INDIAN LUBRICANT INDUSTRY - SHRINKING MARGINS

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1 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 marketing expenditure 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% and Marine lubricants for the balance. Globally, the lubricants industry has been growing at % per annum in the past five years. In developed countries, automotive lubricants have been growing at a slower rate of 1.0% per annum on account of the saturation of vehicle population, improved engine technology and better quality of oil. The region wise distribution of lubricant demand worldwide is shown below: Region wise Demand Asia Pacific 25% Europe 35% Central - Southern America 12% North America 28% Asia is the third largest market for lubricants in the world and is expected in future to grow at a faster rate as compared to other developed markets. Asia s share in the world lubricant market has increased from 22% in 1993 to 25% in The per capita consumption of lubricants in different countries is shown below: Country Per Capita Consumption (Kg) America 31.0 Europe 14.0 China 2.0 India 1.0 International 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. These included the three largest mergers in the petroleum industry in recent times. In late 1998 British Petroleum Plc, UK merged with Amoco Corporation, USA followed by the merger of Total SA, France, with Petrofina, Belgium. The last merger was that of Exxon Corporation, USA with Mobil Corporation, USA, which created the world s largest publicly traded oil company. Though the major merged entities are mainly petroleum or energy companies, they

2 are also large players in the lubricants industry. Exxon was the world s largest base oil manufacturer, while BP, Amoco and Mobil also had strong lube operations. These mergers have changed the structure of the industry significantly. The latest consolidation specific to the lubricants industry has been the acquisition of Burmah Castrol Plc, UK, the world s largest 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 fewer hands. Additionally, most of the merged entities are also large suppliers of base oils worldwide. Hence, the mergers have further concentrated this market, with majors like Exxon, Mobil, controlling the base oil market. This is increasing the volatility in the base oil supply and hence, price. Further consolidation is expected in the global lube industry, especially as independent lube manufacturers would be affected by the sharp rise in base oil prices, following the increase in crude oil prices. Technology Developments Automotive engineering technology has improved significantly in the past few years, with a corresponding impact on the improvement of lubricant quality. Improving engine and lubricant technology has resulted in the decline in the lube to fuel ratio 1. Additionally, there has been a demand from both the OEMs and the customers for better quality lubes with longer life, better properties and lower deposit formation, meeting the stringent emission standards required. A critical requirement for the manufacture of high quality lubricants is the quality of base oil used. Limitations on the physical properties of Group I base oils in various products is expected to result in an increased demand for Group II/III base stocks. Group III base stocks can be manufactured only by newer processing technologies like hydrocracking combined with 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 It is estimated that by 2005, 40% of base oils worldwide will be hydrocracked. The new plants require high investment costs, but can make base stocks from a broader range of crudes, including crudes with high sulphur content. The group II/III lube base oils would cost more than Group I base oils. Hence a shift from Group I to Group II/III base oils would put further 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 (an effective market size of Rs bn.) as against an installed capacity of 1.6 million KL and has grown at a CAGR of around 7.0% over the period 1993 to 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 the Oil Co-ordination Committee (OCC) controlling all aspects of the Industry. Thus, the industry was dominated by the oil Public Sector Units (PSU) - Indian Oil Corporation Limited (IOCL), Hindustan Petroleum Corporation Limited (HPCL) and Bharat Petroleum Corporation 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 is given below: 1 The amount of lubricants used per litre of fuel consumed.

3 Market share - Lubricants Tide Water 4% Gulf Oil 6% Elf 3% Others 6% IOC 34% Castrol 19% IBP 2% BPCL 8% HPCL 18% The lubricant industry in India can be broadly classified into two segments - Automotive Lubricants 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 to , with the commercial vehicle segment accounting for about 70% of the total consumption of automotive lubricants. India s per capita consumption of automotive lubricants is low at around 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 twelfth most industrialised nation in the world. Hence, industrial lubricants account for about 40% of the total lubricant market in India and have grown at a CAGR of 13% from to Recent Trends Increasing Industry Competition In 1993, the Government liberalised the lubricants sector and announced a number of regulatory 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 the Indian lubricants market. Lubricants have the highest margin among refined petroleum products. Companies earn between times more from selling lubricants than other petroleum products. Such a lucrative business encouraged foreign majors like Shell, Exxon, Mobil, Caltex, Elf etc., to enter the Indian market. Currently, the industry is highly fragmented with over thirty players as compared to the five in The share of public sector companies has declined from 90 % in 1991 to less than 70 % in The change in the market share has been predominantly on account of rapid developments in technology, marketing, and distribution strategies of companies.

4 Declining Automotive Demand Growth A critical feature of a lubricant is the time required before it needs to be changed. This feature called the drain life is a function of the quality of the lubricant, the amount of contact between the 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 for lubricants in an Indian car is progressively expected to increase. The improvement in drain life is expected to contribute to a slower growth of replacement demand in the future. Increased Dependence on Imports for High Quality Base Oil Availability of the required quality of base oil is a critical factor in the growth of the Indian lubricant industry. Till 1993, on account of the canalisation of base oil imports, growth of private players was constrained. However, since then with decanalisation of imports, private players (especially Castrol) have been able to grow at a significant rate, as they have imported their requirements of base oil. Currently, indigenous production of base oil is from three refineries IOCL s Haldia refinery, MRL s Manali refinery and HPCL s Mumbai refinery with a combined capacity of around 0.8 MMTPA. While IOCL and HPCL utilise the base oil produced in their refineries for both their in-house blending plants and for external sales, MRL sells the entire production from its refinery. 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 their requirements. Secondly, private players are able to get the supply of these from parent companies 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 and thus prices. Additionally, since refineries determine their product profiles based on the refining netbacks on a certain crude, it is possible that there might be a shortage of base oil, especially in the summer months, when more light crudes are processed to meet gasoline demand 2. Presently, on account of the unavailability of quality base oil, prices for the most popular SN 500 grade had increased from US$187 per tonne in March 1999 to US$345 per tonne in February The recent price rise has put pressure on lube manufacturers in India. Thus, with domestic refineries unable to provide base oil of requisite quality there has been a trend towards higher imports. This would impact the margins of players, as players are unable to pass on the increase in costs to customers in this highly competitive market. 2 Base 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, a refinery producing base oil would also need sufficient secondary processing facilities to meet gasoline requirements.

5 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 between brands. Thus, the strategy in the Indian automotive segment has progressively been shifting from the sales push, commodity type marketing strategy to a brand pull, fast moving consumer 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 automotive lubricants in India. With the product definition of a lubricant is undergoing a change from a commodity to a Fast Moving Consumer Good (FMCG), a wide distribution network and a good brand image are the most important success factors in the automotive lubricant industry. In the medium term, the players in the industry are expected to increase advertising expenses with 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 the day. Margins are declining due to increased expenditure in product promotion, discounts and incentives and money blocked in receivables. PSU oil majors, constrained by their profitability in their principle lines of business are increasing aggression in lubricant marketing through tie-ups with international oil majors to increase penetration in the bazaar trade. 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 of rising base oil prices and increasing competition on account of the presence of a large number of players in this segment, players are expected to focus on Industrial lubricants as the key area 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 position of the existing PSUs and the long gestation periods associated with establishing a clientele in this segment. Thus, with the competition in the industry intensifying, a period of price competition followed by consolidation is expected over the medium term, with smaller players either exiting the industry or merging with larger players.