Viewpoint: Tight supply to support EU base oil prices

European base oil prices are likely to find support in the early part of 2021 from limited spot supply and a seasonal boost in demand.

Consumption could get additional support from a rebound in economic activity as Covid-19 vaccines are rolled out in key markets — although any economic recovery could also trigger a rise in supply, with higher fuel demand prompting an increase in global refinery utilisation rates, thereby boosting feedstock supply and enabling more base oil production.

But in the meantime, Group I supply in Europe will be tight in early 2021, with planned maintenance and closures set to cut up to 324,000t of production in the first half of the year. That is equivalent to a large regional unit's annual production. The impact of turnarounds on spot availability will be compounded by low inventory levels at refineries, which have been producing at reduced rates since March 2020. Refineries are cutting back on spot sales earlier than usual in order to build stocks ahead of shutdowns. They are also taking longer to replenish inventories.

Spot supply could be squeezed further as blenders increase their term volumes for 2021 to guard against the tightness that they faced in the second half of 2020. A rise in term commitments cuts the availability of spot volumes. Tighter spot availability early next year would also weaken the supply buffer that helps cover for unexpected shutdowns. Portugal's Galp is expected to shut its 180,000 t/yr Group I base oil unit as part of the permanent closure of its 110,000 b/d Porto refinery next year.

Group II prices in Europe are likely to find support from stricter technical requirements for premium-grade base oils in the automobile, marine and industrial sectors, which are bolstering demand for Group II grades. And tight and less reliable Group I supply is adding to Group II demand. Meanwhile, the Group II supply outlook remains uncertain. Unlike other markets, regional production is reliant on a single plant. Output of 478,000t in January-September 2020 was 11pc higher than the same period a year earlier, but it reflected only 71pc of nameplate capacity.

Supply from overseas markets was more volatile in 2020. Group II output in the US and Asia-Pacific fell. And demand in those regions, as well as in Latin America and India, rose strongly during the second half of the year, curbing the amount of supply available for Europe.

The Group III base oil market faces similar supply and demand fundamentals, and this could extend well into 2021. Maintenance in Europe will impact supply of base oils with original equipment manufacturer (OEM) approvals. Finnish firm Neste's 250,000 t/yr unit at Porvoo will shut in April for eight weeks of maintenance. The SK-Repsol joint venture's 450,000 t/yr Cartagena unit in Spain is due to undergo maintenance work that was postponed this year. The joint venture had planned to increase the plant's capacity by 50pc in 2021, but it is unclear if this remains on schedule.

The constraints on output coincide with rising demand for OEM-approved Group III grades. Blenders have shown strong interest in producing a new, OEM-approved 5W-30 engine oil with a lower-cost formulation. The cost savings reflect using more Group III/+ base oils and a lower share of high-priced polyalphaolefins. Rising interest in this formulation has boosted demand for Group III/+ base oils.

Demand for semi-approved or non-approved Group III base oils is also likely to remain strong. These could help to cover the shortfall in availability of approved base oils where blenders' legacy formulations allow. Stricter engine oil requirements are boosting demand for Group III base oils in North America, India and China. This leaves European importers facing stiffer competition for limited spot cargoes from producers in Asia-Pacific, the Mideast Gulf and Russia.

By Catherine Caulfield and Clara Toellner