13 Aug IMO 2020: A wind of change for the shipping industry
Beginning January 1, 2020 the International Maritime Organisation (IMO) is putting in place tougher rules on sulphur emissions for vessels. More specifically, the new MARPOL Annex VI regulation is limiting sulphur content of bunker fuel to a maximum of 0.5% (very-low-sulphur fuel oil, VLSFO) from 3.5% (high-sulphur fuel oil, HSFO) which is today. Failure to comply with the regulation will result in fines and penalties.
The regulation is aimed at reducing the impact on human health and the global environment. Ships mainly use heavy oil as fuel type, which is derived as a residue from crude oil during the refining process. Crude oil contains sulphur which, following combustion in the engine, turns into ship emissions that pollute the atmosphere. These emissions can lead to acid rain, which can harm the environment and contribute to the acidification of the oceans. In addition, sulphur oxides (SOx), can damage human health and can cause respiratory problems and other diseases.
Who will be impacted by this regulation
This change will be a major shake-up for the oil and shipping industry, the impact of which can not be underestimated as it will affect every aspect of the ecosystem and the global economy. Shipowners, cargo movers and any firm exposed to transportation fuels may experience a higher cost burden as a result of this regulation. This broad reach means that industry players are likely to see as yet unpriced volatility as they see a significant shock to their cost base. Forward markets of both fuel oil and diesel, for example, are already seeing significant volatility due to the potential pull on higher value molecules in the refining system. And volatility, from a forward earnings perspective is rarely welcomed by corporates.
Potential winners and losers
Different types of fuel will be affected by the IMO 2020 regulation. We would expect to see a drop in fuel price for HSFO as the demand will decrease. On the other hand, low-sulphur fuel products such as diesel, should see a price increase due to higher demand. According to Boston Consulting Group, low-sulphur fuel oil and blends will be the shippers’ near-term choice.
The biggest winner will likely be the refining sector. In particular, refineries which have the ability to make the more valuable fuel types such as diesel and gasoline, could experience higher profits as refinery runs increase.
These themes of a weakening high-sulphur fuel oil market and stronger middle distillate have been the theme for a number of years. The investments into scrubbers were borne out of a combination of these expectations and the pricing differential on a forward basis appearing to incentivise the necessary capital investment in new or retrofitted scrubbers.
As we move into the second half of 2019, the global refining sector is racing to destroy as much high-sulphur fuel oil as it feasibly can based its existing setup or, where investments have been made, roll out new refinery units to remove or substantially reduce high-sulphur fuel oil production. This has to an extreme global tightness in fuel oil supply in the key physical locations of Rotterdam and Singapore.
Over recent weeks, the physical premium that high-sulphur fuel oil has commanded has reached levels never seen before in history. It has sparked a more ferocious and polarising debate around how the pricing interaction will unravel between the existing high-sulphur fuel oil market, the existing diesel market and the new VLSFO product. Questions are now being raised around whether the refining sector’s ability to produce the new 0.5% sulphur fuel oil will drag large volumes of Vacuum Gasoil (VGO) away from secondary refining units as it will be needed for blending to meet the short fuel in compliant fuel availability.
With VGO being an important feedstock to the production of gasoline, through the Fluid Catalytic Cracking (FCC) process, it has implications for the Gasoline market too and how it will need to price to continue ensuring there is sufficient economic incentive to keep these FCCs running. These levels of profitability (refining margin) have over the last year struggled at various points and has been a contributor to reductions in refinery production from these units.
The counter to this theme is the abundance of US Crude Oil supply which has over a sustained period increased the global API (the measure of how heavy or light crude oil is) and been pressurizing gasoline prices downward set against a now seemingly never ending period of OPEC production cuts.
How the shipping sector can stay competitive
Global bunker fuel costs could rise by up to $60 billion annually from 2020 according to Wood Mackenzie. Rising fuel costs may result in higher freight rates, the fees charged for transporting cargo from one place to another, and ultimately these costs will be passed onto the consumers. One of the primary industry concerns is whether there will be sufficient quantities of compliant fuel around ports across the world to meet the rising demand. According to Reuters, “while major fuel bunkering ports such as Singapore, Fujairah in the United Arab Emirates and Rotterdam in the Netherlands are expected to have compliant-fuel supplies, analysts and shipping firms point to concerns over what happens at smaller ports”.
In an industry that is already being stifled by compressed margins, how can oil and shipping companies stay competitive in this highly volatile market?
Whilst the Shipping sector has not always be associated with embracing technological innovation, there is now a goldrush occurring across every component of the value chain from fleet deployment, supply chain optimisation, leveraging high frequency satellite data fused with machine learning and AI for real-time predictive analytics through to improved visibility and execution on procurement of both physical fuels as well as the associated derivative hedges.
In our next article, we will dig much deeper into technology firms which are exploring the multiple facets of the value chain in both shipping and oil and how these technologies can be leveraged to increase efficiency and drive down costs.