Viewpoint: Asia base oil fundamentals to stay tight

Asia-Pacific base oil prices are set to hold firm at least for the first few months of 2021 because of unexpectedly tight supply and strong demand.

Asia-Pacific base oil prices already rebounded by the end of 2020 to their highest levels since 2018. Prices slumped in the first half of the year when Covid-19-related lockdown measures slashed demand in the second quarter. Prices then surged in the second half of the year, when supply-demand fundamentals flipped to increasing tightness.

Prices began 2020 at firm levels. Producers ended 2019 and began the new year with supplies that were more balanced than usual. The lack of any need to clear surplus supplies in late 2019 had helped to support firm prices at that time. This price support extended into the beginning of 2020.

Supply starts 2020 more balanced

Producers' availability was more balanced at the start of the year following extended run cuts in response to persistent oversupply in 2019. The oversupply had left margins unusually weak. The diversion of feedstock and base oil supplies to other fuel markets such as the marine fuel pool added to the relative balance. A narrow price spread between base oils and the other fuels made the diversion feasible. The more balanced supplies then gave producers more leverage with the sale of their remaining volumes.

Producers used that leverage of more limited supply to maintain steady prices even as crude oil values fell throughout the first two months of 2020. Base oil demand also held firm during that period even as the lockdown in China slashed economic activity in the country in February especially. But steep run cuts by Chinese base oil producers cushioned the impact of that decline in activity.

The firmer supply-demand fundamentals helped to support prices well into March, even after crude prices slumped at the start of that month. The combination of steady base oil prices and lower crude and diesel prices triggered a sharp rebound in base oil margins.

Widespread lockdowns slash demand

But lockdowns were then implemented in a growing number of countries throughout the region to curb the Covid-19 outbreak. The moves triggered a sudden and widespread slump in base oil demand. The lockdown in India especially forced regional base oil producers to target other outlets in place of one of the region's largest importers.

A pick-up in Chinese demand in March also began to falter as buyers held back to cut their exposure to the risk of lower prices.

The slowdown in demand put more pressure on Group II producers especially because of the large volumes of supplies that usually move to base oil import giants India and China. Group I producers faced less pressure from oversupply because of run cuts in southeast Asia and Japan, and still-steady demand in China.

Producers slash prices

Group II producers responded to the lack of buying interest by slashing their prices. These fell by early April to an unusual discount to Group I base oils. This discount widened to more than $50/t by early May for Group II light grades.

But the lower prices made more arbitrage opportunities to markets like the Mideast Gulf and east Mediterranean feasible in April, and then to southeast Asia in May.

Group II heavy-grade prices also fell below Group I base oils. But they faced less pressure than Group II light-grade prices amid a steady rise in Chinese demand for heavy-grade base oils.

China soaks up surplus

The lower prices also coincided with steadier domestic prices in China. The widening spread between falling fob Asia cargo prices and steady Chinese prices made the arbitrage increasingly attractive, providing an ideal outlet for South Korean producers to clear their surplus cargoes. With their supplies more balanced, producers were then able to target firmer prices.

The stronger heavy-grade fundamentals also supported a steady rise in the heavy-grade premium to fob Asia Group II light-grade prices. The heavy-light premium rose to more than $80/t by the end of June, up from $20/t in March.

Group II prices began their steep downward correction from the first half of March. Group I base oil prices followed several weeks later, led initially by a slump in bright stock prices.

Prices for Group I light and heavy neutrals then fell as southeast Asian producers offered sizeable volumes at increasingly lower prices to clear a large overhang. Surplus supply had risen because of steady output levels in markets like Thailand in March and April, while the country's lube demand slumped. The surplus volumes attracted buyers from a range of markets, from China and southeast Asia to the Mideast Gulf.

Fundamentals balance out

The region's Group I and Group II producers had cleared most of their surplus supplies by the second half of May. Crude prices were also continuing their strong rebound at that time after bottoming out in the second half of April. Economic activity was reviving in a growing number of countries as lockdown measures were gradually relaxed during the final weeks of the second quarter.

The base oil market then switched from a state of surplus to increasing supply tightness as demand revived strongly in key markets throughout the region.

Supply tightens, demand rebounds

Extended run cuts throughout the region added to the supply tightness. The planned shutdown of several Group II plants in Asia-Pacific in the third quarter curbed those producers' supplies as they built stocks ahead of the maintenance work.

The firmer fundamentals, rising feedstock prices and squeezed margins prompted Group I and Group II producers to target increasingly higher prices, especially for heavy grades.

Heavy-grade premium rebounds

The supply of heavy grades became tighter because of a drop in shipments from several Mideast Gulf producers, the closure of some production capacity in South Korea in the fourth quarter of the year, and China's structural shortage of those base oils. Persistent refinery run cuts also trimmed feedstock supply. This curbed some producers' room to raise base oil production in response to the surge in margins.

The trend triggered a rebound in the heavy-grade premium to light grades throughout the second half of the year.

Buyers in other regions such as India, Europe and Latin America also faced tight supplies in their own markets. They responded by targeting the limited spot volumes that were available in Asia-Pacific. The pick-up in competition for the supplies triggered a further rise in prices for all base oil grades throughout the fourth quarter of the year.

The sustained competition for those tight supplies left fob Asia Group I bright stock prices more than $150/t higher than at the start of the year. They were also up by more than $350/t after bottoming out at close to $500/t in early May.

Fob Asia Group II heavy-grade prices ended the year more than $140/t higher than at the start of the year. They were also up by more than $350/t from their lowest level in late May.

By Iain Pocock