Viewpoint: Demand falls for Iranian base oils

Mideast Gulf base oils extended their rise in the first few months of 2018, before steadying in mid-year and then losing all of their earlier gains during the second half of the year.

The regional price weakness throughout most of the year partly reflected the impact of its price strength at the start of the year. These firm prices opened the arbitrage for a wave of supplies to move to the region from Europe, the US and Asia-Pacific. This then covered buyers' requirements well into the second quarter of the year and during Iran's new year holiday when prices typically rise.

The US' announcement in May that it would reimpose sanctions on Iran had little initial price impact, partly because a steady and plentiful flow of supplies from other markets were already curbing buyers' requirements for this country's supplies.

Iranian producers raise prices in early 2018

The rise in regional prices at the start of the year extended their firm rebound during the last few months of 2017 in response to tight supplies and rising crude prices. But Iranian base oil producers raised their prices faster than other markets.

A producer raised its fob Iran SN 500 price to $825/t early in the year. This was its highest price since 2014 and up from $705/t at the start of the fourth quarter of 2017. European SN 500 prices by contrast trended lower during the fourth quarter of 2017, while Asia-Pacific and US Group II prices rose at a much more muted pace.

The effect was to narrow the price spread between Iranian supplies and cargoes from these other markets like Asia-Pacific, Europe and the US.

Buyers target Europe, Asia-Pacific supplies

Iranian cfr UAE SN 500 cargo prices flipped to a premium of as much as $40/t to fob Europe cargo prices at the start of 2018. They had been at a discount of more than $40/t at the start of the fourth quarter of 2017 and of more than $100/t in the third quarter of 2017.

Iranian SN 500 prices similarly moved to a premium of more than $25/t to fob Asia Group II prices in early 2018 from a discount of more than $80/t in the third quarter of 2017.

A steady flow of these Group I and Group II arbitrage shipments then reached the region during the first quarter of the year.

These shipments cut demand for Iranian supplies, whose market shrank mostly to buyers in the ex-tank market.

Sanctions have limited impact

Buying interest in Iranian supplies improved in the second quarter, when rising European and Russian base oil prices closed the arbitrage from these markets. Rising crude prices added to regional producers' incentive to raise their prices. But a steady flow of Group I supplies from Asia-Pacific curbed their room to target higher prices.

Slowing demand ahead of then during the Islamic fasting month of Ramadan from mid-May added to the price squeeze. A gradual trend among consumers to switch to using higher quality branded lubricants instead of localised brands added to the slowdown in demand for Iranian supplies and muffled the impact of the US's announcement that it would reimpose sanctions on Iran later in the year.

The persistent availability of Group I supplies from southeast and northeast Asia provided a steady flow of supplies for the region and kept pressure on Iranian base oil prices. More supplies also moved to the region from the US and Europe at the end of the second quarter.

Distributor's closure squeezes demand

Weak demand was then exacerbated by the closure of a regional base oils distributor in July. A consequence of the closure of the firm was the increased difficulty for small blenders to access to financial facilities to pay for supplies.

Iranian base oil prices then dipped even further late in the third quarter as producers sought to encourage distributors and blenders to secure more volumes instead of alternative supplies from other regions. The lower prices squeezed margins even further at a time when crude prices were rising to their highest levels in four years.

But the lower prices also spurred demand at a time when some distributors were seeking to build up their stocks of Iranian supplies ahead the imposition of US sanctions on Iranian base oils from the start of November.

Sanctions halt Iranian shipments to UAE

The imposition of these sanctions prompted a halt to the shipment of Iranian base oils to UAE ports, at least initially. More supplies were instead offered to India.

But there was little impact from the loss of these supplies. Some distributors continued to sell ex-tank volumes that they had bought earlier. Many blenders had also already switched to using Group I supplies from Europe or Asia-Pacific. Some distributors were also eyeing moves to ship more Russian base oils to the region late in the year or in early 2019.

Availability of light-grade base oils was tighter than heavy grades. Asia-Pacific producers preferred to focus more on moving supplies to India. Spot volumes from a new Group II unit in the region were also limited. While Group I heavy-grade prices began to weaken from the start of the second quarter, ex-tank Group II light-grade prices held firm through to the start of the third quarter.

Group III substitutes for Group II

But some Group I volumes moved to the region from Europe, while some Group II supplies from the US. There was also growing use of Group III base oils as a substitute for Group II light and even heavy grades because of their ready availability and competitive price. This combination of factors pressured ex-tank Group II light-grade prices throughout the third and fourth quarters. But they faced less pressure than heavy grades, resulting in an increasingly narrow price spread between the two grades.