ILMA Compoundings September 2016 - 28

SPEAKER SPOTLIGHT U.S. Base Oil Pricing Mechanisms in a Global Base Oil World Amy Claxton, P.E. C rude or crude-linked feedstocks are raw materials for base oils, so the price of crude provides an obvious platform on which to assess base oil prices. For decades prior to the advent of multiple API base oil groups, crude price was fairly well correlated with the price of paraffinic and naphthenic base oils. Regional base oil prices tracked local crude prices, rising or falling based on supply tightness within a fairly predictable band. This straightforward supply-demand model existed for decades and represents conventional pricing theory, whereby the highest-cost supplier in each region acts as the marginal producer and sets a price floor to cover their costs. When the base oil market became undersupplied, base oil prices rose to levels set by buyers who were willing to pay higher prices, usually based on the cost of alternative blends to meet a total formulated cost. When the base oil market was oversupplied, prices drifted downward until the highest-cost producer was no longer covering their costs. If this situation persisted, the high-cost producer(s) would eventually cease production, bringing supply and demand back into balance. Within this pricing model, paraffinic and naphthenic higher-viscosity base oils historically commanded a premium over lower-viscosity base oils. In other words, the prices for Bright Stocks were higher than prices for heavy neutrals, which in turn were higher than the prices for light neutral base oils. This fundamental relationship relates to the cost of processing heavier oils. In solvent processing, heavier oils have lower yields and reduced operating throughputs relative to their light neutral counterparts. Bright Stock carries an additional cost burden thanks to an extra processing step (deasphalting), which also must be recovered in its price. Thus, in addition to typical supply-demand-related price fundamentals, there is a historical supply-side viscosity premium for heavier viscosity oils, meaning there is a supply-side cost-recovery factor required for heavier base oils. quality premiums are directly related to specific end-user product requirements, whereby a base oil confers the requisite qualities needed to meet a finished formulation. Complicating the transparency of this demand-side base oil quality premium is the fact that different API groups can be blended together (including naphthenics in admixture with paraffinics) to meet a finished formulator's quality requirements at the lowest cost. In addition, base oil buyers may choose Group II oils despite the adequacy of Group I base oils from a technical standpoint, if local Group II supplies are more abundant than Group I supplies. Where there is no technical demand for abundant Group II base oil supply, the prices will equilibrate to match Group I prices, Today's base oil industry has undergone significant changes since the mid1990s, with the introduction of hydro-processed base oils in combination with rising quality requirements for subsets of industry. Structural changes occurred which have increased the complexity and permanently changed the price-setting mechanisms for base oils. Within the paraffinic API Groups I, II and III and the naphthenic subset of Group V base oils, demand-side quality premiums have arisen which recognize and reward better saturates and/or higher viscosity index if needed in a specific application. These Vol. 66 No. 9 * 28 * September 2016 Compoundings

Table of Contents for the Digital Edition of ILMA Compoundings September 2016

FROM THE CEO
BOARD BRIEF
NOTES FROM MSCI
THE HEART OF ILMA
THE ARGUS ANALYSIS
VOICES & VIEWS
INTERNATIONAL INSIGHT
SPEAKER SPOTLIGHT
FAMILY BUSINESS
FINANCIAL FREEDOM
RULES & REGS
POWER PLAY
LEGAL EASE
THE WHITE PAPER
ADVERTISERS INDEX
ILMA Compoundings September 2016 - 1
ILMA Compoundings September 2016 - 2
ILMA Compoundings September 2016 - 3
ILMA Compoundings September 2016 - 4
ILMA Compoundings September 2016 - FROM THE CEO
ILMA Compoundings September 2016 - 6
ILMA Compoundings September 2016 - 7
ILMA Compoundings September 2016 - 8
ILMA Compoundings September 2016 - BOARD BRIEF
ILMA Compoundings September 2016 - 10
ILMA Compoundings September 2016 - 11
ILMA Compoundings September 2016 - 12
ILMA Compoundings September 2016 - NOTES FROM MSCI
ILMA Compoundings September 2016 - 14
ILMA Compoundings September 2016 - THE HEART OF ILMA
ILMA Compoundings September 2016 - 16
ILMA Compoundings September 2016 - 17
ILMA Compoundings September 2016 - 18
ILMA Compoundings September 2016 - 19
ILMA Compoundings September 2016 - 20
ILMA Compoundings September 2016 - THE ARGUS ANALYSIS
ILMA Compoundings September 2016 - 22
ILMA Compoundings September 2016 - 23
ILMA Compoundings September 2016 - VOICES & VIEWS
ILMA Compoundings September 2016 - 25
ILMA Compoundings September 2016 - INTERNATIONAL INSIGHT
ILMA Compoundings September 2016 - 27
ILMA Compoundings September 2016 - SPEAKER SPOTLIGHT
ILMA Compoundings September 2016 - 29
ILMA Compoundings September 2016 - FAMILY BUSINESS
ILMA Compoundings September 2016 - 31
ILMA Compoundings September 2016 - FINANCIAL FREEDOM
ILMA Compoundings September 2016 - 33
ILMA Compoundings September 2016 - RULES & REGS
ILMA Compoundings September 2016 - 35
ILMA Compoundings September 2016 - POWER PLAY
ILMA Compoundings September 2016 - 37
ILMA Compoundings September 2016 - LEGAL EASE
ILMA Compoundings September 2016 - 39
ILMA Compoundings September 2016 - THE WHITE PAPER
ILMA Compoundings September 2016 - 41
ILMA Compoundings September 2016 - ADVERTISERS INDEX
ILMA Compoundings September 2016 - 43
ILMA Compoundings September 2016 - 44
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