ILMA Compoundings - September 2020 - 16

INDUSTRY RUNDOWN

Market Report
U.S. Base Oil Market Faces Higher Costs
Entering COVID-19 Demand Recovery
By Amanda Hay
U.S. base oil market players entered the second half of
2020 facing upward price pressure from firm costs and
balanced-to-snug supplies - bullish factors that were
offset by ongoing demand weakness downstream.
The only certainties appeared to be that higher upstream
prices were holding steady and that the base oil supply overhang was reduced through exports and lower refinery rates.
Demand recovery remained a wild card. The trough
of the COVID-19 demand destruction was likely in the
rearview mirror, but players were cautious as to whether the
midsummer demand pickup was a function of restocking or
truly indicative of downstream recovery.
PRICES RISE BEFORE TRUE DEMAND RECOVERY
U.S. base oil producers implemented separate posted price
increases ranging from 15 cents per gallon to 16 cents per
gallon starting in mid-June, citing firm costs for feedstock
vacuum gas oil (VGO) on the back of May's crude price rally.
Crude and VGO prices showed no signs of weakening
in the summer as global oil supply became more balanced.
West Texas Intermediate (WTI) crude futures hit $40/bbl in
late June and held either side of that threshold through July.
Global oil supply cuts were apparent and supported
firmer crude prices. OPEC+ producers agreed to extend production cuts of 9.7million bbl/day into July. Saudi Arabia
ended voluntary additional cuts of 1 million bbl/day at the
end of June, but crude held firm.
While U.S. producers did not make any cut agreements,
natural market forces prompted reduced shale output.
The Dallas Federal Reserve reported that 82% of exploration and production companies that it had polled had shut in
production in the second quarter due to low wellhead prices.
The U.S. oil rig count declined from 683 operating in the
week ending March 13 to 180 in the week ending July 17,
according to Baker Hughes.
U.S. shale producers generally need crude prices to be
$40-$50/bbl to spur activity in the oil patch.

SEPTEMBER 2020

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Shut-in production began to return in late June. Domestic crude output hit 11.1 million bbl/day in the week
ending July 17, according to the U.S. Energy Information
Administration (EIA), up from a low of 10.5 million bbl/
day reached in mid-June. While higher oil prices may
restore shut-in production, new drilling activity remains
limited, and shale well productivity declines quickly.
The U.S. rig count appears to have bottomed out at historic
lows, which will be apparent in 2021 crude output volumes. The EIA anticipates 2020 production to average 11.6
million bbl/day and 2021 output to average 11.0 million bbl/
day, compared with 2019's record 12.2 million bbl/day.
As oil supply drops, demand is projected to gradually rise
over the next year. "As the global economy recovers from the
lockdowns, oil demand will improve, aiding refinery margins, which will in turn help run rates to recover somewhat,"
said ICIS Senior Analyst Ajay Parmar.
With rising prices upstream, base oil margins became
even more challenged. Without a clear outlook on demand
recovery, refinery rates are expected to stay relatively low.
SUPPLY BALANCES, SUPPORTING HIGHER PRICES
Entering the second half of 2020, U.S. base oil inventories were in a more balanced position compared with
pre-COVID-19 as a result of reduced refinery rates, fewer
imports during the second quarter and export opportunities
to clear any length, as domestic demand generally remained weak.
Group I refiners had ample inventories of lighter viscosities, but brightstock became tight. Refiners were not
necessarily targeting higher run rates yet as margins were
thin on paper and likely more squeezed in reality given
ongoing weak demand. Suppliers looked to manage length
through exports.
Group II lighter viscosities were readily available, while
supplies were more snug for heavier viscosities. Where
possible, producers were managing length through increased
interest in export markets, particularly to India.

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ILMA Compoundings - September 2020

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