The volume-value question
By Lisa Tocci for Lubes’n’Greases Magazine.
In volume terms —sheer tons of product needed to keep the world well-oiled — lubricants demand has barely budged from what it was back in 2000.
Put a yardstick to the industry’s value however, and you’ll find gross margins to be double and triple what they were 15 years ago. That provocative contrast — flat volume, escalating value — took center stage at a recent industry meeting in London.
At the ICIS World Base Oils & Lubricants Conference, Apu Gosalia, head of global competitive intelligence and chief sustainability officer of Fuchs Petrolub in Mannheim, Germany, got the ball rolling with a look at how the industry fared in 2014. He pointed out that global car production was up 4 percent for the year, chemicals production was up 2.8 percent, steel production gained 1.2 percent, and GDP rose 3.3 percent on a global basis.
Did all this activity spur a healthy appetite for lubricants? Alas no, so far as volume is concerned. Lubricant volumes in 2014 grew only 0.5 percent above 2013, and have not recovered yet to the peak seen in 2007, before the worldwide economic crisis, Gosalia reported. According to estimates by Fuchs, global lubricants demand in 2014 hit 35.4 million metric tons, versus 35.3 million in 2013 and 35.0 million in 2012. (Those figures exclude marine oils, which are not tallied in the company’s estimates; other sources suggest marine oil demand accounts for another 2.5 million to 2.7 million tons a year.)
Looking back even further, global demand in 2000 was around 36.4 million tons, a shade higher than it is now, Gosalia emphasized. But while the overall size of the market has not shifted, its geographic distribution has.
“Asia-Pacific and the rest of the world accounted for only 39 percent of the global lubricants market in 2000, while in 2014 it was 53 percent,” he said. “The Americas, which held 34 percent of the market in 2000, now are just 28 percent. And Western and Eastern Europe together have about 19 percent, versus 27 percent back then.”
Forecasts examine the two faces of market growth
By region, demand growth varied widely in 2014. North America saw demand rise 1.4 percent versus 2013, while Latin America saw demand fall back 1.4 percent. Demand in Eastern Europe in 2014 fell off by 3.8 percent, and Western Europe was down 1 percent.
Meanwhile in Asia-Pacific, lubricant demand rose 1.4 percent in 2014, a slower rate than prior years. “Asia-Pacific is a mixed market,” Gosalia continued. “It includes developing countries such as India and China, and mature markets such as Australia, and Japan where we saw demand decline 6.0 percent. Korea also was down.”
The strongest improvement came from the Middle East, up 4 percent in 2014 from the year before. “The Middle East is a growth region these days,” said Gosalia, “due to its increasing oil and gas exploration, construction industries and steel production.”
Going on to rank the world’s Top 20 lubricant consuming countries in 2014, Fuchs puts China at the top of the list, thanks to a decade of rapid growth. Second is the United States, then India, Russia and Japan. Filling out the Top 10 in 2014 were Brazil, Germany, Korea, Iran and Indonesia.
These rankings changed quite a bit from 2013, Gosalia added. “Mexico is out of the Top 10 now, and Italy has fallen completely out of the Top 20, while Saudi Arabia is on the list now for the first time.” Due to expansion elsewhere, “only three countries in Western Europe are left on this list — U.K., Germany, France — while only one Eastern European (Russia) still is on the list.”
Regional Lubricants Demand*
(million metric tons)
*without marine oils
2014 Regional Share
The two countries at the top of the heap couldn’t be more dissimilar: “At number two, the United States has the highest per-capita lubricants consumption in the world. But China, with a per-capita consumption nearer to 5 kilograms per person, now uses more lubricants overall. We don’t expect China will ever reach U.S. levels of consumption, but it may get to 6, 7 or 8 kilograms per person — and it has close to 1.5 billion people.”
These signals all point to continuing growth in volume demand in developing countries, “while for the mature countries of Europe, Asia and North America, growth is going to be on the quality side.”
Europe already is deep into this shift towards higher quality, longer-life lubricants, and the effect on volumes has been dramatic. The continent’s appetite for lubricants has fallen 30 percent, Fuchs calculates, from 9.6 million tons in 2000 to just 6.7 million in 2014. This change appears to be systemic, and has only accelerated since 2007. “In Western Europe, lubricants demand has fallen to about 80 percent of pre-crisis levels,” Gosalia said. “Germany, which is back up to around 95 percent of precrisis levels, came out better than most because of its manufacturing and exports.But U.K. is down 25 percent over that time, sorry to say.” Demand in France is not quite 78 percent of pre-crisis consumption.
In Eastern Europe, “we believe the Russian lubricants market fell close to 5 percent in 2014 versus 2013,” said Gosalia, “and Ukraine probably contracted by double-digit rates. Yet Poland has a strong industrial base, where the chemicals sector is the second largest contributor to GDP growth.”
Prodded to put a value on the global lubes industry, Gosalia said transaction effects, currency fluctuations, inflation, lack of pricing data and other factors make it extremely difficult. “Of course you can come to some guesstimation,” he commented later to Lubes’n’Greases, “but the question is, what for? Isn’t it enough to know that one ton of lubricant sold today has a completely different product, regional, customer, price, margin and value portfolio behind it, than 15 years ago? Here lies the challenge for the industry in the future.”
Jagger declared that “the total gross margin pool for the global lubricants industry is around $65 billion a year."
Some hints came from Suzan Jagger of Jagger Advisory in Litchfield, Conn. A longtime strategy advisor to multinational oil companies, she identified three overriding trends for the London audience:
First, the global industry is seeing technological disruption, as low-cost, unconventional oil and gas flows through the cost base and margin base of the industry, Jagger noted. Also potentially disruptive are “smart” vehicles and products; these may change mobility and sustainability, although “there is no clarity on this yet.”
Second is the accelerating use of synthetic lubricants, from automotive to industrial applications. “There are more players here, and as the technology becomes available across the marketplace there could be some commoditization.”
Third, “market volatility is not going away.” That ongoing pressure requires an adaptive business model and ongoing investment to stay ahead of the curve.
Stepping back to survey the current scene, Jagger declared that “the total gross margin pool for the global lubricants industry is around $65 billion a year.” Sharing in this are lubricant marketers, base oil suppliers and traders, distributors and additive companies.
“Marketwide, since 2000, global lubricants volume has increased only 4 percent, by our numbers,” Jagger said, “but the gross margin pool has grown two-and-a-half times in size.” She emphasized that integrated models tend to stabilize margins over the long term — which is why integration is the hallmark of major players.
“We’ve seen a three-fold increase in base oil prices since 2000,” Jagger pointed out, “but we’ve also seen marketers layer higher margins on that base, largely via portfolio uptrading, new route-to-market models, supply-chain consolidation and digital marketing efforts. Social media is another trend to watch, although the jury is still out on how these investments will be monetized,” she cautioned.
In its research, Jagger Advisory found that in 2000 — when the largest automotive OEMs first began urging wider use of synthetic lubricants — base oil cost an average $300 per metric ton. That’s also when a wave of consolidation hit the major oil brands (such as Exxon and Mobil, Chevron and Texaco, Shell and Pennzoil).
Share of Global Integrated Gross Margin Pool
Total Pool: $65 Billion
By 2006, base oil had risen to $600/ton, and most of the post-merger integration had been accomplished. That allowed the lubricant leaders to focus on widening their margins over base oils costs. They rationalized brands, cherry-picked their supply chains and learned to leverage their distributors to get to market more efficiently, Jagger explained. They also began moving resources into Asia-Pacific, to capture a share of that region’s huge growth.
By 2012 base oil was costing around $1,000/ton — triple what it had been 12 years earlier — and the best lubricant players built on that, she added, pushing return on capital employed to double what it had been, and tripling their unit gross margins.
The challenge for marketers right now, Jagger said, is finding where to capture the best unit margins. She highlighted two strong possibilities: “Consumer synthetics are a play of branding and performance claims,” she observed, “while industrial lubricants will see a lot of value generation from moving to premium and synthetic opportunities.
“The global lubricants business is the golden nugget in the downstream area,” Jagger maintained. This is especially true for companies with a high-grade brand portfolio. But it also presents challenges: foreign exchange headwinds; questions about where to invest geographically and technologically; how to best allocate resources across both mature and growth markets.
“That’s a major question right now. Oil company budgets are under pressure, and even if a lubricant company is not directly hurt, it will be affected.”
The case for investment varies depending on which segment of business is involved. For base oil producers, Jagger suggested, the goal may be to stabilize earnings and monetize surplus base oil capacity. National oil companies may aim to strengthen an advantage in their local markets. Lubricant marketers may strive to leverage an existing position, or consider a move into base oils. And chemical additive manufacturers have their own distinctive needs and technologies. She sees this last group trying to extract greater value from the lubricants business, and using scale to achieve the best cost basis they can.
“We also see additive companies seeking out areas where they can go in without competing with their customers,” she said. “And they have found some, such as specialized metalworking fluids manufacturing.”
More immediately, there’s the question of what 2015 will bring. Based on forecasts by the International Monetary Fund and others, Fuchs believes that Europe’s lubricants market can expect more of the same — perhaps a bit more gently. Europe’s lube market will shrink another 1 percent this year, “but remember it was down 2.5 percent in 2014 versus 2013,” Gosalia added consolingly.
“What are lubricant manufacturers to make of this outlook?” Gosalia asked. “How do we respond to the changing supply situation?” By having flexibility, a diversified portfolio of customers, and a well-diversified portfolio of sectors, regions and products, he suggested.
On the plus side of the scale, there is good opportunity now to improve product portfolios and capture more value. “API Group II base oil is now widely available everywhere, and reasonably priced. But there’s still good demand for Group I, and with lower crude oil costs, we may see that Group I refineries in the Middle East are able to continue operating at a lower sustainable cost.
“Everyone says there is no growth in lubricants, on a quantity basis — but on a quality basis, there is demand,” Gosalia asserted. “And to me, quality means growth.”
What could make “headlines” in 2015? “You’ll see what I call ‘Shell-shock’ as that major puts more focus on the competitive performance of its lubricant operations,’ Jagger said later to Lubes’n’Greases . “In 2014, Shell Lubricants delivered strong value and earnings, and you can expect them to follow through on that momentum.”
Also, Jagger predicted, the growth trajectory of synthetic lubricants will begin to moderate as more players and competitors join the fray. “It’ll be interesting to see how global players with a premium position in synthetics, such as ExxonMobil, deal with these headwinds and erosion.”
Lastly, “the OEM factory-fill segment has become a battleground,” she stated. “This business only makes sense if suppliers can leverage it for their own aftermarket and branded lubricants business — and that begins to accelerate in 2015.”