John R. Auers, P.E., Executive Vice President, Turner, Mason & Company Image Credit: Turner, Mason & Company
The decision last October by the International Maritime Organization (IMO) to move forward with significantly lowering the sulfur content of bunker fuel on January 1, 2020 has causing serious hand wringing in both the oil and shipping industries. Potential impacts are large and stakeholders and analysts involved in both are devoting notable efforts to try to understand those impacts and develop strategies to meet the new requirements.
The specific regulations involved come from the MARPOL VI agreement* which was originally adopted in 1997. The final and most significant step in this process is a mandated reduction in the maximum allowable sulfur level of fuels used for ship propulsion from 3.5% to 0.5%, now scheduled to take effect in less than three years.
Most of the discussion to date has focused on the impact on high sulfur fuel oil and distillate prices, along with crude differentials, and we have written about this several times in previous blogs. However other components of the refinery product value chain will be affected as well, with one notable one being the anode coke market.
Turner Mason and Cascade Resources, having analyzed this market some 20 months ago in consort with AZ China, concluded at that time a looming major deficit in this critical raw material, necessary for the production of primary aluminum. We saw that other factors are already driving this shortage and the IMO rules will only exacerbate the situation. Very soon the industry could be finding itself really relating to the lyrics from the classic Tom Petty tune, "Don't Do Me Like That" as both the IMO rules and other factors such as developments in the world's largest aluminum market, China, work together to drive the impending deficit.
* Details about the IMO decision can be found here: http://www.ics-shipping.org/key-issues/all-key-issues-(full-list)/global-sulphur-cap—a-critical-decision
"Listen Honey, Can You See" – Explaining the Basics
As we enter the second half of 2017, our analysis makes us believe the actions of the IMO will have profoundly negative impacts to the primary aluminum industry, which in turn will have major effects on other competitive industries producing such materials as steel, titanium, high strength composites, etc.
The value of the lighter liquid products produced provide a return on the coking investment AND income from the petcoke by-product over what could be realized by selling the VTB's as bunker oil
The mechanisms are complex and interconnected and at the same time appear to not be receiving the attention they deserve. Bringing these concerns to light is to the benefit of all stakeholders, whether they be suppliers, customers or competitors. We will attempt to outline the reasons for our concerns in the following scenarios we see as happening after the IMO implementation date of Jan 1, 2020.
It is helpful to understand how marine bunker fuel oil (referred to as "bunker fuel") is produced. Most refineries buy a blend of crudes. In the oil refining process, the crude oil blend is heated. As the lighter fractions, such as gasoline, diesel, jet fuel, etc. are boiled off and recovered, the remaining heavier fractions of oil along with impurities such as sulfur, metallic elements and sediment form a residue, called vacuum tower bottoms (VTB's). As one can imagine, many of the impurities in the crude oil are concentrated in the VTB's…an important point further in the discussion. The VTB intermediate refinery product is then further processed into bunker fuel which can vary in sulfur content depending on what type of crude is being processed.
The VTB's can also be used as a feedstock to a coker which is a unit in the refinery which thermally cracks the VTB into gasoline and other distillates (diesel, gas oil, etc.) and leaves a solid carbon residue resembling, in a superficial way, coke made from coal. This solid residue is called petroleum coke or "petcoke" for short. The value of the lighter liquid products produced provide a return on the coking investment AND income from the petcoke by-product over what could be realized by selling the VTB's as bunker oil. This difference in realized value between coking the VTB or selling it as bunker oil is called the "coking incentive".
The petcoke contains much of the impurities in the VTB feed. If the crude is sweet and low in impurities (meaning low in sulfur and metals), the petcoke is also low in sulfur and metals making it suitable as an important raw material in the production of primary aluminum. This type of petroleum coke is called anode grade green petcoke, or GPC for short ... an important point to be elaborated on further.
"Givin Someone Else a Try" – Bunker Fuel Steals LS Resid From Anode Coke Markets
As always, economics enters the picture in determined what barrels flow to which markets. Bunker fuel oil, power plant feedstock and other heavy fuel oil (HFO) products made from VTB, generally sell at large discounts to the crude oil it is made from, the discount ranging from 10-20%. As an example, if the crude costs $50/bbl, then the resulting HFO product may sell between $45-40/bbl. The lighter products sell for prices much higher than HFO. The reason some complex refineries use cokers to further process the VTB's is to extract the higher value gasoline and distillates from the VTB's so its value is upgraded. Those refineries that do not have cokers are forced to use the VTB's to make HFO.
As much as 2 million BPD of heavy fuel oil (HFO), which is produced from VTB, coulld be displaced from the bunker market by MDO and MGO in the immediate aftermath of 0.5% rule going into effect in January 2020
When the new IMO sulfur regulations come into effect, the global shipping industry will be forced to use middle distillate products such as marine diesel oil (MDO) or marine gas oil (MGO) which will be the only option available to readily meet the post-2020 0.5% sulfur specification. As much as 2 million BPD of heavy fuel oil (HFO), which is produced from VTB, coulld be displaced from the bunker market by MDO and MGO in the immediate aftermath of 0.5% rule going into effect in January 2020. This will result in a significant increase in distillate margins, with MDO selling at 20% or more above light crude oil, while high sulfur HFO declines to discounts of 30 to 40% below that same crude oil. At the same time, low sulfur HFO which can meet the 0.5% specification, either directly or through blending, will significantly increase its spread vs. high sulfur HFO. In fact, these barrels, which have been priced as a power plant feedstock, and sold at discounts to light crude oil, will instead compete with MDO and MGO in the low sulfur bunker market after 2020 and provide similar product margins for refiners.
Because of these dynamics, a dramatic shift will occur in the economics for refiners producing anode coke. Where prior to 2020, these refineries had been coking relatively low valued low sulfur VTB's, they instead will find that the large coking incentive has disappeared. Instead of running the high operating cost coker, they will instead be able to directly sell their low sulfur VTB as a blendstock for bunker oil at a premium to the crude oil used.
the LS VTB feedstock value could soar to north of $60 per barrel and maybe even approach $70 per barrel, making it a no-brainer to sell it directly
To illustrate the shift in anode coking economics that will occur beginning in 2020, we offer the following, very general, example. In a $50 Brent world, low sulfur VTB could be worth in the neighborhood of $40 per barrel if it were to be sold directly as an HFO blendstock. Processing this VTB through a coker to produce LPG, naphtha, distillate, FCCU feedstock and anode coke would result in a net upgrade in product value (after adjusting for the cost to operate the coker) of $50 per barrel, resulting in a $10 per barrel coking margin for the refiner. Post 2020, the net product value from the same coker (holding anode coke prices flat) would increase by $2 to $3 per barrel to $52/$53 per barrel, due to the increase in distillate margins. However, the LS VTB feedstock value could soar to north of $60 per barrel and maybe even approach $70 per barrel, making it a no-brainer to sell it directly.
If those refineries currently producing GPC now decide to sell their VTB as low sulfur bunker fuel, a foregone conclusion unless anode coke prices increase tremendously, supplies will shrink while at the same time global demand for aluminum is growing at between 3-5% per year.
Typically, a 0.5% sulfur VTB, if used as a coker feedstock, would yields a coke with between 1.4 – 1.7% sulfur content. Most of these low sulfur VTB's also have low metals making this coke ideal anode grade. Just how much anode grade coke could be removed from the market? Estimates vary but a reduction of between 15-25% would not be unreasonable.
Furthermore, with cokers at these refineries underutilized, they will find very cheap high sulfur VTB's which are no longer going into the high sulfur fuel oil market, to replace their own low sulfur VTB's now going into the low sulfur bunker market. The high sulfur VTB's generally do not produce a petcoke suitable for aluminum smelting although some small percentages of marginal qualities can be blended. But in our opinion, there will not be enough GPC to meet the demand.
"Baby You Could Bury Me" – Bad News for The Aluminum Industry
The above developments will place the aluminum industry in a very difficult position for the simple fact that anode coke is an absolutely indispensable feedstock in the manufacturing of aluminum. The aluminum industry needs one-half ton of GPC to smelt and produce one ton of primary aluminum. There is no other commercially available technology to produce primary aluminum. GPC petcoke comprises between 10-15% of the cost to produce aluminum. That GPC has be processed and combined with other materials to produce an "anode" used in the aluminum electrolytic cell known as a "pot". Most refiners consider petcoke as a by-product. They do not choose the crude quality based on petcoke quality. Furthermore, if a refinery can generate more revenue by selling its low sulfur VTB's after Jan 1, 2020 in the bunker fuel markets than coking, that is what will happen.
This is a subject which has been ignored, not out of ignorance, but out of a lack of knowledge and understanding of the complicated value chain we have just presented
Today's price for aluminum is close to $2,000/tonne. If the cost of their critical raw material GPC increases 5 or even 10 fold, unless aluminum prices increase, how can primary aluminum producers afford the increase of anode grade GPC prices?
Furthermore, as aluminum prices increase, would they not lose their competitiveness to high strength steel, titanium and composites? Boeing is already building their 787 Dreamliner wings from composites. The aircraft fasteners (rivets) are still aluminum but advances in composite technology may replace those aluminum fasteners. This is a subject which has been ignored, not out of ignorance, but out of a lack of knowledge and understanding of the complicated value chain we have just presented.
As our readers know well, Turner, Mason & Company focuses on helping refiners and other elements of the downstream refining industry understand and develop strategies to meet the challenges of a rapidly changing market and regulatory environment. Cascade Resources specializes in doing the same for aluminum producers. The IMO rules will be among the biggest drivers of the changes impacting both of these industries over the next several years. As a result, both of our organizations will be working diligently over the next two years studying those impacts and possible strategies for reacting to the changing market situation.
Some of TM&C's analysis will be including in our semiannual Crude and Refined Products Outlook, with the next edition scheduled to be released in early August. We will also be discussing this subject on a regular basis in this blog, as well as potentially developing focused multi-client studies addressing key aspects of the IMO impacts, including the anode coke issues we discussed today. Because the impacts and solutions are very organization specific, our (both TM&C and Cascade) expertise can best be utilized in targeted consulting engagements. Please feel free to contact us if we can answer any questions or provide assistance in any way.
Today's guest co-author, Stu Ehrenreich, has been in the solid fuel trading business for over 35 years. He founded Pacific Basin Coal & Carbon in 1980 which was sold to Bill Koch in 1984 to form the core of the petroleum coke trading business around which Oxbow was built. He has worked in China for Occidental Petroleum, SSM Carbon, Koch Industries and Alcoa touching all aspects of both the fuel and anode grade petcoke business. He is currently Director of Cascade Resources and Consulting focusing on global petcoke supply/demand drivers for both fuel and anode grades. Stu also holds a USCG 100 ton Merchant Marine Masters license as well as a PADI open water diver certification and private pilot's license. He can be reached at
Phone +1 (360) 630-3884