* Profits from lube business plug gaping hole from refining
* Capacity increase may bite lube margins in late 2014
By Meeyoung Cho and Chris Lee
SEOUL, Sept 23 (Reuters) - Profits from robust lubricant oilsales helped offset steep refining losses at South Korea's topthree oil refiners in the first half, but planned productionhikes later this year threaten to erode margins and sever theirearnings lifeline.
Korean refiners have focused on specialty lubricants, usingheavy oil upgrading systems to feed residual oil from therefinery process into lube base oil, and have enjoyed robustsales this year to Europe and the United States.
Profits in lube base oil, the feedstock for engine oils andgreases, covered nearly two-thirds of refining losses at SouthKorea's top three refiners despite making up only six percent ofsales, helping them weather a refining industry downturn.
"Refineries are experiencing many losses when it comes torefining ... they're passably making a profit in lubricants andchemicals. The lubricant market isn't doing well like it wasback in 2011 but it's still basically an oligopoly market," saidYeon-ju Park, an analyst at KDB Daewoo Securities.
SK Lubricants Co Ltd, owned by SK Innovation Co Ltd, GS Caltex Corp and S-Oil Corp reportedcombined profits from their lube oil and lubricant businesses of389 billion Korean won ($374 million) over the first six monthsof this year, doubling year on year, according to an analysis ofcompany filings.
Over the same period, SK Energy, also owned by SKInnovation, GS Caltex and S-Oil accrued a combined 623 billionwon operating loss in their refining businesses, which were hitby weak oil prices and soft regional energy demand, swingingfrom 509 billion won profit a year earlier.
But a planned 30 percent increase in four South Koreanrefiners' lube oil production capacity - to 144,300 barrels perday (bpd) - before the end of the year poses a major risk tolubricant revenues, and could expose the country's energy giantsto harsher operating conditions, analysts said.
South Korea has the fourth-largest refining capacity in AsiaPacific at 2.9 million bpd, but run rates and refinery saleshave eased this year, although lube oil and lubricant salesjumped 17 percent in the first half to 3.4 trillion won.
ADDING CAPACITY
Lube oil has five major markets depending on quality andusages, the largest of which are 'Grade II' for industries andautomobiles, and 'Group III' for premium market vehicles.
European and U.S. demand for high-end automobiles isprojected to remain brisk, but premium lube production capacityis rising.
"They're all flocking at the same time because they have noother choice. This is part of the reason why lubricating oilproduct prices are unable to rise," said Kyu-won Hwang, ananalyst at Tong Yang Securities.
South Korea's combined lube production capacity will jump 30percent to 144,300 bpd later this year as SK Lubricants jointlywith Spain's Repsol will open a 13,300 bpd plant andHyundai Oilbank with Shell Petroleum Co, a refining unit ofRoyal Dutch Shell, will start 20,000 bpd plant.
Shell is also betting on lubricants along with its chemicalsand retail fuel sales to help it boost the performance of itsdownstream division, where oil refining will remain a drag onearnings in many regions.
"The supply is out there, and lubricating oil margins arealso easing, so profits will be diminished," said Young-joo Son,a senior analyst at Kyobo Investment Trust.
(1 US dollar = 1,042.5 Korean won) (Reporting by Meeyoung Cho and Chris Lee; Editing by RichardPullin)
