Northeast Asian base oil prices face supply challenge

The northeast Asian base oils market faces the prospect in 2020 of managing a wave of new supplies that came on line in 2019.

Northeast Asian Group I base oil prices fell in 2019, with bright stock sliding the most. Group II prices ended the year at a similar level to the start of 2019, after falling mid-year.

Demand was slow at the start of the year as buyers waited for prices to bottom out from a slump during the last few weeks of 2018. Prices had fallen sharply in December 2018 in response to sliding crude prices during the fourth quarter of that year.

Buyers delay stockbuild

The drop in prices prompted buyers to hold off moves to replenish stocks until the start of 2019 rather than during the last few months of 2018. The previous year they had begun building stocks in late 2017, ahead of the spring oil-change season in early 2018.

The move to delay building stocks left buyers with lower than usual inventories just weeks ahead of a seasonal pick-up in demand from around the end of the first quarter of the year. The prolonged three-month shutdown of a Group II base oils unit in south China from February removed a major supply source from the market.

The start-up of several new base oil plants in China was also pushed back further until later in the year. They had originally been scheduled to start operations in the fourth quarter of 2018.

But, unlike in early 2017, there was no supply squeeze or significant rise in prices. Chinese buyers were instead able to secure with ease a wave of surplus supplies from other producers throughout the region. They secured the supplies at unusually competitive price levels. Imports increased from markets like South Korea, Taiwan and Singapore.

Buyers were also confident that they could secure sufficient supplies as and when required. They were also confident that prices would remain in a narrow range. This reduced their need to hold larger stocks. The strategy in turn spread over a longer period a seasonal pick-up in demand, reducing its market impact.

Imported cargo prices for Group II base oils edged slightly higher during the first quarter of the year. But the increase was small relative to the larger rise in prices in other markets like India. The increase also outpaced unusually steady domestic prices in the Chinese market during the first three months of 2019.

Tax cut benefit proves limited

Regional producers sought to benefit from a seasonal pick-up in Chinese demand from March and a subsequent cut in China's value-added tax on base oils from the start of April last year. But they struggled to raise their prices after the tax cut lowered Chinese buyers' purchasing costs. Distributors instead had to pass on the cost saving through lower prices.

A wave of new Chinese base oils production capacity then began to start commercial operations or test runs from the end of the first quarter. This trend continued during the second quarter. The new plants included Shanxi Lu'an's 300,000 Group III+ coal-to-liquids base oils unit and Hengli Petrochemical's Group III unit in northeast China.

New plants close arbitrage

The availability of these new supplies at competitive prices put pressure on rival domestic producers and overseas refiners alike. Term buyers in China sought to divert some of these overseas supplies to other markets instead in response to the closed arbitrage to the country.

The subsequent rise in regional supplies put pressure on imported cargo prices. These then fell steadily from May. By the end of the first half of 2019, Group II cargo prices had fallen below price levels at the start of the year to their lowest levels since 2017. These weak prices forced domestic refiners in China to cut run rates and offer more of their supplies as white oils. They also forced regional producers to target other markets instead where prices were at higher levels.

Chinese demand remained unusually weak throughout the third quarter of the year. Blenders and distributors preferred to work down stocks and delay any replenishment plans. The moves triggered a slump in Chinese base oil imports in July to their lowest level since 2013.

The lack of buying interest prompted a wave of Group II shipments from Taiwan to move to India instead during the third quarter. Falling domestic Group III prices in China also halted shipments to this market from the UAE.

Demand revives from September

Chinese buying interest revived from September as blenders and distributors moved to replenish depleted stocks. Besides lower imports, supplies had tightened after some Chinese refiners trimmed output because of weaker margins. Lower prices for light-grade base oils relative to diesel also boosted the attraction of blending these supplies with diesel.

Prices also got support from rising demand for supplies classified as base oils. Most of China's new plants were offering their supplies as white oils to benefit from avoiding the cost of China's consumption tax. But a repercussion was more limited availability of base oils. Buyers turned instead to imported supplies, and especially shipments from Taiwan.

Firmer demand for base oils supported a steady rise in China's domestic Group II prices from September. These climbed to levels that made the arbitrage more feasible to import supplies from Asia-Pacific. The firmer demand and higher prices prompted Taiwan to direct most of its supplies to China in the fourth quarter. A repercussion was a sharp drop in supplies to other markets like India.

The Group I base oils market also faced sustained pressure throughout the year because of muted demand and competitive prices for Group II base oils. Buying interest focused mostly on bright stock, for which China is structurally short.

Bright stock faces sustained pressure

A closed arbitrage from Europe and a heavy round of plant maintenance in Japan prompted buyers to focus on covering requirements with supplies from producers in southeast Asia during this period.

Even with the more limited supply options, these volumes proved to be sufficient. Imported cargo prices rose by some $50-60/t in the two months to April in response to the seasonal pick-up in demand, before steadying. Prices then began a sustained slide from the end of this month to early September amid slower demand and a lack of alternative outlets.

Bright stock prices edged up at the end of the third quarter ahead of several plant shutdowns in southeast Asia in the fourth quarter. But supplies from the Mideast Gulf then supplemented steady availability in Asia-Pacific during the last few months of 2019. The ample availability put renewed pressure on prices at the end of the year.

By Iain Pocock