrowed to less than Yn100/t by the start of the third quarter, from more than Yn550/t at the start of the second quarter.

While Group II prices had held firm, Group III prices for unapproved supplies slipped steadily throughout the second quarter amid regular availability of supplies of Mideast Gulf origin. Buyers' increasing familiarity with these supplies, and their steep discount to supplies with approvals, spurred a steady rise in demand for the product. This discount also prompted a growing number of blenders to obtain their own internal approvals to boost consumption of these base oils.

Currency depreciation closes arbitrage A repercussion of the deprecation of China's currency versus the US dollar from June was to close that arbitrage from the Mideast Gulf and halt these Group III supplies.

The currency volatility also encouraged Chinese buyers to tap supplies from domestic producers.

Availability from these producers faced the prospect of a further surge in supplies during the second half of the year and in early 2019 because of the expected start-up of a wave of additional production capacity. The new capacity included a Group III plant that is scheduled to start operations in early 2019.

Producers switch to make more diesel Steady Group II light-grade prices from the start of the second half of the year contrasted with higher crude prices during the third quarter. The effect was to push domestic diesel prices first to a growing premium to white oil prices and then to a premium to domestic base oil prices. Producers diverted more of their feedstock supplies to make diesel in response.

The move helped to limit the supply overhang at the start of the fourth quarter, supporting steady to firm base oil prices. Their premium to diesel then surged in November following the slump in crude and diesel prices in October and early November.

Buyers delay stockbuild These higher premiums prompted a switch back to making more base oils. These added to plentiful supplies, amid scarce plant maintenance in China or northeast Asia.

But buyers held back following the slide in crude prices, putting off any moves to start building stocks early. The result was a further slide in light-grade base oil prices in December to their lowest levels in more than a year.

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