Calculating Base Oil Production Costs

For some, calculating production costs is a contentious issue, but Solomon Associates has been using a standard formula for many years to analyze the performance of refineries around the world. Irrespective of the method used, it is important that refiners keep costs down said Brunk. Refiners that are going to stay in business have to be low-cost producers.

To calculate the cost to produce base oil, the Solomon methodology takes the raw material cost less the revenue from any by-products plus cash operating expenses. If you are making base oil, you have some things go out the door that are not high value products, such as asphalt, Brunk said. The cost to produce figure is then divided by the total base oil volume to obtain the base oil production cost per unit of base oil, which could be per ton or per barrel. Feedstock cost minus by-products revenue gives the net raw material cost.

Solomon Associates divided the cost to produce into quartiles; in other words, each segment represents 25 percent of the industry. The first quartile shows some producers are very low cost, but there is an even distribution across the second and third quartiles. The curve shows that the bulk of the refineries produce at about the same cost, Brunk added. The highest cost producers are found in the fourth quartile.

Building on that methodology, it is possible to rank the cost to produce from the lowest to highest and also include raw material cost and operating expense. Brunk said, These two pieces of cost can vary such that a high raw material cost refinery with lower operating expenses can be sitting next to a refinery on the curve that has high operating expense and lower raw material cost. When looking at the cost to manufacture base oil, it does not matter how the two pieces look separately, its the total that matters. If we plot the average cost of the base oil plants that have shut down since 2008, it falls in the upper part of the fourth quartile. Yet, Brunk added, the highest cost plants were not shut down. The highest cost plants often have factors other than financial performance to justify continuing operation. Often, they are state run oil companies whose purpose is to provide jobs even if it is at the expense of profits.

The chart also shows the impact of the difference in the average spot price of Brent in 2008 and 2012 the most recent benchmark analysis conducted by Solomon. It is obvious that lower cost producers always have a higher margin than higher cost producers, and that fact becomes even more important as the base oil industry contemplates a future where excess capacity is expected to drive margins lower.

For the Middle East, Solomons analysis illustrates that regional refiners may not be low cost producers when compared to their international counterparts. Base oil plants in Asia generally occupy the center of the third quartile but are ahead of West Asia, which includes India and the Middle East and is a major supplier of base oils. If we look at the Middle East, plants in this region tend to have higher costs, said Brunk.

Technology can also impact production costs. The average hydroprocessing plants have lower costs than their solvent equivalents, although the top four solvent refineries globally are nevertheless low cost producers.

Solomon analyzes only paraffinic refineries and estimates there are fewer than 20 naphthenic base oil refineries in the world. It conducts the analysis on a semiannual basis with the next planned assessment due later this year.

Reducing Costs

According to Solomon, refiners can consider several options to get better economies, particularly when it comes to raw material costs. Feedstocks are important and vacuum bottoms (highly viscous residuum from the vacuum tower), which ultimately produce bright stock, are cheaper to purchase than vacuum gas oil, which produces neutrals. Plants running a higher percentage of vacuum bottoms can have lower feedstock costs, claimed Brunk. Hydrocracker bottoms, which are the left over material from a fuel hydrocracker, are the highest cost materials. It is a higher quality material from a lube standpoint, and you pay more for it.

Base oil yield is also important and is governed by the refining technology deployed. Conventional solvent refining is expensive and does not yield as much as hydroprocessing technology. It follows that solvent dewaxing is less efficient than catalytic wax isomerization, and vacuum bottoms, although cheaper to buy, have lower yields. The higher amounts of base oil you can get out of your feed, the better off you are. Conventional solvent refining yields extracts and asphalt that are low value material in the market. In contrast, hydoprocessors produce low sulfur diesel fuel, which has high value.

In 2012, the industry average yield for base oils used for lubes was close to 39 percent, 56 percent for low value by-products, just under 3 percent for waxes and specialty products 2.3 percent of the feed. Yields are more striking for a solvent plant. Conventional plants on average yield almost 32 percent base oils, more than 61 percent by-products, 3.7 percent waxes and 3.1 percent specialty products. Solvent plants are at a disadvantage because they make less base oil per unit of feed, but they do make a higher percentage of waxes. Hydroprocessors cannot make wax, Brunk noted.

On average, hydroprocessors produce almost 60 percent base oils as well as higher value by-products at 40.5 percent and almost no wax at 0.6 percent. That makes a big difference to the economy of an operation. Geographically, feedstocks in Asian base oil plants yield 46.8 percent of base oils, 50.2 percent of by-products, 1.6 percent speciality products and 1.3 percent waxes. The higher than average base oil yields are skewed largely because of two large hyrdroprocessors in South Korea.

There are fewer hydroprocessors in West Asia, which impacts the average yield in the region. With a large contingent of solvent refiners, the yield is typically around 34 percent base oils, 62.4 percent by-products, 2.6 percent specialties and 0.9 percent waxes.

In value terms, hydroprocessors produce the highest value by-products on a dollar per ton basis, followed by foots oil (a by-product of solvent dewaxing), waxes, intermediates, extracts and asphaltenes (with the lowest market value).

The Hydroprocessing Advantage

In simplest terms, hydroprocessing offers a technological advantage. Hydroprocessors tend to use less energy, less manpower [and require] less maintenance than solvent plants, said Brunk. The choice of plant location worldwide can significantly affect operating expenses as does total plant utilization. Location is critical given the large differences in global energy costs. In 2012, energy costs in Asia accounted for as much as 65 percent of average operating expenses against 21 percent in the United States and Canada.

Worldwide, the average plant was still spending as much 50.5 percent on energy costs. Cheap energy in North America is the result of the so-called shale revolution and the glut of shale gas, which has caused prices to tumble. The comparsions between burning oil using natural gas are jolting. According to Solomon, in 2012 refineries in North America were paying $3.39 per gigajoule on average, compared to a worldwide average of $9.06 per GJ. In Asia, that figure rockets to $14.98 per GJ, almost five times greater.

Another major operating expense is maintenance, which averaged 19.1 percent globally in 2012 but was as high as 32.6 percent in the U.S. and Canada. Nonmaintenance personnel costs are also markedly different with a global average of 18.2 percent compared with 26.7 percent in the U.S. and Canada.

In terms of personnel efficiency, Solomon has calculated the number of hours required to manufacture base oil. Hydroprocessors tend to have the lowest manpower requirements, but the top four solvent refiners compete closely. However, man hours do not show the whole picture because labor costs in places like the Middle East are significantly lower. On a cost basis, Asia and the Middle East are efficient and compete with the top four solvent refiners. On average, hydroprocessors have higher personnel costs but are still ahead of plants in West Asia and their solvent refining counterparts.

Plant utilization has fallen overall, although the top four solvent plants are the most efficient in the world, and refiners in Asia and Middle East feature prominently in terms of efficient plant utilization, says Solomon. Hydroprocessors plant utilization is high, but despite the performance of the leading solvent refiners, the average solvent plant generally has lower utilization.

Future Refining Strategies

With refiners facing increasing economic downtime, it is vital that operating efficiency be maximized and costs controlled. Low cost production is the answer, said Brunk. And if you are low cost, you can continue to produce no matter what happens in the marketplace. That presents challenges for refiners based in Asia and the Middle East. Solomon said that both conventional and hydroprocessing technologies can be low cost, but high cost producers are those using conventional technology. The Middle East has a mix of technologies and, therefore, a mix of high and low cost producers.

Refineries most at risk are the high cost producers, but other factors will weigh on whether those plants stay in business. This is particularly true in the Middle East with its preponderance of national oil companies with government and social obligations that in some cases render profits secondary.

With that in mind, the sector will continue to face a challenging business environment, exacerbated by significant oversupply in the market. Indeed, refining economics will remain a mission critical requirement.