European base oil prices are likely to continue to face sustained pressure from structural oversupply of Group I, Group II and Group III grades. This will probably dampen any upwards price movement in the first half of 2020.
Persistent oversupply in 2019 squeezed base oil values relative to crude and diesel to multi-year lows. It also narrowed the price spread between Group I, Group II and Group III base oils to as little as $150/t, from around $250/t a year earlier. A sustained narrow price gap will give blenders more options to switch between grades.
Group I prices are likely to find support from reduced inventory levels and lower output as the IMO 2020 sulphur cap drives fuel demand. Stockpiling at the beginning of 2020 could add to upward price support. But any upward pressure is likely to be capped by ample availability. No Group I plant closures have been announced. There have also been scant announcements on planned plant maintenance work. Ready availability of Group II base oils is also likely to curb any significant price rise.
European Group I producers responded to historically weak margins in 2019 by paring back output through run cuts and maintenance. The differential of Group I SN 150 to gasoil fell to the lowest level in at least 10 years in 2019. Prices held at a premium to gasoil for only six weeks of the year. This prompted refiners to cut run rates and prioritise fuel production. A heavy round of plant maintenance in Europe also curbed supply. The drop in output mitigated the seasonal supply overhang at the end of 2019.
The IMO's 0.5pc sulphur cap on marine fuels, which comes into effect tomorrow, raises the prospect of additional pressure on base oil margins as demand for low-sulphur feedstocks and distillates increases. Refineries seeking to boost profitability could opt to cut base oil production. There could also be an incentive to pour light-viscosity Group I supplies back into the fuels pool after higher-value bright stock and wax cuts are removed. But any shortfall in Group I supply or significant price rise in 2020 would boost the attraction of Group II base oils, whose supplies have surged over the past year.
European Group II base oil imports have been rising strongly in recent years, and the start-up of 900,000 t/yr of domestic capacity in the first quarter of 2019 added to regional availability. Total supply from domestic production and imports rose to 980,000t in the first half of 2019, up from 814,000t in the same period of 2018.
Group II prices fell by around €100/t following the start-up of the new capacity. Lower prices and greater security of supply increased the incentive for blenders to switch from Group I to Group II base oils.
But Group II supplies and costs face new challenges in 2020, following the EU's decision to remove a Group II import duty waiver from the start of the year. It has instead introduced a 200,000t import quota between January and June 2020. Imports above the quota from countries that do not have a free trade agreement will be subject to a 3.7pc import tax.
These uncertainties could boost the attraction of using regional Group II supplies. But they could also deter blenders from switching to Group II, choosing instead to take advantage of plentiful availability of Group III base oils at increasingly competitive prices.
Competition in both approved and unapproved Group III markets is likely to maintain downward pressure on prices in the first half of 2020. Imports from Asia-Pacific and the Mideast Gulf are expected to continue to rise next year. Over 5mn t/yr of capacity came on line in China in 2019, redirecting flows to Europe. Availability will be topped up further by new OEM-approved exports from the US following the start-up of new production in late 2019. Imports from Bahrain, Qatar, South Korea, Malaysia and the UAE amounted to 530,000t in first half of 2019.
By Catherine Caulfield
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