Industry Insight: Bunker Down for New Fuel Regime

Grace Quinn, Baringa Partners

The shipping industry stands on the brink of new regulations that will affect marine fuel specifications and in turn the global market. Currently residual Fuel Oil (FO) dominates as the bunkering fuel of choice; however the impending regulations will impose limits affecting the types of marine fuel that will remain compliant within certain jurisdictions.

The International Maritime Organization (IMO) has introduced new regulations to reduce the maximum sulphur emissions limit for all vessels traveling in Emission Control Areas (ECAs) by 2015. Global refining, bunkering and commercial shipping industries will be affected, and any vessels traveling through ECAs will be forced to shift to low sulphur fuels such as Marine Gas Oil (MGO), or alternatively stimulate exhaust gas scrubbing.

Both options carry significant economic and financial implications for the shipping industry, and specifically those who are responsible for bunker fuel costs. In most cases, this responsibility lies with ship owners and poses a significant challenge as the market faces uncertainty across numerous variables.

The global sulphur emissions limit was reduced in 2012, with further plans to reduce emissions to 0.5% by 2020. The proposed cap will be subject to a feasibility review across fuel availability. However if it goes ahead, it will still be more lenient than the ECA's 2015 requirements. Furthermore, industry speculation suggests that the global emission reduction could be pushed back as far as 2025.

The European Union (EU), on the other hand, has committed to the 0.5% limit as mandatory in EU waters by 2020. This has fuelled controversy from the shipping industry because it leaves the region at a competitive disadvantage to the rest of the world, should it not have to comply until 2025 (see Table 1).

As the imminent ECA deadline of 2015 calls for many to 'walk the plank', concern is understandably mounting.

So what's the bottom line for the shipping industry?

Compliance Options

Whether you own and operate local passenger ferries, fishing trawlers, tug boats, bulk, crude, chemical or gas tankers (to name but a few) in EU or ECA waters, you need to consider what your compliance options are:

1. Switching to burning MGO when in these areas (considerably more expensive than FO)
2. Investing in an Exhaust Gas Scrubbing System (very costly particularly if the vessel spends minimal time in EU/ECA waters)
3. Planning and development to accommodate the use of Liquefied Natural Gas (LNG) as a bunker fuel (a longer term solution that faces uncertainty around supply and significant investment)
4. Changing trade routes and commercial operations to limit exposure in the near term
5. Choosing not to comply and be subject to hefty fines, charges and operating constraints

Each of these options affects the bottom line. Likewise, not all options will be feasible for each vessel type or fleet.

A fleet's degree of exposure and flexibility to respond to the regulations will vary depending on commercial operations and the markets in which they operate. Clearly, those with significant operations within these waters will be at a competitive disadvantage to those not similarly exposed.

For example, passenger ferry services within ECA/EU waters will be heavily susceptible based on the amount of time they spend in the region and the rigidity of their operating model. Similarly, cruise ships operating within the same region will have less flexibility to use alternative routes if they are to meet their commercial commitments. This is in stark contrast to tankers, which generally operate across more diversified routes that open the door for more strategic use of assets.

For many ship operators and owners, the obvious solution for compliance is to limit your exposure in the near term by changing trade routes and commercial operations where possible. These are the key ingredients for a form of market arbitrage: where operators and owners select routes and ports that best suit their bunker fuel budgets.

So how are ship owners going to comply in 2015 while optimising their fleet's commercial operations?

Compliance Options

Some would argue that switching to MGO is the only viable option and for many vessels this is true. A scrubber may be too costly an investment, particularly if you do not spend enough time in these waters to justify the payback period. Alternatively, the vessel may not be physically large enough to operate a scrubbing system and accommodate its ongoing upkeep, or the vessel may not have enough commercial life left to warrant the investment.

Commercially you may operate heavily within ECA and EU regions, where alternative routes are not a feasible consideration in continuing to honour commercial commitments. If this is the case, then you reach the same conclusion as many others – MGO appears to be the only short term solution, presuming vessels can be modified to switch fuels.

For ship owners, deciding the best compliance option is only the first step. Compliance should not lead to complacency regarding the knock-on effect this will have.

As industry stakeholders, ship owners should not underestimate the impact that near term decisions will have on their flexibility to respond as the market and environment plays out over the next 15-20 years. With so many uncertainties surrounding market fundamentals (supply, demand, technology and regulations), one can only make assumptions on how various scenarios will impact their operational structure and bottom line in the future. The challenge today is making decisions which optimise operations in the short term, without restricting the opportunity to sustain margin in the long term, regardless of the future landscape.

A starting point would be to analyse how today's compliance options (1-5 above) and investment decisions fare down the line if the following scenarios occur:

1. LNG becomes a readily available bunker fuel within Europe and the price spread is more favourable between FO and LNG than the FO to MGO spread
2. As in '1' but the price spread between FO and LNG is less favourable than FO to MGO
3. Price of FO increases to the point it is at parity with orsurpasses LNG and MGO
4. Globally the 2020 emissions cap is postponed indefinitely
5. Regulations impacting other modes of transport force an intra if not full modal switch to shipping

It is necessary to bear in mind that the impact of each of these scenarios will vary for every business and market player, depending on their unique commercial model.

With uncertainty around the timing of global regulations, fuel supply balances and the price of MGO, how can ship owners mitigate their risk and exposure while remaining competitive?

Change

What is certain is that the competitive landscape will change, as those exposed to the 2015 and 2020 regulatory constraints undertake internal reviews and impact assessments, in turn putting short to medium term strategies in place.

The ways in which shipping companies respond to the new requirements will have a direct impact on the demand quality of marine bunker fuels. Likewise, the response of the refining industry to perceived customer requirements will affect the availability and pricing of these marine fuels.

It is clear that stakeholders within the shipping industry need to define how the new sulphur regulations will ultimately affect their commercial operations both in 2015 and beyond, ensuring the scope includes not only monetary implications but also analyses where commercial cost savings can be achieved. The decisions made now in an attempt to optimise operations in 2015 will have an implication on the numerous scenarios which could play out in the future. Many companies may find that their in-house expertise and resources are limited in their ability to address these impending decisions. Have you started thinking about how you will address this?

After all, you don't want to miss the boat.