Viewpoint: Sellers target India with surplus base oils

Indian base oil prices trended lower in 2018 as a surge in supplies forced sellers to compete to secure buyers in one of the few markets able to absorb a large slice of these surplus volumes.

The persistent availability of surplus supplies contrasted with 2017. Buyers had struggled to secure sufficient volumes that year because of a heavy round of planned and unexpected plant shutdowns. The delayed start-up of a new Group II unit in Saudi Arabia added to the tightness.

The tight supplies forced buyers to bid at increasingly higher levels throughout the second half of 2017. Surging crude prices during this period added to the upwards price trend.

Prices by the start of 2018 were at their highest levels in more than three years. Light-grade prices were also at unusually firm levels versus crude.

Buyers lock in large volumes in 1Q

The supply tightness throughout most of 2017 prompted buyers to lock in large volumes of spot supplies of Group I and Group II base oils from Europe and the US when they became available in late 2017 and early 2018. These supplies helped to cover the peak demand period in India before the end of the 2017-18 fiscal year on 31 March. They also helped to cover against the possibility of a further rise in prices.

But buyers by the end of the first quarter were increasingly aware of the market's different supply fundamentals compared with 2017, and of the limited room for prices to rise much further.

Buyers had already locked in unusually large volumes of supplies from the US. Most of these shipments arrived in March and April. Total imports from the US in the first four months of the year were at a record high of more than 180,000t. The volume was up from 135,000t during the same period the previous year, which had itself been a record high.

Buyers had also secured a large volume of spot supplies from Europe. Total Group I imports from the region were more than 35,000t in the first four months of the year, up from around 6,000t during the same period in 2017.

Saudi exports to India increase

Buyers were also starting to receive an increasingly large wave of Group II supplies from Saudi Arabia. The shipments followed the start-up of the new Group II unit in this market at the end of 2017. Exports from the unit began in February.

The wave of buying left many buyers with maximised credit lines. With their financing used up, they were unable to take more volumes until they liquidated some of the shipments that they had already secured. A major banking fraud case in India then prompted banks to tighten buyers' access to credit facilities. The move slowed further buyers' interest in and ability to secure additional supplies.

Base oil prices were relatively steady at firm levels in the second quarter of the year amid a standoff between buyers and sellers. Buyers targeted lower prices because of their ample stocks and signs of increasingly plentiful supplies. They expected the availability of surplus volumes to rise even more during the third quarter of the year, when demand was to slow in the largest consumer markets — the US, Europe and China.

Sellers struggle to raise prices

But sellers were targeting even higher prices because of pressure from rising feedstock costs. The light-grade base oil premium to gasoil fell to its lowest level in a year. Producers were able to avoid this kind of pressure on margins in 2017 by raising their price offers. They had much less leverage to employ similar moves in 2018 as buyers instead turned to other suppliers.

But buyers continued to top up their inventories throughout the second quarter, especially with geographically closer supplies from the Mideast Gulf. They also picked up a regular flow of US shipments, even if these volumes were much smaller than in the first quarter. They then began to target more US cargoes and some European supplies for delivery in July and late August. These would help to replenish their inventories as the monsoon season drew to a close.

The regular purchases left buyers' stocks brimming as they headed into the third quarter. But they remained comfortable seeking even more volumes to maintain high inventories. The strategy contrasted with previous years, when they typically consumed some of these inventories during the third quarter, before buying replenishment supplies at the end of the quarter.

The change of strategy followed buyers' unusually tight supply situation during the second half of 2017. For 2018 they now preferred to maintain high stocks and keep topping them up. The move exposed them to the danger of lower prices and a drop in the value of their stocks. But the continual buying also enabled them to average up or down the value of their stocks with any such change in cargo prices.

Buyers struggle to absorb oversupply

Even with this strategy, buyers struggled to absorb the wave of supplies they were offered during the third quarter, especially from South Korea. Base oil imports from this market rose in August to a record high, even with a key South Korean plant having maintenance in August and September.

The plentiful availability and buyers' large stocks curbed any impact of the unexpected shutdown of Bharat Petroleum's Group II base oils unit in August following a fire at its Mumbai refinery. The unit remained off line for the rest of the year.

Imported cargo prices began to edge lower from second-half June. But buyers' preference for more light-grade base oils, and persistent availability of heavy grade base oils, supported a faster drop in heavy-grade prices.

By August the Group II heavy grade premium to N150 had narrowed to $60/t from more than $140/t in the fourth quarter of 2017.

This heavy-grade premium to light grades then continued to narrow over the following months as producers competed increasingly aggressively for outlets. By September the spread had narrowed to $20/t and then to close to parity by the start of the fourth quarter.

Seasonal rise in demand lags expectations

Indian base oil demand typically rises from the end of the third quarter as buyers replenish stocks ahead of the peak demand period in the fourth quarter of the year. But this pick-up in requirements was much weaker than usual because buyers had kept their stocks brimming throughout.

Weak demand and plentiful availability continued to curb producers' leverage to raise their prices. This trend coincided with the sustained surge in crude prices during the third quarter. These reached a four-year high by the start of October.

Margins improve at year's end

Prices initially steadied from the start of the fourth quarter. By then cfr India prices for N70 had fallen to a discount to Singapore gasoil prices, from a premium of more than a $140/t premium early in the third quarter. The weak base oils price prompted more refiners to pour their light grades back into the diesel pool, or to hold back supplies. But the rise in base oil prices was relatively muted.

But base oil values then rebounded versus feedstock values following the sharp drop in crude price in October and early November. Some producers faced pressure to lower their prices. But even these adjustments were smaller the size of the fall in crude prices.

Prices then fell in December as Asia-Pacific producers sought to clear a wave of supplies before the end of the year. But even then the size of the drop was smaller than the fall in crude prices, leaving light-grade values especially at much firmer levels.