In 2016, International Maritime Organization (IMO), a sanctioning body for the world’s shipping fleet and a specialised agency of the United Nations, decided to stringently implement the use of marine fuels by commercial shipping lines with a sulphur content of 0.5% (mass by mass) from the existing 3.5% limit, with effect from 1 January 2020 – five years earlier than expected by many. Marine fuels within the Emission Control Areas (ECA), comprising northern Europe and the US, will remain at the current cap of 0.1% sulphur.
The specification will affect over three million barrels per day (mbpd) of residual fuel oil and will have an impact on up to 70,000 ships around the world. Surprisingly, these ships collectively use more than three million barrels per day of residual fuel oil, which has a sulphur content that surpasses levels found in automotive gasoline by more than 1,000 times. Using fuels with high sulphur content results in large level of toxic air emissions, including sulphur oxides, which are a serious threat to human health and the environment.
This regulation has resulted in the global refining and shipping industries experiencing watershed changes, and significant cost and operational impacts. The direct impact is on consumers of high sulphur fuel oil (HSFO), namely shippers, and on refineries that produce large quantities of HSFO. The IMO cap will result in major disruption in global oil markets, lower refining margins for many refiners and extraordinary margins for some, and a major surge in fuel costs for shippers.
Options for ship owners
For compliance with IMO specification, ship owners have several options: continue to use non-compliant fuel oil and install scrubbers that clean out exhaust fumes, including sulphur content; burn LNG, or methanol; or use IMO 2020 compliant fuels such as low sulphur fuel oil (LSFO), or marine gas oil. In order to comply with IMO 2020, ship owners can adopt one of these solutions, or a combination of the solutions.
If they switch to LSFO with 0.5% sulphur content, or below, it will involve minor capital expenditure to ensure the segregation of fuels. However, this is a costlier option, as compliant fuels will be priced at a premium compared to HSFO. Massive adoption of this option by ship owners will inevitably result in higher demand for LSFO and a surplus of HSFO.
Using scrubbers will allow ship owners continued use of HSFO with 3.5% sulphur content, or above, but it can lead to increased fuel consumption and CO2 emissions. For ships planning to retrofit scrubbers, a GPCA report estimates that capex of $0.5mn to $1mn will be incurred, depending on the size of the vessel. But, according to an IHS Markit report, worldwide, between 5,000 and 10,000 ships will undergo scrubber installation at a cost of between $2mn and $7mn each, plus increased operations costs.
Using alternative fuels such as LNG and methanol will require vessel modifications and higher upfront capex. This will result in reduced demand for both gas oil and fuel oil, and lower fuel costs for ship owners. While this will also significantly reduce CO2 emissions from ships, since LNG bunkering has not developed globally and there is a lack of LNG infrastructure, LNG being used as alternative fuel for ships moving on standard and short-haul routes will be very limited.
The most alarming element in the implementation of IMO 2020 is the high level of uncertainty involved on various fronts. For example, as it is not clear which of the compliance options will be the most cost effective, it is very difficult for ship owners to make a studied decision.
As of now, refineries worldwide do not have sufficient production capacity to meet the IMO 2020 compliant marine fuel demand. While the rise in ultra-low sulphur fuel oil (ULSFO) demand may put pressure on the refineries to increase capacity utilisation of residue fluid catalytic cracker, coker, and hydrocracker units, strict compliance with the regulation can result in disappearing of substantial quantities of HSFO used by the shipping industry.
And, even in the scenario that the global refining industry is able to produce sufficient quantities of IMO 2020 compliant fuel, there is no guarantee that the machinery on ships designed to run on HSFO can switch to LSFO easily.
As a result of IMO 2020, a number of new fuels and fuel blends have already entered the market, and more are likely to appear in the near future. Using multiple fuel oils, if not managed properly, can result in a variety of problems for the machinery on ships – especially when the fuels are unfamiliar. These issues can vary from clogged fuel systems to, in the worst case, engine stoppage.
At the same time, refiners will undergo major price impacts as they transition production to deliver more LSFO to the market and, at the same time, find a market for the surplus HSFO from their refineries.
And, adding to the problems of the ship owners, according to some major insurance companies, compliance assurance is mandatory for vessel insurability.
Triggering investments and forcing costs
Majority of the refining and shipping companies are ill-prepared for this watershed change. Total compliance with the IMO 2020 regulation is a significant change that requires tens of billions of dollars in investment. Apart from putting a significant cost burden on the refining and shipping industries, compliance with the specification will impact the petrochemical producers with volatile feedstock pricing and higher freight charges.
Worldwide, HSFO was 90% of the fuel in the bunkering business till 2019. It is estimated that more than two mbpd of HSFO will be displaced from the bunker market as bunkering, in addition to power generation, is a key demand sector for fuel oil (FO). Definitely, decline in demand for HSFO will affect the revenues of the refiners. And, HSFO will clearly drop in 2020 in terms of price because it is non-compliant with the IMO sulphur cap.
The refineries which did not invest in cokers and other residue destroying equipment for containing HSFO production will find it difficult to market the fuel. But, globally, the era of HSFO is coming to a dramatic end.
According to Wood Mackenzie, global bunker fuel costs will rise by up to $60bn per annum from 2020 as a result of the IMO sulphur regulation, with bunker costs taking up 70%-80% of total voyage expenses in a full compliance scenario. The IMO specification also forces a significant investment on refiners.
“The IMO sulphur cap for marine fuels is going to trigger major investments in the refining industry in terms of desulphurisation, or additional conversion capacities, which will run in to many billions of dollars worldwide,” claims Mirko Rubeis, partner and managing director, The Boston Consulting Group, Dubai.
Altering supply chain landscape
The IMO 2020 regulation will dramatically alter the global supply chain landscape, resulting in serious implications for the entire oil value chain, particularly on the refining and petrochemical side. The chemical industry, in the GCC as well as globally, will be affected on two key areas: (i) by higher freight rates related to the transportation costs of its products; (ii) feedstock pricing.
All six states in the GCC are signatories to the IMO. The region’s chemical industry has one of the longest and most costly supply chains as one of the highest export-oriented industry in the region, with 83% of chemical output being shipped to over 100 countries worldwide.
According to the Gulf Petrochemicals and Chemicals Association (GPCA), transportation costs are estimated to account for five percent of total chemical sales, warehousing for 3.5%, and additional cost related to supply chain planning and administration accounts for 1.5%. Thus, overall supply chain costs take up 10% of total chemical sales.
In 2015, when LSFO became compulsory in the ECA, Maersk Line introduced low sulphur surcharges ranging between $15/TEU and $80/TEU, depending on the route. According to GPCA, if the same scenario is taken into consideration for the new IMO regulation, export freight rates for the GCC producers can increase by as much as 10% reaching $1,688 on average.
As a result, GPCA estimates that transportation cost will increase its share in total chemicals sales to six percent, up from five percent previously, while total chemical supply chain costs will increase to 11% from 10% earlier.
Given the scale of the change, the entire oil value chain is likely to see high volatility during 2020. The 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 ‘pushes’ some volume of high-sulphur fuel oil to the power sector.
Collateral benefits for petrochemical producers
In the IMO 2020 regime, refineries will drive containing non-IMO compliant products by using lighter and low-sulphur crudes, resulting in collateral benefits for petrochemical producers – since lighter crude tends to yield greater proportion of naphtha, there is a possibility for an increase in naphtha oversupply.
Eventually, structural oversupply in naphtha will be beneficial to naphtha-based petrochemicals production. As methanol can be considered as an alternative fuel for ships under the new IMO 2020 regulation, in long term, demand-side opportunity for methanol producers can also be expected.
While fluid catalytic cracking (FCC) propylene production is likely to decline, the gasoline crack spread, and associated naphtha to crude crack spread are projected to increase. The IMO regulation is significant enough to substantively move refined product price relationships as the aromatics and olefins chains are closely connected to the refining chain.
Advantage Middle East
While the IMO regulation will have a detrimental effect on the profits of refineries producing HSFO, it will make a positive impact on the margins of the modern complex refineries. It is a fact that all the refineries in the Middle East are not modern. There are many refineries with high HSFO yield and low desulphurisation capacity in the region. These refineries will clearly suffer in margins because of the IMO regulation.
At the same time, it is important to note here that a large part of the Middle Eastern refineries are new. As these refineries produce and export distillates, the region will be in a better position in the aftermath of the IMO sulphur cap. And, new refinery complexes coming online in the Middle East and Asia are in advantage to process high-sulphur crude in to IMO 2020 compliant fuels.
According to an APICORP report, Saudi Arabia, in particular, can benefit significantly if shippers choose to switch to LSFO, or marine diesel, as it will be able to meet this demand and increase exports. On the other hand, if scrubbing is the preferred route, there is enough demand from the country’s power sector to absorb its existing HSFO production, and at a reduced cost.
Geared to producing more diesel, the GCC will be in a good position to adjust to the IMO rules, with ample opportunities for the likes of Saudi Arabia and Kuwait to utilise excess HSFO in their respective power sectors. As far as the GCC is concerned, the FO displaced as a result of IMO 2020 may potentially flow to Saudi Arabia, where demand for FO in power generation is increasing in order to replace direct crude burning in power generation, particularly in peak months.
“The Middle East will also be affected – but the situation is slightly different as fuel oil is used for power generation in the region. There will be an expected growth during the period through to 2025 – driven not only by the increased use of fuel oil in power generation but also the increase in bunker demand for ultra-low sulphur fuel oil,” observes Colin Chapman, president, Euro Petroleum Consultants.
One of the most anticipated changes of IMO 2020 is that the complex and flexible refineries in the Middle East may flourish and make better profit margins. For example, ADNOC made ‘zero fuel oil’ refining a high priority when the IMO 2020 regulation was first proposed. ADNOC is well-positioned to benefit from the regulation, as the company has complex refining facilities that can process cheaper heavy crude, while maximising output of distillates.
Abdulaziz Abdulla Alhajri, director, Downstream Directorate, ADNOC, says: “The Carbon Black and Delayed Coker Project announced in Q3-2018 will strengthen our ability to market and sell marine fuels, following the International Marine Organization’s decision to reduce the sulphur content in marine fuels to 0.5% by 2020. Our CFP (Crude Flexibility Project) will be able to process heavy crude to produce high-value products. ADNOC will produce zero sulphur content bunker fuels by 2020.”
In another development, Brooge Petroleum and Gas Investment Co (BPGIC) has announced plans to set up an oil refinery to produce marine fuel with a capacity of 250,000bpd in the Emirate of Fujairah. The facility will be the first-of-its-kind in the Middle East and North Africa to comply with the IMO 2020. The first phase of the planned refinery is to be completed by Q1-2020.
In yet another initiative from the UAE, ENOC Group has announced a strategic alliance with Indian Oil Corporation to jointly develop cylinder oil compliant to the sulphur cap of 0.5%.
Opportunities for technology providers and equipment manufacturers
While operators and technology providers are seriously focused on reducing capital and operating costs of sulphur management projects, the IMO sulphur cap for marine fuels is going to trigger major investments in the refining business. Running into many billions of dollars worldwide, these investments will be for desulphurisation, or additional conversion capacities.
With IMO 2020, finding ways to convert the bottom of the barrel cost effectively is one of the most pressing challenges facing the refining industry today. Refiners worldwide are looking for technology options that will help them to reduce HSFO production and increase margins.
A number of residue upgrading projects have been announced and started recently, especially in the Middle East and Asia. But, even though large-scale projects can be done now in less time than earlier, all planned capacity will not still start up on time to fulfil the strong demand for IMO 2020 compliant fuel.
“When you are talking about the IMO sulphur cap on marine fuels, you are talking about more sulphur – may be 15% more sulphur from the refineries by removing the sulphur from those fuels. Most of the region’s refineries have already done their specifications to the Euro levels; but, IMO regulation will have more than an impact if the refineries here choose to implement the regulation. But, easily it can be addressed through hydrotreating capacity, or oxygen enrichment,” comments Angie Slavens, managing director, UniverSUL Consulting.
At the same time, IMO 2020 regulation is not a threat for all market players. It is an opportunity not only for licensing companies, which provide technologies and equipment to treat and minimise sulphur, but also for catalyst providers. One of the main drivers for global refining catalyst demand growth is stricter environment and safety regulations worldwide – both for fuel specifications and composition, and for environmental impact.
One of the most well-known refinery technology that has been developing for decades to be able to process different feedstock blends, sustain optimal working parameters and stability of gasoline quality and yield is the FCC process. Some industry forecasts say that FCC catalyst market will value over $3bn by 2025. Now the share of FCC catalyst is close to 50% of all refining catalysts. The IMO regulation may surge the market for FCC catalysts as refineries aim to produce maximum middle distillates.
Compliance is the key
The implementation of the IMO regulation is left to individual countries. Monitoring the enforcement of the IMO cap on sulphur content in marine fuels is a key issue. The big shipping companies will comply fully with the IMO regulations because of the risk of losing the licence to operate, which is a big deterrent.
For the biggest players in the shipping industry, there is also a significant reputational risk on non-compliance since most of them are huge publicly listed organisations with a need to maintain strong corporate image.
Compliance remains the biggest uncertainty for IMO 2020. There is no guarantee that sufficient quantity of compliant fuels will be available in the ports around the world. For the IMO 2020 regulation to have any real impact, enforcement of penalties for breaches of its specifications have to be stringent.
Risk-free non-compliance as a result of inadequate detection methods, limited sanctions and a lack of robust legal framework are serious causes for concern. As of now, no global body is responsible for enforcement, or sanctions, as these are framed locally and can differ drastically from one region to another, making consistent and effective enforcement a real challenge.
“On the IMO 2020 sulphur cap, it is important to call for collaboration between the producers, regulators and shipping companies. We can expect high global adoption rates in 2020, equivalent to 85% of residual bunker demand. What remains uncertain is the enforcement framework, as inspection of ships at high seas is simply not practical,” opines Dr Abdulwahab Al-Sadoun, secretary general of GPCA.
The way forward
The most appropriate step for refiners against the backdrop of the IMO 2020 is investing in the refinery in terms of its desulphurisation capacity. Normally, this is very expensive, leading to investments in the level of many hundreds of millions of dollars – around $900mn per facility. Some refinery players, once faced with investments of hundreds of millions, may also opt to upgrade the assets with hydrocracking capacity, or coker capacity, or both.
If majority of the shipping lines are opting for compliance through LSFO, the highly complex refineries as well as refiners with deep conversion and distillate-focussed configurations will be the winners.
Crude-price relationships will broaden around the disruptive period of compliance – between 2020 and 2025 – specifically between light-sweet and heavy-sour crude.
As a result of IMO 2020, while refiners of sour crude will be negatively impacted by the nearly valueless sour-crude residue, refiners of sweet-crude conversion will gain relatively higher margins. At the same time, sweet-crude prices will reflect the low-sulphur residue value. The biggest gainers will be the high-conversion refiners of sour crude, who will benefit from extraordinary margins.
Complex refineries in countries like the US and China can change their current refinery configurations for increasing production of IMO 2020 compliant fuels. Simple refineries having access to ultra-sweet crude from coasts of West Africa and US shales can also reduce the supply-demand gap in the compliant fuel by ramping up their ULSFO production.
From IMO 2020, highly complex refineries with the flexibility to convert different grades of crude oil into a wide range of refined products will benefit most, which will produce the least amount of residual fuel oil and the highest amount of distillate and gasoline in comparison with lower-complexity refiners.
In the consumer markets, the end result of IMO 2020 will be higher freight costs for all cargoes, and even higher cruise ship fares. Ultimately, those costs will be passed on to the end consumers, thereby increasing household expenses worldwide. Soon, companies and households across the world will begin to feel the impact from higher freight costs.
(This story incorporates quotes from industry leaders given for earlier cover interviews of Refining & Petrochemicals Middle East.)
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