Economic recovery: What next for Lubricants Marketers and Base Oil Suppliers?

Good morning, I am delighted to be here and honoured to have the opportunity to be your key note speaker.

My main focus this morning will be on looking at the longer term trends which will affect our businesses and the significant growth opportunity this region presents. Those trends will include the need to reduce carbon dioxide emissions; to manage volatility; and to develop the technology and partnerships which will help us meet future needs.

But before turning to what may lie ahead, I would like to spend a few minutes looking back over the past year and where we have come from.

2009 – A Roller Coaster Year
Just over a year ago I presented at a similar event in Hanoi when we were in the middle of truly turbulent times. Our central focus was on weathering the economic storm of a global recession. And even in an industry known for its ups and downs it was a roller coaster year.

It is perhaps only now that we can see quite how bad things were then. Figures from the PFC consultancy show that lubricant demand volumes reduced by almost 8 per cent in 2009. That decline was seen in all regions and in all sectors and created one of the most difficult markets we have ever experienced.

One year on, the picture is a little better. The worst of the global recession appears to be over, with the rate of decline in demand slowing. However, the recovery remains very fragile especially in the markets of Western Europe and North America where there is a risk of a double-dip recession. It will also take time for economies to return to full health, with Kline predicting that lubricants demand will not return to 2007 levels until 2012.

What now for 2010?
So let me turn now to the year ahead and what we can expect from a post recession world. I think we need to recognise that it will not be a return to business as usual. The roller coaster ride will continue. Even if recovery takes hold, we cannot expect the path to be smooth or consistent. The industry will need to be prepared for further volatility in the base oil market as a result of oil price uncertainty. As the Director of the International Energy Agency has said “With proliferating uncertainty, the oil market could easily become again more volatile once economic growth returns and the market potentially tightens”.¹ 

The base oil market is likely to be even more volatile than the crude oil market. We have already seen that supply shortages can emerge rapidly and bring significant price changes. Increasing demand for more Group II and III base oils will also add further complexity to the market. In addition, in this region we can expect supply to be affected by planned maintenance shutdowns, but also face constraints from unexpected events. The Pertamina refinery fire in Indonesia earlier in the year is an obvious example of how, even in a more benign environment, we will need to be prepared for further turbulence.

Growth in Asian Markets in 2010
Amid this volatility, however, there are some points of certainty. The most important of these is that there will continue to be a significant growth opportunity for lubricants in Asia.

It is now clear that Asian economies are leading the world out of recession. The International Monetary Fund is forecasting GDP growth of seven per cent across the region and has identified China, India, Indonesia, and Korea as the key growth markets for 2010.²

The resilience of these economies is remarkable, as is their future potential. In the markets of China and India, PFC are predicting lubricants demand growth of five to ten per cent for this year. This is being driven by significant growth in vehicle ownership. Last year new vehicle sales in China outstripped those in the US for the first time, growing by 53 per cent^.3 With only 3 per cent of the population owning a car, forecasters such as Kline predict double digit growth in car sales over the next three years and by 2017 China is on track to overtake the US in terms of overall car ownership.⁴

I am told there is a Chinese saying, “To get rich, build roads first,” and the Chinese government is certainly following that path. It has a commitment to connecting all its cities with populations of more than 200,000 with new expressways by 2035. It will have completed 65,000 kilometres of that programme by the end of this year. We are seeing a similar focus in India where contracts have been awarded to build 25,000 kilometres of new road in the next two years.⁵  Clearly such programmes will stimulate demand for the lubricants sector in two ways, firstly during construction phase and second with the growth in the number of vehicles on the road.

So, Asia is now consolidating its position as the largest lubricant consuming market and looks set for future growth. That means it will continue to be an attractive destination for investment and certainly Shell is committed to continuing to build and develop our business in the region.

For example, at the end of 2009 we opened our sixth lubricants complex in Zhuhai, China. As a result of growth in demand, we have accelerated the delivery of product to the market with part of the plant now operational and producing while, in parallel, the remainder of the process equipment is being commissioned.  The plant is currently producing six million litres a month and when fully operational, will have the potential to produce 400 million litres a year.

Shell is already the largest lubricants supplier from among the international oil companies present in China with a 10 per cent market share and China is Shell’s second largest market after the United States. We currently supply lubricants to eight out of the top ten car manufacturers in China as well as 47 of the top 50 steel companies.  We have now seen very strong growth in demand for lubricants across China in the early part of 2010 and we see Zhuhai as playing a central role in meeting that increased demand.

As I will outline later, technical innovation is going to be central to the future success of our industry, which is why Shell has also invested in a technical facility at the Zhuhai plant to offer services including a quality control laboratory , marketing and training services related to customers and vehicle manufacturer’ lubricants applications.

Our approach reflects a wider shift in technological development to Asia. Recent figures published in The Economist highlighted that 98 Fortune 500 companies have R&D facilities in China and 63 in India. Shell is one of those companies. As well as plans for Zhuhai, we opened a technical facility in Bangalore in 2006 and this is playing a key role in our technological development across our businesses.

I believe that this region is going to take an increasingly central role in technical innovation across all sectors. The lubricants  industry will need to make sure that we keep up with the resulting demand for more high quality products

Long-term trends – improving fuel efficiency and reducing emissions
As the broader economic picture improves, the underlying trends affecting our industry are regaining their importance. I will now look at these in more detail and what we need to do to ensure our businesses are equipped to meet the challenges they present.

One of the most significant trends we will face is the need to reduce both carbon dioxide emissions and energy usage. With transport accounting for a quarter of the world’s carbon dioxide emissions⁶, we believe that the fuels and lubricants sector will be at the very heart of helping customers reduce emissions and achieve improved fuel efficiency.

That means there will be increasing demand for advanced lubricants products to meet ever more stringent environmental performance requirements of legislators. At the same time, vehicle manufacturers will focusing on new engine designs to maximise efficiency and will look to our industry to supply the advanced products to help them do so. So this trend will undoubtedly lead to increased demand for higher tier base oils and that demand will need to be met in the context of the ongoing base oil market volatility I have already mentioned.

Impact in Asia
Some have argued that these pressures are more important in mature markets and less relevant in this region. That is no longer true. With the increasing convergence of automotive technology around the world the impact of these trends is now as strong in Asia as in any other region.

Indeed it is emerging markets which are now driving technical innovation across a whole range of sectors. From Tata’s $3000 cars to low cost heart machines, technical developments in developing countries in Asia are increasingly bringing products which used only to be available to elites to the mass market. That will also apply to their vehicles and machinery and we will need to make sure we keep up with those developments and supply the high quality products which meet their needs.

Technology and Partnerships
Meeting this central challenge of providing customers with the products to help them  reduce emissions and improve fuel efficiency will require a renewed focus on innovation and technology,  and on partnerships.

Shell examples
Shell has a long history of investing in the technology to develop advanced lubricants which can deliver better environmental and economic performance.  One example is Shell Rimula, a heavy-duty engine oil for trucks, coaches and buses. The oil was developed in order to respond to customer needs for a low viscosity, fuel efficient oil which also offered high levels of engine protection and low emissions. After extensive testing we developed a product Rimula R6 LME that, in combination with fuel economy gearbox and axle oils has shown fuel savings of up to five per cent, helping customers use less.

Other products such as Shell Helix Ultra improve engine efficiency by using low-viscosity, friction-reducing formulations which keep the engine clean. This, in turn, can help to achieve better fuel economy. And we continue to invest in research to develop and improve these products further.

Using Shell Helix Ultra can increase fuel economy by up to 2.2% (compared to 15W-30 conventional mineral oil and based on a mileage of 10,000 miles per year for a petrol car in the UK with an average fuel economy of 33 mpg) This is a small change in one vehicle but if multiplied by the total number of vehicles– that adds up to a serious reduction, for example here in Korea there are 16 million vehicles⁷ on the road so if this level of efficiency could be achieved across the whole vehicle fleet then we could cut carbon emissions on a larger scale.

Impact on Base Oil Market
The continued development and demand for advanced products is going to have a significant impact on the base oil markets. These higher tier lubricants need to offer lower viscosity, reduced environmental impact and reduced wear and that means for many of them Group II and III base oils become ‘technical must haves’. So these developments will have significant impact on the base oil market. Many players have already recognized the potential of these changes with a number of Group II and III base oil plants planned or coming on-stream, and there will be more to come.

Leaders in the lubricants industry, those who will be successful over the long term, will be those who can respond effectively to these trends and anticipate the effect they will have on the base oils market.

GTL
Shell’s approach has been to invest in a range of options. One of these is gas to liquids fuel in which Shell has made a significant investment. The Pearl Gas to Liquids plant in Qatar will produce more than 140,000 barrels a day of GTL products including fuels, chemical feedstock and lubricant base oils. Construction is on schedule to be completed at the end of this year with production ramp up during 2011.

Most GTL gasoil is likely to be used as a high quality blend component, since it can be supplied through the existing diesel distribution system and blended easily with conventional oil. This will help to diversify the diesel fuel supply. Another benefit of GTL fuels and lubricants is that they are high quality, which can support advanced engine developments. We believe GTL, as a high quality group III base oil, will help us to bring the next generation of lubricants to market which will help to improve energy efficiency, reduce maintenance costs and extend equipment life.

Shell’s approach to collaboration
Greater collaboration with automotive manufacturers is going to need to underpin all this work to reduce emissions and improve fuel efficiency. At the moment collaboration tends to mean finding the most effective lubricant that you can for the latest, but already fixed, hardware design. We now need to move on from that to develop partnerships where the hardware and lubricant can be developed together to give the best overall solution.

For example, reducing lubricant viscosity will reduce bearing drag, but it will also reduce oil film thickness making the engine more susceptible to wear. If bearing length and diameter are modified to restore the original oil film thickness, then this co-engineering will have delivered optimised fuel economy whilst preserving durability. 
 
The true benefit of this kind of approach is the way it can open the door to a much more innovative approach. It means we could imagine engine oil systems being developed that can deliver the lubricant to the engine at its target viscosity independently of operating temperature. We might be able to devise transmission systems in which traction is also independent of temperature. Then maybe both of these might be brought together to operate simultaneously to deliver exceptional economy and performance. These are just examples. They may not be feasible in the end but by working much more closely together with manufacturers I think we can open our minds much more to the developments which will truly transform what we do. 

Shell has a long history of collaboration with OEMs, these add hugely to our expertise and benefited our customers by delivering better performance or improved efficiency. A recent example is our long term relationship with Hyundai. The partnership began in 2005 and has recently been renewed. It is partly a contract to supply lubricants but it goes beyond that by establishing collaboration on lubricants research and development, as well joint marketing activities to maximise the benefit to customers of both companies. 

Another very successful collaboration has been with ZF, a driveline and chassis supplier. They needed an oil to lubricate an advanced automatic transmission. This transmission had a very high specification with the potential to deliver a six per cent improvement in fuel economy. This was a real challenge for us but, by being part of the team from the start and having worked with ZF on previous transmission oils, we had a real advantage in the design process. It also meant we could develop the new product more quickly and coordinate testing and development work. By working together and using our long standing relationship we were able to provide a product which met ZF’s needs and helped their customers use less fuel.

While one focus of this innovation is passenger vehicles, this work is also helping commercial and industry customers meet their energy efficiency targets and demand for higher performance products. These customers need hydraulic fluids which can deal with higher temperatures, water contamination and more exacting cleanliness standards and this is leading to increased use of Group II and III base oils in industrial applications.

The development of Shell Tellus EE hydraulic fluid is an example of how we are responding to this demand. Tellus EE was developed after rigorous work examining the way energy consumption operates in hydraulic systems. This was then developed further by mathematical modelling which provided new insights into the drivers of energy use. This knowledge was then applied to develop the Tellus EE fluid that contains a unique and patented additive technology, and addresses a key customer concern about rising energy costs in manufacturing. After comprehensive endurance testing by Shell and by OEMs and 200 customers, Shell Tellus EE has been shown to deliver an average of eight per cent energy savings in the machines in which this product was used.

A very powerful example of the benefits of Tellus EE in action can be found in a trial undertaken by POSCO, the steel manufacturer here in Korea.  Working with the customer at every step of the way, the new lubricant was introduced in to their systems. Over a five month trial, Tellus EE delivered a 16 per cent reduction in the electricity consumption of the machines in which it was used, as well as an extension in maintenance cycles and longer oil life and a reduction in product waste and disposal costs. POSCO now intends to apply Tellus EE to all of its plant’s hydraulic systems.

Alternatives
This work to improve the efficiency of oil based fuels needs to be carried out at the same time as developing the products that can respond to the emergence of alternative energy sources such as biofuels or looking to the longer term, electric, hydrogen and hybrid vehicles. These will present many new opportunities to grow and develop our business to provide the advanced products which meet the technical demands of these alternatives.

But there are also challenges, the first of these is determining which of these alternatives will achive critical mass. It is difficult to pick winners. We have only to look at the beginning of the last century when the electric car was seen as the future and the internal combustion engine regarded as an eccentric alternative. 

The second challenge is to understand the length of time it takes to develop alternatives and to move those alternatives from the laboratory to the road. On average it takes thirty years for a new energy development to gain a one per cent market share. So anticipating future trends will test us all.

This is especially true of electric and hybrid vehicles which clearly have potential but where there is much more research and testing to be done before they can offer a realistic option for a critical mass of customers. There are still real challenges to be overcome around the journey range of batteries and around recharging. Equally, battery powered cars are not an entirely environmentally friendly option. They use scarce resources for batteries and the electricity to power them is, in the immediate future, unlikely to be produced from renewable sources.

These constraints mean that in the short to medium term, the most practical option is likely to be more biofuels as well as hybrid vehicles which can combine some of the advantages of battery power over short distances but also have the efficiency of liquid fuels for longer journeys. We need, as an industry, to work to maximise the benefits of the development of hybrids and that will mean a focus on upgrading products to meet new demands. Again this means higher tier lubricants derived from higher group base oils and going to be ever more important.

Summary
So in conclusion, we can see that there are many developments planned or already in place to address those key requirements of reducing carbon dioxide emissions; increasing the focus on technology and partnerships; and seizing the growth opportunities in this region.

Those developments are likely to gather pace in this region. Investments in Group II and III plants will continue and will be vital in this increasingly sophisticated and growing market. As I have outlined, we can be sure that the demand for high performance products is only going to grow both in the developed and developing economies.  That means we will need continue to invest in the technology and partnerships that support new product development and maximise the benefits for customers in reducing emissions and maximising fuel efficiency. And the background to all this work will be continued volatility in the base oil market.

So, in conclusion, as we have seen over recent years, working in the oil industry will always be something of a rollercoaster but if you have a strong stomach, a rollercoaster can make life very exciting. And those who have the resilience to withstand the ups and downs of our industry, and who are prepared to take the lead in meeting the challenges ahead, will have real opportunities to grow and develop their business.

END

 ¹ Reuters 26th February http://uk.reuters.com/article/idUKTOE61P05520100226
 ² IMF http://www.imf.org/external/np/speeches/2010/030210.htm
 ³ Economist 14th January 2010, http://www.economist.com/research/articlesBySubject/displaystory.cfm?subjectid=478048&story_id=15271181
 ⁴ http://www.hsbcnet.com/solutions/emerging-markets/china_road.html
 ⁵ http://www.hsbcnet.com/solutions/emerging-markets/china_road.html

 ⁶ IEA https://www.oilmarketreport.org/press/pressdetail.asp?PRESS_REL_ID=293

 ⁷ Kline