In recent decades, sustainability has come to play a larger role in influencing global industry regulations. More and more, we see governments and international organisations combining their efforts to reinforce regulations at both regional and global level in line with wide-spread targets to mitigate climate change and lower harmful emissions to the environment.
One such initiative that carries significant implications for businesses worldwide is the new 2020 IMO sulphur fuel regulation. The switch to a compliant low-sulphur bunker fuel, considered as ‘the most disruptive product quality change in decades’, is expected to cost the shipping industry billions of dollars globally, causing freight rates to go up and raising costs for their customers.
Impact on supply chain costs
As the world prepares to adopt the new regulation, it is important to measure the impact on both sides. In the Arabian Gulf, Saudi Arabia and Kuwait are both signatories to the IMO, and the UAE is yet to sign. As one of the most heavily export-oriented industries in the region, with 83% of chemical output being shipped to over 100 countries worldwide, the GCC chemical industry will be heavily impacted as major pressure would be put on its supply chain costs.
Let us take, for example, the so-called Emission Control Areas comprising northern Europe and the US. When low-sulphur fuel became compulsory in 2015, Maersk Line introduced ‘low sulphur surcharges’ ranging between $15/teu and $80/teu, depending on the route. If we take the same scenario for the new IMO regulations, export freight rates for the GCC producers could rise by as much as 10% to $1,688 on average.
The regional chemical industry has one of the longest and most costly supply chains, and after the increase in freight rates, transportation will account for 6% of total chemicals sales, up from 5% previously, warehousing for 3.5%, and other logistics expenses for 1.5%. Thus, the chemical industry’s supply chain costs will increase to 11% of landed product prices.
Following the upcoming changes in bunker fuel content, across all shipping sectors, bunker costs may take up 70-80% of total voyage expenses, with the lion’s share of the increase likely to be absorbed by the customer.Compliance with the new fuel specification will involve significant costs for the refining and shipping industries. It will also influence all shippers, who would face significant compliance costs by having to upgrade equipment, or switch to more expensive fuels. By some estimates, in a full compliance scenario, shipping costs could rise by up to $60bn annually from 2020 onward.
According to consultancy firm Wood Mackenzie, switching to marine gas oil (MGO) will be a more costly solution, and at 100% adoption would see freight rates go up by around $1 per barrel.
In any case, higher freight rates will influence relative differentials on both the feedstock and product sides of the supply chain, but the effect will vary depending on the dynamics present in each value chain and market.
Impact on projects in the GCC
Greenfield upgrading investments from refiners are unlikely to be purely driven by the IMO regulation, and there is a need to look at longer-term rationale and strategic fit of these projects. For refiners choosing not to invest, the focus should be on infrastructure to capture the opportunity from their existing configuration and internal streams.
Changes in refined product spreads will affect crude producers’ sales netbacks, while chemical producers will see the cost of their oil-based feedstocks also change. Market price for crude oil and naphtha feedstocks are likely to rise as the refining system increases crude runs to supply the additional demand for distillate bunker fuels and also ‘pushes’ some volume of high-sulphur fuel oil to the power sector.
The gasoline crack spread, and associated naphtha to crude crack spread, is projected to increase, while FCC propylene production is likely to decline. The aromatics and olefins chains are closely connected to the refining chain, and the IMO bunker quality changes are significant enough to substantively move refined product price relationships.
Creating winners and losers
The new IMO specification change will create winners and losers on both sides. The winners will be highly complex refineries and refiners with deep conversion/distillate-oriented configurations. Refiners, particularly in the US and China, will also benefit from the changes by capturing the value of their ultra-low sulphur fuel oil component streams and growing their share of the global bunker market.
Confronted with a more level playing field, the GCC chemical producers would need to examine additional opportunities to improve their performance and overall completeness. Companies would need to pursue excellence across functions including manufacturing, marketing and sales, and capital productivity. Manufacturing excellence programmes can drive gains in margins through improved variable and fixed costs. They can also help to unlock further production capacity through improvements in plant reliability and throughput.
Marketing and sales excellence can contribute not only to performance-related improvements via higher margins driven by more effective pricing, but also to additional volume growth based on an enhanced and more granular understanding of markets as well as more effective allocation of marketing and sales resources. And finally, capital productivity (CAPEX excellence) will ensure that future investments are fit for purpose and delivered on budget and on time.
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