Grace Quinn, Baringa Partners
1st January 2015 saw the shipping industry become subject to new regulations which affect marine fuel specifications and in turn the global market. The International Maritime Organization (IMO) has reduced the maximum sulphur emissions limit for all vessels traveling in Emission Control Areas (ECA's) to 0.1 per cent.
All vessels traveling through these areas are now required to burn low sulphur fuels, such as Marine Gasoil (MGO) or Liquefied Natural Gas (LNG) as a replacement for Fuel Oil (FO). Alternatively, vessels will need to stimulate exhaust gas scrubbing.
Globally, the sulphur emissions limit was reduced in 2012 with further reductions in scope for 2020, to a 0.5 per cent limit. However, this cap will still however be more lenient than the ECA's 2015 requirements, with industry speculation suggesting that it could be pushed back until 2025.
The EU on the other hand have committed to this 0.5 per cent limit as mandatory in EU waters by 2020 which has fuelled controversy from the shipping industry as it leaves the EU at a competitive disadvantage to the rest of the world, should they not have to comply until 2025.
Where we are today
In recent years the cost of compliance has been a mounting concern for ship owners and operators.
Previously, the price of MGO has been considered by many to be prohibitive as a long term compliance option
However, these new regulations have coincided with a fall in oil prices which has allowed ECA compliant MGO to present itself as a feasible option. Previously, the price of MGO has been considered by many to be prohibitive as a long term compliance option. As a result the return on investment (ROI) figures for those investing in alternatives to MGO has significantly changed. For example a reduction in the price differential between High Sulphur Fuel Oil (HSFO) and MGO will negatively impact the payback time for scrubbers .
The gas market has not mirrored the significant fall in price witnessed by the crude oil market. Consequently, the price advantage once offered by LNG as an alternative to MGO no longer yields the same value. As a result, the business case for LNG as a bunker fuel is significantly more challenging in the near term.
For many owners the reduced oil price has afforded them time to hold back on investment decisions regarding scrubbers or a switch to LNG, both of which require significant capital investment.
Despite these obstacles the momentum for LNG as a bunker fuel continues.
Supply and Demand
Global supply of LNG is set to expand over the next few years as production increases and new supplies come online; developments in Russia, the US and Australia will be major contributors to this influx. While this increase in supply will support the already growing appetite for LNG as a bunker fuel, the short-term picture is one of oversupply as global demand will not increase at the same pace, particularly if current oil price levels remain.
LNG bunkering in Asia in particular is predicted to grow significantly as tighter regulations on sulphur emissions come into play
LNG as a marine fuel has already been embraced in North Europe with significant traction being made in North America. According to New-York-based market intelligence firm Transparency Market Research (TMR) the market for LNG as a bunker fuel will expand at a rate of more than 60 per cent a year for the next ten-years .
So what is driving such significant growth?
Expanding ECA regions is likely to be a large component of this increased demand. LNG bunkering in Asia in particular is predicted to grow significantly as tighter regulations on sulphur emissions come into play. China has recently published an action plan for 'Ship and Port Pollution Prevention (2015-2020)' which promotes LNG as a marine fuel and the establishment of China's own ECAs. Additional proposals have also been put forward to extend ECAs to Japan and Southeast Asia.
Promotion of LNG as a bunker fuel will also be a contributor to this growth forecast. This can be seen to vary by region. For example, the Maritime and Port Authority of Singapore (MPA) have requested that interested parties apply for an LNG bunker supplier licence. Singapore's LNG terminal further supports this request with plans to introduce both a jetty for LNG bunkering and a station to supply bunkers by truck.
Such activity will likely broaden the market and appetite for LNG as a bunker fuel.
Progress since January 2015
The first year of ECA regulation has seen some notable progress in establishing LNG as a global marine fuel.
Questions surrounding the degree of compliance being observed have been commonplace
The International Code of safety for ships using gases or other low-flashpoint fuels (IGF) has been defined and adopted which establishes a clear design for LNG-fuelled vessels and provides a much needed international framework. This code is an important step in the adoption of LNG as a bunker fuel.
Questions surrounding the degree of compliance being observed have been commonplace. To date the results obtained for Europe have been encouraging. Data submitted to the European Union (EU) THETIS-S database reports that of 1,458 ships inspected in Q1 2015, 6 per cent (89) showed non-compliance, mostly related to documentation errors. Only 1.4 per cent were based on fuel sulphur tests. Figures from Denmark suggested that 98 per cent of the ships passing an emissions monitoring station in the Great Belt complied with the ECA sulphur limits.
Progress within the LNG bunker market has heavily relied on key stakeholder 'buy-in'. In the past year some significant players have come to the table. For example:
Carnival Corporation, the world's largest cruise company, has thrown its weight behind LNG by ordering what it says will be the first cruise ships able to run liquefied natural gas (LNG)
Shell plans to charter LNG-powered barges for use in northwest Europe from late 2016 while North America's first LNG bunker barge is scheduled to be launched in February
Initiatives to further support LNG can be seen by port authorities in Europe. For instance in Rotterdam a discount on port fees is applicable for vessels loading LNG bunkers until 2020.
The adoption of LNG as a marine fuel does, however, face numerous challenges.
Uncertainty around regulatory developments - one in particular is when the global sulphur cap of 0.5 per cent will be introduced. This, coupled with a low oil price, does not create a climate which entices capital investment, particularly when alternatives are available at an affordable price.
The pricing dynamics of LNG also continue to challenge the industry, as globally they can vary quite considerably
The pricing dynamics of LNG also continue to challenge the industry, as globally they can vary quite considerably. For example, new supply coming online is expected to soften global spot LNG price but that does not necessarily translate to price delivered to ship. Ambiguity surrounding LNG pricing is largely as a result of uncertainty as to how LNG will be indexed in the bunker market. For example, as an oil-indexed price or a gas-indexed price based on the National Balancing Point (NBP).
One of the biggest hurdles to LNG as a global marine fuel is the perception that there is a lack of infrastructure to support it. Ship-owners have been reluctant to invest until they can be assured such infrastructure is in place. Suppliers on the other hand have sought evidence of demand, which for many has progressed to a commitment of investment. To date, infrastructure to support truck delivery has dominated the market which can be restrictive for larger vessels and trades. While the spot market for bunkers still has some way to go in satisfying owner or operator requirements, current plans and developments underway suggest a close in this gap over the next few years.
Outlook for LNG
The past year has shown that in the face of uncertainty, for many, pursuing a strategy that allows flexibility is the answer. Choosing dual fuel engines that can burn both gas and fuel oil and can be converted to LNG will go somewhat towards risk mitigation. For others, preference has been a strategy which provides bargaining power in the short term for a long-term opportunity, LNG fuelled vessels.
The price relationship between HSFO, MGO, LNG and alternative fuels will continue to underpin the business case for LNG investment
The price relationship between HSFO, MGO, LNG and alternative fuels will continue to underpin the business case for LNG investment. However, advancements in infrastructure, LNG production and increasing demand in the LNG bunker market suggests that stakeholders expect a continued tightening of regulatory requirements and a return to higher oil prices.
While there are a lot of favourable trends enabling LNG bunkering, its cost competitiveness remains uncertain.
The challenge today is making decisions in the near term which do not restrict your ability to retain margin in the long term. In other words 'future-proofing' your business model.