lubricant industry crisil

8/13/2019 Lubricant Industry Crisil

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INDIAN LUBRICANT INDUSTRY - SHRINKING MARGINS

Declining demand growth of automotive lubricants, increasing competition on account of the

presence of a large number of players, and increasing raw material costs and marketingexpenditure are leading to declining player margins in the lubricant industry.

Global Scenario

Global demand for lubricants in the world is estimated at around 41 million (mn) KL.Automotive lubricants account for around 54%, Industrial lubricants for around 41% andMarine lubricants for the balance.

Globally, the lubricants industry has been growing at 2.0-2.5% per annum in the past fiveyears. In developed countries, automotive lubricants have been growing at a slower rate of1.0% per annum on account of the saturation of vehicle population, improved enginetechnology and better quality of oil.

The region wise distribution of lubricant demand worldwide is shown below:

Region wise Demand

Nor th

America

28%

Europe

35%

Asia Pacific

25%

Central -

Southern

America

12%

Source: Published Sources

Asia is the third largest market for lubricants in the world and is expected in future to grow ata faster rate as compared to other developed markets. Asias share in the world lubricantmarket has increased from 22% in 1993 to 25% in 1998. The per capita consumption oflubricants in different countries is shown below:

Country Per Capita

Consumption (Kg)

America 31.0

Europe 14.0

China 2.0

India 1.0Source: Published Sources

I nternational Consolidation

The global lubricants industry consists of more than 1700 players of which less than 2%control around 70% of worldwide sales.

The years 1998 and 1999 have witnessed a number of mergers in the oil industry. Theseincluded the three largest mergers in the petroleum industry in recent times. In late 1998British Petroleum Plc, UK merged with Amoco Corporation, USA followed by the merger ofTotal SA, France, with Petrofina, Belgium. The last merger was that of Exxon Corporation,

USA with Mobil Corporation, USA, which created the worlds largest publicly traded oilcompany. Though the major merged entities are mainly petroleum or energy companies, they


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are also large players in the lubricants industry. Exxon was the worlds largest base oilmanufacturer, while BP, Amoco and Mobil also had strong lube operations. These mergershave changed the structure of the industry significantly. The latest consolidation specific tothe lubricants industry has been the acquisition of Burmah Castrol Plc, UK, the worldslargest player in the consumer (retail) lubricants segment by BP Amoco Plc, UK.

The mergers have further concentrated a large part of the world lubricant market in fewerhands. Additionally, most of the merged entities are also large suppliers of base oils

worldwide. Hence, the mergers have further concentrated this market, with majors likeExxon, Mobil, controlling the base oil market. This is increasing the volatility in the base oilsupply and hence, price.

Fur ther consolidation i s expected in the global lube industry, especial ly as independent

lube manufacturers would be aff ected by the sharp ri se in base oil pri ces, fol lowing the

increase in crude oil pri ces.

Technology Developments

Automotive engineering technology has improved significantly in the past few years, with acorresponding impact on the improvement of lubricant quality. Improving engine andlubricant technology has resulted in the decline in the lube to fuel ratio1.Additionally, therehas been a demand from both the OEMs and the customers for better quality lubes with longerlife, better properties and lower deposit formation, meeting the stringent emission standardsrequired.

A critical requirement for the manufacture of high quality lubricants is the quality of base oilused. Limitations on the physical properties of Group I base oils in various products isexpected to result in an increased demand for Group II/III base stocks. Group III base stockscan be manufactured only by newer processing technologies like hydrocracking combinedwith other processing stages like hydro-isomerisation, iso-dewaxing and catalytic dewaxing,which would require additional investments from the lube refiners. Group III base stocks will

also facilitate compliance with the API P 9 emission standards scheduled for 2002. It isestimated that by 2005, 40% of base oils worldwide will be hydrocracked. The new plantsrequire high investment costs, but can make base stocks from a broader range of crudes,including crudes with high sulphur content.

The group I I /I I I lube base oils would cost more than Group I base oils. Hence a shi ft f rom

Group I to Group II /I I I base oils would put fur ther pressure on the margins of lubricant

manufacturers.

Indian Scenario

India is the sixth largest lubricant market in the world, with a consumption of around 1.12

million KL in 1998-99 (an effective market size of Rs. 55-60 bn.) as against an installedcapacity of 1.6 million KL and has grown at a CAGR of around 7.0% over the period 1993 to1998. However, with the industrial downturn and also slower growth in the automobile sector,the growth of the industry has slowed down to around 4.0% in the last few years.

Till 1993, the Indian Lubricant industry was totally controlled by the Government, with theOil Co-ordination Committee (OCC) controlling all aspects of the Industry. Thus, theindustry was dominated by the oil Public Sector Units (PSU) - Indian Oil CorporationLimited (IOCL), Hindustan Petroleum Corporation Limited (HPCL) and Bharat PetroleumCorporation Limited (BPCL). Castrol was the only major private sector player in the industry.The market shares of the key players in the industry as in 1998-99 is given below:

1The amount of lubricants used per litre of fuel consumed.


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Market share - Lubricants

IOC

34%

HPCL

18%

IBP

2%

Gulf Oil

6%

Tide Water

4%

Castrol

19%

BPCL

8%

Elf

3%

Others

6%

Source: Published Sources

The lubricant industry in India can be broadly classified into two segments - AutomotiveLubricants and Industrial Lubricants, with automotive lubricants accounting for over 60 % of

the total lubricant market.

The automobile lubricant market has grown at around 4% from 1993-94 to 1998-99, with thecommercial vehicle segment accounting for about 70% of the total consumption ofautomotive lubricants. Indias per capita consumption of automotive lubricants is low ataround 1 Kg per annum on account of the low penetration of automobiles in the country.

India has the second largest railway network, fifth largest mining industry and is the twelfthmost industrialised nation in the world. Hence, industrial lubricants account for about 40% ofthe total lubricant market in India and have grown at a CAGR of 13% from 1993-94 to 1998-99.

Recent Trends

I ncreasing Industry Competiti on

In 1993, the Government liberalised the lubricants sector and announced a number ofregulatory changes. These included

Entry of foreign companies into the Indian market. Decanalisation of imports of base oil. Decontrol of pricing of base oil. Reduction in customs duty on base oils (progressively reduced from a peak of 85% to the

current level of 25%).

The deregulation of the lubricant industry has had a severe impact on the structure of theIndian lubricants market. Lubricants have the highest margin among refined petroleumproducts. Companies earn between 20-30 times more from selling lubricants than otherpetroleum products. Such a lucrative business encouraged foreign majors like Shell, Exxon,Mobil, Caltex, Elf etc., to enter the Indian market. Currently, the industry is highlyfragmented with over thirty players as compared to the five in 1993. The share of publicsector companies has declined from 90 % in 1991 to less than 70 % in 1999. The change inthe market share has been predominantly on account of rapid developments in technology,marketing, and distribution strategies of companies.


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Decli ning Automotive Demand Growth

A critical feature of a lubricant is the time required before it needs to be changed. This featurecalled the drain life is a function of the quality of the lubricant, the amount of contact betweenthe two surfaces and length of use of the machine or automobile.Improving lubricant technology has progressively increased the drain life of lubricants.Additionally, significant improvements in automotive engine design has also had an impact

on the drain life of lubricants.

Over the medium term, with improving lubricant quality and engine design, the drain life forlubricants in an Indian car is progressively expected to increase.

The improvement in drain l if e is expected to contr ibute to a slower growth of r eplacement

demand in the future.

I ncreased Dependence on Imports for H igh Quali ty Base Oil

Availability of the required quality of base oil is a critical factor in the growth of the Indianlubricant industry. Till 1993, on account of the canalisation of base oil imports, growth ofprivate players was constrained. However, since then with decanalisation of imports, privateplayers (especially Castrol) have been able to grow at a significant rate, as they have importedtheir requirements of base oil.

Currently, indigenous production of base oil is from three refineries IOCLs Haldia refinery,MRLs Manali refinery and HPCLs Mumbai refinery with a combined capacity of around 0.8MMTPA. While IOCL and HPCL utilise the base oil produced in their refineries for boththeir in-house blending plants and for external sales, MRL sells the entire production from itsrefinery.

However, since the base oil produced by domestic refineries does not meet the quality

requirements of lubricant manufactureres, majority of MNC players prefer to import theirrequirements. Secondly, private players are able to get the supply of these from parentcompanies or from global vendors.

Globally, since the commodity is controlled by a select set of world majors like Exxon,Mobil, Chevron, any disruption in their output could severely impact base oil availability andthus prices.

Additionally, since refineries determine their product profiles based on the refining netbackson a certain crude, it is possible that there might be a shortage of base oil, especially in thesummer months, when more light crudes are processed to meet gasoline demand2.

Presently, on account of the unavailability of quality base oil, prices for the most popular SN500 grade had increased from US$187 per tonne in March 1999 to US$345 per tonne inFebruary 2000.

The recent pr ice rise has put pressure on lube manufacturers in I ndia. Thus, with domestic

ref ineries unable to provide base oil of r equisite qual ity there has been a tr end towards

higher imports. This would impact the margins of players, as players are unable to pass on

the increase in costs to customers in thi s highly competi tive market.

2Base oil is a heavy end. Hence, any refinery producing base oils would also produce a higher quantity

of heavy ends and would also need to use heavy and waxy crudes. Gasoline maximisation is through

the use the of sweet, light crudes and would not produce higher quantities of heavy ends. Hence, arefinery producing base oil would also need sufficient secondary processing facilities to meet gasolinerequirements.


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Changing Marketing Strategies

There has been a shift in the customer preferences in buying lubricants. Brand name, price,accessibility and services offered are becoming the deciding factors for choosing betweenbrands. Thus, the strategy in the Indian automotive segment has progressively been shiftingfrom the sales push, commodity type marketing strategy to a brand pull, fast movingconsumer good (FMCG) product type of marketing strategy. This is especially in case of the

Bazaar trade, which currently accounts for around 40% of the sales of the automotivelubricants in India.

With the product definition of a lubricant is undergoing a change from a commodity to a FastMoving Consumer Good (FMCG), a wide distribution network and a good brand image arethe most important success factors in the automotive lubricant industry.

In the medium term, the players in the industry are expected to increase advertising expenseswith a lot of focus on development of brand image and improving brand equity.

Higher dealer discounts, longer credits and higher inventory are becoming the norm of theday. Margins are declining due to increased expenditure in product promotion, discounts andincentives and money blocked in receivables. PSU oil majors, constrained by theirprofitability in their principle lines of business are increasing aggression in lubricantmarketing through tie-ups with international oil majors to increase penetration in the bazaartrade. IOC has captured a 10% market share in the bazaar segment.

Conclusion

With the slower growth rate in the automotive segment, declining margins on account ofrising base oil prices and increasing competition on account of the presence of a large numberof players in this segment, players are expected to focus on Industrial lubricants as the keyarea for future growth in the Lubricant Industry.

But, although, private players are increasing their presence in the industrial segment,penetration in this segment is expected to be slow on account of the well-entrenched positionof the existing PSUs and the long gestation periods associated with establishing a clientele inthis segment.

Thus, with the competition in the industry intensifying, a period of price competition followedby consolidation is expected over the medium term, with smaller players either exiting theindustry or merging with larger players.

lubricant industry crisil

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