Seize the Moment!
As the seasons transitioned from summer to fall, it brought to mind the theme of change. That applies to our thoughts at Jagger Advisory and, I’m sure, to yours too in the lubricants business.
It’s no secret that the lubricants market is changing. A lot. As case in point, look at industrial lubricants in North America. Some powerful forces are at work. They are altering the way we view investment opportunities in the region, which leads us to ponder:
How will the winds of change reshape the profit potential for industrial lubricants players?
To answer this question, we start with the global context. Then we drill down to the financial drivers for North America and what they mean strategically. After all, we’re all players on the world stage.
The winds of change have rattled the integrated business value chain. They have left a trail of consolidation all along it – an effect that spans supply chain operations, marketing, distribution and B2B and B2C customers. A number of key players are integrating both backward and forward to find new sources of value.
This change is accompanied by other major trends and disrupters in the industry. Examples include government activity restricting chemicals in-plant, automation and machining advances and regional expansion of the OEM manufacturing base. These and others generate new sources of value. They also come with major strategic challenges. The most important are: mitigating forces of margin compression; commoditization of certain product categories; and the downward pressure on volumes.
Charting the present and the best way forward
As a means for developing strategies, we aggregate the value chain into five gross margin pools: (1) refining; (2) specialty chemicals; (3) lubricants marketing; (4) lubricants distribution; and (5) trade and services. In all, they define an integrated business portfolio.
Which is winning today? The global prize goes to marketing, which contributes almost half – 46% – of the $69 billion in total integrated gross margin. The runners up are, in descending order: trade channels, distribution, then base oil refining and specialty/additives marketing.
Which is on the path to winning in the future? As we look at the long-term trajectory, since 2000, global lubes volume has only grown by a total of 4% – essentially flat growth rate – as gains in Asia and the Middle East have been offset by declines elsewhere from two major recessions. At the same time, the gross margin pool has grown 2½ times, telling us that the lubricants marketing business is the focus for margin opportunities. Our assessments also show that global competitors need a good amount of geographic diversity to offset the volatility in some of these so-called growth markets.
Here’s the main thrust of our “seize the moment” message. Even though lubricants marketing volume growth in North America is viewed as relatively flat, there’s an upside. The strong stable economy and high quality product mix make it an essential element to a strong global portfolio.
Most lubricants marketing growth is driven by up-trading and Route-to-Market.
As we look out to 2023, we project that the value growth in marketing and trade will outpace other areas as driven by continued portfolio up-trading to premium and synthetic products.
Putting a deeper lens on marketing, the foundation of value creation is built on our ability to deliver margin growth in the face of extremely volatile cost movements. The market conditions in 2017 and 2018 are perfect examples of this challenge. Other factors beyond portfolio up-trading provide opportunities for cost and capital efficiency. And if you look longer term beyond the quarterly and annual business cycle dynamics, you see that marketing has demonstrated relatively reliable earnings performance compared to the fuels refining and chemicals businesses.
Factoring electric vehicles into this situation
Will electric vehicles (EV) disrupt this picture? If we take the more generally accepted view where, by 2040, EV is projected to grow to 11% of the on-road vehicle parc and the passenger car market growth peaks slightly at about 2035. If we believe the more extreme “sky is falling” Bloomberg case with 33% EV penetration, the volume declines begin in 2025 and drop 25% by 2040. Despite all the uncertainty in the timeframe as well as what countries will really support the development of EV…
We see leading lubricants marketers moving aggressively to re-balance their portfolios.
This view is based on the expectation that EV will conquer some of its developmental hurdles. What’s more, attractive product and service opportunities in the commercial & industrial (C&I) sectors will drive value. As a result, we project that the global C&I margin pool will grow to 70% of the total by 2040.
Taking a cue from Wayne Gretsky
As said by this famous Canadian hockey player…
Skate to where the puck is going, not where it has been.
So what is the lesson for industrial lubricants vis-a-vis EV in North America?
There is lots of noise about what states and regions will be supporting EV. However, without strong federal incentives and support as well as a region with relatively low cost of fuel, the consensus view is a very modest EV penetration level. The West Coast and Northeast metro markets are exceptions. In all, based on what we know now, we expect EV penetration in the U.S. and Canada to be in the 3-5% range by 2040.
On the C&I lubricants front, customers are seeking new products and services and digital-centered solutions. Their goal? Provide business connectivity with customers and suppliers as well as drive down customers’ operating costs.
Putting this altogether, the main takeaways:
- Industrial players are finding new opportunities that take advantage of powerful industry trends and market disrupters
- Operating and financial guideposts for success are moving at a fast pace, recognizing the forces of commoditization and the customer’s emerging needs for digital solutions
- Solutions must provide strong connectivity along the value chain and drive-down operating costs, as automation advances in automotive and aerospace manufacturing, power generation, mining and general manufacturing industries
Next time: What strategies and portfolios will deliver value in North American industrial lubricants through 2040?