2011 has ended, and we are back to doing what we were some three years ago: contemplating how bad the economy will get before it gets better. There is bad news everywhere. The list of critical countries in the euro-zone grows longer by the day. Greece, Ireland, Spain, and Portugal have been lately joined by Italy. France could be next. Outside the euro-zone, the United Kingdom, with its large financial industry and significant exports to the euro area, is being sucked into recession. The United States is also battling its own problems. High unemployment, low consumer confidence, high government debt, and political deadlock are all hampering recovery. Asian economies played an important role in pulling the world economy of out recession in 2009, but now they are not up to the task. Both China and India have battled high inflation. Interest rate hikes in response to the inflation and the high fuel prices have acted as a dampener on consumer demand. China needs to reorient its economy from export driven growth to domestic consumption driven growth. This is proving very difficult with the current level of interest rates. India has also seen a huge drop in its currency from INR 45.45 to USD 1.00 in December 2010 to INR 51.59 to USD 1.00 in December 2011. Given that India is dependent on oil imports, this is translating into higher fuel prices and still higher inflation.
What has been the impact on the global lubricants industry? As per Kline & Company’s estimates, global lubricant consumption peaked in 2007 at about 39.8 million tonnes. Consumption declined by 3.5% in 2008 to 38.4 million tonnes and by a staggering 9% in 2009 to reach 35 million tonnes. Consumption grew by 7% in 2010 to reach 37.4 million tonnes. In 2011, we estimate that the industry grew by 2% to reach 38.2 million tonnes. The economic roller coaster ride of the past three years has generated a debate on the nature of lubricant demand and its growth in context of economic growth. Does lubricant demand growth track GDP growth rate? Can we define a relation between GDP growth and lubricant growth? Has the lubricant market grown at all in the last 10 to 15 years? Let’s try to lay out our view on these questions.
Does lubricant demand growth track GDP growth rate?
Lubricants permeate every aspect of our life and are needed wherever machines are used. For our convenience, we break down the industry in terms of consumer segment which covers all privately owned cars, SUVs, motorcycles and small engines; commercial segment which covers all trucks, buses, tractors, and other commercial vehicles; and industrial segment which covers lubricants used in machinery in all industries and also includes metalworking fluids used in variety of metal processing industries. If we take a broad time horizon, then lubricant consumption growth should indeed track GDP growth rate given its wide usage. However, there are two caveats. First, not all sectors of the economy use lubricants to the same extent so lubricant demand growth is dependent on which part of the economy is growing. GDP is divided into manufacturing, services, and agriculture. Manufacturing GDP is most lubricant intensive, and services are the least intensive. In most affluent economies (Germany is an exception), GDP growth is primarily driven by growth in services hence the impact on lubricant demand growth is weak. Growth in manufacturing intensive economies will have a strong relation with lubricant growth. The second factor to consider is the degree of mechanization in the manufacturing sector. Many growth economies may have a large manufacturing sector, but their manufacturing is labour–intensive, using less mechanical power and hence less lubricants. As such economies grow, lubricant consumption would show some growth, but this growth would have been much stronger if it were to occur in an economy which is highly mechanized. Similarly, if growth comers from the Agricultural segment it is important to understand if agriculture is primarily mechanized or labour intensive. In our view lubricant demand growth is driven by GDP growth. However, the relation between the two is nebulous and changing based on where economic growth occurs.
Can we define a relation between GDP growth and lubricant growth?
To be able to quantify the relation between GDP growth rate and lubricant demand growth rate, we need a repeatable, consistent measure of “actual” global lubricant demand, as opposed to estimates. Unfortunately, lack of common definitions and spotty reporting by marketers means that we do not have consistent measure of actual lubricant demand. Data is indeed collected by various national associations but the data is strictly not comparable year to year as the list of participants keeps on changing. Also, differences in what is included make comparison between data from two sources difficult. Is process oil included? What about marine oils? How do re-refined oils get counted? Unless we have a robust, repeatable measure of global lubricant consumption covering all market segments (top tier to bottom tier), the correlation with GDP growth rate is not representative of the total market.
Even if we can’t quantify lubricant demand, we can quantify growth. It’s how much more was sold this year compared to the year before. We can therefore track lubricant demand growth with GDP growth and determine if there is a relation, right?
The answer is: maybe. The lubricants industry is very vast in terms of products, market segments, supply chain position, and geography. The growth rate experienced by industry constituents is based on their position. Niches within the total market may have high or low growth rate because of some underlying trend which drowns out the “real” demand growth. For example, an installer may experience a better than average growth rate if there is a significant shift from DIY demand to DIFM demand. Similarly, a Group III supplier may experience strong growth far in excess of the industry growth due to shifts in blending approaches. An additive company may experience a sudden spurt in demand related to the introduction of a new quality level. These market participants would experience some slowing down if the total market declined, but they would not be able make out if this was due to the slowing down of the market trend or slowing of the overall growth.
Due to supply chain effects, growth rates can be all over the place during times of economic turbulence. When growing at a steady pace, the lubricants industry is like a taut railway train with all chugging along at more or less the same pace. When economic growth stalls the impact on different supply chain levels is different. We did see in the latter half of 2008 and early 2009 massive destocking by lubricant marketers. This caused a more rapid contraction in demand for baseoil and additives suppliers than would have been justified by the contraction in the true demand. Similarly during the upswing in second half of 2010, these suppliers benefited from restocking. As a result, during this turbulent period, it would have been difficult for basestock and additive suppliers to relate their business growth to the GDP growth.
Finally, even if there is no special trend in play and no economic turbulence, growth of individual marketers will be higher or lower than the total market depending on whether it is gaining or losing market share. The point is that growth rates of individual market participants are unreliable indicators of overall market growth. The growth rate of the individual market participant may have been influenced by some major market trend unrelated to overall demand. It could also be the case that the company in question is losing or gaining market share.
Has the lubricant market grown at all in the last 10 to 15 years?
We cannot hold both views that lubricant demand tracks GDP growth and that lubricant consumption today is at the same level as it was 10 years ago, for the real GDP has grown in this period.
Between 2000 and 2010, cumulative global passenger car and commercial vehicle production accounted for nearly 718 million new units1. Even allowing for vehicle scrappage, there has been a big increase in the global vehicle population. Between 2001 and 2011, steel production grew by 408 million tons2. Other industrial end-use industries saw similar growth in production levels. Did lubricant consumption remain flat in face of such massive growth in vehicles population and industrial production? To be sure there has been a dampening of lubricant demand due to longer lasting lubricants, lower losses in use due to better equipment design, smaller sump sizes, better housekeeping, better re-refining, and other such factors. However, they have not been enough to cancel out the growth in the underlying demand for lubricants. Innovations such as longer drain engine oils have not spread out to Asia where the cost of insufficient lubrication far outweighs the cost of the lubricant. In our view, global lubricant consumption is likely to exhibit growth due to increasing vehicle population, industrial production and increased mechanization in growth economies. This growth rate will be lower than what you would expect from the build-up of vehicle population and growth industrial production, but still a long way from a flat market.
Finally, a word on our methodology.
Kline measures lubricant demand by a combination of lubricant usage norms (covering crankcase size, drain intervals, and top up demand where applicable) applied to passenger car, motorcycle, and commercial vehicle populations; lubricant usage intensity in different end-use industries; and estimates of sales by major marketers and their market shares. Usage norms in automotive segment and usage intensity in industrial segment are developed on the basis of end-user and installer interviews. Projections are based on growth in end-user segment and any shifts in the usage norms.
What do you think are the important parameters to be considered for estimating lubricant demand? What factors should we look at for projecting demand growth? Please provide your feedback at vera.sandarova@klinegroup.com. We would love to hear from you.
In closing, we wish you a healthy, happy, and profitable 2012!
