The IMO marine fuel low-sulphur regulations will result in a period of huge upheaval in global oil markets, extraordinary margins for some oil refiners, and a potential doubling of fuel costs for shippers.
“In 2016, the IMO confirmed that global refiners and shippers would have to comply with these new environmental regulations five years earlier than many anticipated, which sent tidal waves through two industries that typically take many years to adapt to such significant change,” said Kurt Barrow, VP, downstream research, IHS Markit.
Barrow, along with Sandeep Sayal, vice president, downstream energy research at IHS Markit, is author of a new quarterly IHS Markit research deliverable dedicated to analysis of the impact of the IMO low-sulphur bunker fuels regulations, entitled ‘IMO 2020 – The Global Bunker Fuel Sulphur Cap’.
The level of compliance by shippers has been widely viewed as one of the greatest uncertainties surrounding the implementation of the IMO’s new marine fuel regulations, and the compliance level has a significant weighting on projections for refined fuel prices, spreads and margins during the ‘IMO 2020 disruption period’, IHS Markit said. A high level of compliance would result in a high level of market disruption while weak compliance would curtail price impacts, to a degree.
“Because the potential cost to shippers is so high and freight rates have been so low, many shippers opted to take a wait and see approach until they could determine if the IMO was serious about enforcement before committing to a pathway to compliance,” Barrow said.
“It is an understandable, if not costly, gamble, but I think they now have their answer based on IMO actions in recent months. As we at IHS Markit predicted from the beginning, the IMO is firmly committed to enforcement of these new regulations and therefore, compliance will be relatively high.”
Moving ahead with implementation
“The recent signals from the IMO have been clear. At a February 2018 meeting, an IMO subcommittee announced a proposal to ban the carriage of non-compliant bunker fuel (fuel that exceeds the 0.50% sulphur limit) aboard ships that have not installed on-board ship scrubbers (exhaust gas cleaning systems),” Barrow said.
This proposal was approved by the IMO in April, and is likely to be formally adopted later this year. If the proposal is adopted, as expected, it will severely minimise the opportunity for ships to burn non-compliant fuel in the open seas.
In addition, Barrow said progress has also been made by the IMO in 2018 on a number of other issues relating to the new regulations, including transitional plans, verification issues, control mechanisms, and the role of port states, as well as on the reporting of fuel oil non-availability.
“These moves just further reinforce our long-held IHS Markit view that there will be a high-level of enforcement and compliance for the new IMO regulations,” Barrow stated.
“In another potentially crucial development, the insurance industry has begun to debate whether non-compliance with the 0.50% sulphur limit should result in ships being declared ‘unseaworthy’, therefore relieving the insurance provider of liability for any claim the owner might want to make,” Barrow said.
Such a move would be a significant deterrent to non-compliance. Further, there is a large reputational risk of non-compliance for the biggest players in the shipping industry, who are often large publicly listed companies with a need to maintain a strong corporate reputation.
IHS Markit researchers expect that on-board ship scrubbers, devices that capture harmful pollutants from exhaust gas, will be a primary compliance pathway for existing large ships, which could continue to burn lower-cost, higher-sulphur fuels if a scrubber is installed.
The impact on refining industry
Refiners will experience significant price impacts as they shift production to deliver more lower-sulphur fuels to the market and, at the same time, find a market for the higher-sulphur fuels they produce.
“For refiners, there is now insufficient time to initiate large-scale ‘IMO-focused’ refining investments, with 18 months to go until the regulations go into force,” Barrow observed.
“However, refiners are continuing to announce relatively small-scale revamps as they do their best to shift production to deliver more low-sulphur bunker fuels to the market. Refineries, like ships, do not turn on a dime, so it takes significant investment and market demand to retool a refinery to deliver new supply.”
According to the IHS Markit report, the primary challenge with the bunker fuel quality change for refiners (which requires sulphur content in marine fuels to be reduced from 3.5% by weight to 0.5% by weight) is the disposal of high-sulphur residual fuel – not the production of low-sulphur bunker fuel.
“When we account for all the supply and demand factors for the sour residual balance, including new conversion projects, capacity creep, scrubber and liquefied natural gas (LNG) capacity, as well as quality compliance, our bottom line is that a sizable portion of today’s fuel oil will be pushed into lower-price tiers, notably oil-fired power-generation plants,” Sayal opined. “Refining capacity will exist in 2020 to produce the low-sulphur bunker fuel, but higher overall crude runs will be required.”
The impact on refining margins will be fleeting but extremely significant, according to the IHS Markit research, with impacts felt most notably in 2020 and 2021. IHS Markit expects an unprecedented light-heavy crude oil price spread during 2020 to 2021, significantly affecting refinery feedstock costs. During these years, middle distillate prices (diesel, kerosene, jet fuel) will spike dramatically while pricing for high-sulphur fuel oil (HSFO) will plummet.
Winners and losers
There will be big winners and some losers in the refining industry, Barrow predicted. “Simple refiners of sour-crude will be negatively impacted by the nearly valueless sour-crude residue, while refiners of sweet-crude conversion will experience moderately higher margins, but sweet-crude prices will reflect the low-sulphur residue value,” Barrow commented.
“It is the high-conversion refiners of sour crude that are expected to have extraordinary margins. They produce the least amount of residual fuel oil and the highest amount of distillate and gasoline.”
As ship owners respond to the large-scrubber investment incentives, high-sulphur bunker fuel demand will rebound somewhat after 2022, although not to prior 2020 levels.
Due to this increasing demand and addition of debottlenecking capacity for residue conversion, IHS Markit estimates price spreads will moderate within a few years, but the timing of the price recovery will be dependent upon a number of variables.
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