LUBRIZOL

Capital expenditures at Lubrizol Additives are likely to top $300 million this year
and $250 million in 2013, says the com- pany's president. Much of the money will go to construct an additives plant on a greenfield site in China, for research lab- oratories in Asia, and for upgrades to existing manufacturing facilities in Texas and France.
After 2013, the additive company
expects to continue investing at the rate of around $200 million a year to improve its infrastructure, ensure supply security, cre- ate and commercialize new technologies, and add more capacity - largely in Asia.
Back in 2006, the Wickliffe, Ohio-based company could only have dreamed of being in a position to make such reinvest- ment, President Dan Sheets told the recent ICIS World Base Oil & Lubricants Conference in London. That year, the entire additives industry was on the
ropes. Supply and demand were unbal- anced, productivity had been battered by hurricanes the year before, and emerging markets like Asia, Eastern Europe and Brazil were crying for attention. Plus, thanks to an earlier wave of mergers and acquisitions, major customers in the lubricants industry had grown to wield a substantial amount of buying power. Between their purchasing clout and rising raw material costs, additive company margins suffered.
"Lubricant and additive companies faced poor profitability in 2006," Sheets said on Feb. 24. "At that point, reinvest- ment funds were not there."
The picture today is greatly altered, and
margins have improved. "Financial health
is improving," he said with evident relief, "and while global growth remains at a modest 1 to 2 percent level, the future looks cautiously optimistic."
Lubrizol was bought last year by Berkshire Hathaway Inc. and folded into its portfolio of industrial holdings, so it no longer publishes its financial results. However, the company and one large
additives rival were publicly traded in both
2006 and 2011, and together their finances might be taken as a bellwether for the additives industry, Sheets suggested.
The two companies' average operating margins doubled from 10 percent in 2006 to hit 20 percent in 2010, he noted. (While he did not name the other com- pany, only Newmarket Corp.'s Afton Chemical business fits the description.) Meanwhile, lubricant manufacturers, based again on a limited number of pub- licly traded companies, saw their average returns nearly triple in that same period. So together, the additives and lubricant industries appear to have lifted them- selves to "a pretty good place," he said.

Unique, Boutique

In terms of global volume sales, Lubrizol has seen about 1 or 2 percent compound annual growth since 2002, Sheets said. "This is not a big, top-line growth kind of industry. It's a very unique business though, and I don't know another one like it. Additive companies are unique in this industry and in the specialty chemi- cals industry. We have to provide not only specialty chemicals and components,
but formulation technology and proof of
performance."
He estimated that the cost of replacing
Lubrizol's current infrastructure would be
$4.6 billion; it requires $180 million a year in capital investment just to keep it run- ning. This is another reason strong mar- gins are so critical, Sheets indicated. Meanwhile, complexity is becoming the industry's biggest challenge and is com- pounding its need for capital investment.
"Lubricant technology, for example,
now sees continuous upgrades, with new engine oil specifications coming along about every two years," he said. "That adds complexity, because older specifica- tions don't go away just because new ones are introduced."
Geographically, markets are shifting too, "with new customers and new OEMs," Sheets told the ICIS gathering. "Security
of supply has become front-of-mind for many customers, who now demand busi- ness continuity planning from suppliers like Lubrizol."
R&D remains the heart of the business, and also demands constant attention. Regulatory requirements to improve energy efficiency and reduce emissions are one example; another is the growing
number of base oil suppliers. "There are a lot of new base oil players, and our cus- tomers want the broadest base oil cover- age they can get for their formulations - and we have to support that."
This shifting landscape requires a strong R&D pipeline, Sheets said, and is why "Lubrizol evaluates 300 new essential chemistries a year." The additives indus- try spends nearly $250 million per year to perform industry-registered drivetrain
and engine tests, Sheets pointed out, and

Technology and complexity are driving the additive company's investments, says Dan Sheets. (Photos: Lubrizol)

Presses for Profits

1 COPYRIGHT 2012, LUBES'N'GREASES MAGAZINE. REPRODUCED WITH PERMISSION FROM THE APRIL 2012 ISSUE.

BY LISA TOCCI

COPYRIGHT 2012, LUBES'N'GREASES MAGAZINE. REPRODUCED WITH PERMISSION FROM THE APRIL 2012 ISSUE. 2

that price tag doesn't include all the development work that precedes any engine testing. He estimated the total R&D spend for the additive industry in
2011 topped $600 million, versus about
$430 million in 2006.

'What If?'

Another factor that's demanding more attention and creating more complexity is business continuity planning. Since the disastrous hurricane season of 2005, cus-

Drivetrain and engine oils require a strong R&D pipeline, says Lubrizol.

tomers have increasingly included contin- gency planning in their contracts, and many enforce it by checking their suppli- ers, Sheets said. Major customers expect additive companies to show they have strategic relationships with
suppliers, keep qualified materials on hand, and have back-up inventories available in case of disruptions.
"2005 set the tone for this," Sheets later elaborated to Lubes'n'Greases. "Quite a few of our customers put real
teeth into their business con-
They want to have a back-up plan in
place themselves in case of disruptions in supply, and they expect the same from their suppliers. So the addcos need docu- mented back-up supply plans. These cus- tomers want to see documentation too; we even had some 'mock drills' with
some customers, where they threw simu- lated supply issues at us, and we had to show how we'd manage it."
All of this is difficult and costly, espe- cially given the 2008-09 financial crisis, Sheets said, but Lubrizol is making head- way towards the goal. In 2005, the com- pany held about 78 days of qualified products in inventory, valued at a little over $400 million. In 2011, its inventory cushion had grown to 102 days, and was valued at almost $1 billion. This reflects both higher cost-of-goods and a deliber- ate decision to carry redundant invento- ry, "which eats up a lot of working capi- tal," Sheets emphasized.
More complexity also is seen in Lubrizol's manufacturing metrics, he con- tinued. In 2002, the average batch size of one of its additive blends was 120 metric tons and involved 10 components. Ten years on, the average batch is about 15 percent smaller, and it contains more components - up to 24 or 25 in the
case of some driveline products. In part this is due to the proliferation of lubri- cant specifications, and customer desires to field a range of differentiated products serving multiple performance tiers. But the upshot, Sheets said, is that the plants must make, manage and store more batches to supply the same volumes.
These forces are similar to what the industry has seen in the past, but more intense and complex, Sheets said. And despite the need for large capital and R&D investments, only modest overall
growth is expected, "so to continue, we need to keep having the kind of return on investment that we've built up to now," he reiterated.

Planting in Asia Additive manufacturing and infrastructure also demand investment, especially as Asia

major consumers of lubricants. The number of vehicles in China and India doubled from 2005 to 2009, with more to come, Sheets said, so his company must put more supply capacity in these markets.
Lubrizol is not alone in trying to rebal- ance its manufacturing assets to be ready for growth in Asia. Sheets noted that Afton Chemical is adding capacity in Singapore, as are Infineum and Chevron Oronite. Lubrizol is building its own new plant in the southern China city of Zhuhai, near Macau, which will begin operating in 2013. Moneys also are going to a new research laboratory in Zhuhai, and to an existing lab in India.
"The Zhuhai plant will have a very care- ful, phased-in start up," Sheets told the ICIS meeting. The company will begin by base-loading some of its blending capaci- ty with additives currently made at other Lubrizol plants. "Transferring some busi- ness from other plants will let us quickly move closer to customers in China and the Asia region," he said.
In his interview with Lubes'n'Greases, Sheets gave more details about these plans, explaining, "Our plant in China is mostly about security of supply. We need to have assets in Asia to be close to customers."
Transfer of manufacturing to the Zhuhai plant will mostly involve compo- nents and materials made at a plant in Deer Park, Texas, he added. "Initially, additive components rather than full packages will be shipped from Deer Park for blending in Zhuhai, which will com- bine and blend the components there.
"Deer Park will see no jobs lost or changed," he continued, "and will have plenty to do, with no immediate big impact. And with less pressure on capaci- ty, we'll be able to improve our customer response time and better serve the domestic and Americas markets.
"China in the first phase will make detergents, like sulfonates and phenates. Then we'll look at the global supply chain and future needs, and at those compo- nents where we're most vulnerable.
Phase one is to come, and could include
viscosity modifier solubilization and
"In 2009, we said we'd make this invest- ment, and we're doing it. We see the
need to demonstrate our commitment to
Asia. In 10 years more, the plant in Zhuhai will look more like an integrated additive plant, although smaller than Deer Park."

Life With Warren

Creating differentiated products, building new capacity and fielding more additive packages - it's all worth doing if the additive company receives a good return for its dollars, Sheets remarked to Lubes'n'Greases. "It all adds complexity. That's okay, we can deal with complexity
as long as it's worth dealing with. If it's just complexity for the sake of complexity, if it doesn't add anything, then it may not be worth investing in. On the other hand, complexity can be a good thing in some cases, where it's possible to achieve a competitive advantage.
"The reality is, if the lubricants indus- try wants the addcos to be viable, we have to get the returns to support the capital and technology investments that it requires us to make. I'll point to what our CEO James Hambrick has said: 'It's less about prices than profitability; what's really important is the outcome on your margins.'"
What kind of margins would those be? Sheets declined to say, noting that his
ICIS presentation gave a rare glimpse into Lubrizol's life under Berkshire Hathaway. He said the acquisition made it possible for Lubrizol to fund growth independent- ly, rather than selling itself to a larger chemical company or borrow against assets to raise capital.
All the SEC filings and published reports now have been replaced with quarterly financial summaries, delivered by
Hambrick to Berkshire Chairman and CEO Warren Buffett and CFO Marc Hamburg. Daily internal governance is handled by a management advisory committee which includes Sheets as a member.
"Life under Berkshire is a joy," he said. "It's streamlined, it's simpler, we have faster decisions on capital, and more flexi- bility." As for future investment, Sheets
repeated, "if we see a gap or need for new
tinuity planning after that.

Dan Sheets

and the Middle East become
industrial lube additive packages.
capacity, it's likely to be built in Asia."