Navigating Through Complexity: IMO 2020 and Opportunities Created by Fuel Market Dynamics

by Matt Muenster, Senior Manager of Applied Knowledge, Breakthrough
Wednesday October 10, 2018

With January 1, 2020 just 15 months away, compliance with the IMO's sulfur cap has the complexity of a game theory framework. Key compliance stakeholders, such as container carriers and refiners, have found their decision-making and likely outcomes are interdependent and made more complex by a volatile energy market that just experienced the highest price of crude oil in four years.

Although the post-2020 energy market is the focus of the coming regulations, the current energy market continues to factor prominently into decision-making for IMO 2020 compliance. Through the first three quarters of 2018 upward price pressure for crude oil and refined products has increased uncertainty for the growing mix of fuels to be consumed by the maritime industry. Consequently, fuel reimbursement practices, too, will become more complex.

How has today's market shaped tomorrow's plans for compliance?

The climbing prices of crude oil and refined products have provided momentum for scrubbing technology adoption and, therefore, boost 2020 estimates of HSFO demand. Not only have bunker prices steadily climbed since July of 2017, but the differential or spread between HSFO and LSMGO has continued to widen. This offers a glimpse of the anticipated market behavior to continue as IMO 2020 approaches.

Additionally, the spread between IFO380 and LSMGO has remained over $200 per metric ton across major bunkering ports since January and has recently climbed to a range closer to $250 per metric ton. As the spreads between presently available high and low-sulfur fuels continue to increase, the projected pay-back period for scrubbers continues to narrow, and the interest in scrubbers has continued to grow.

The fundamental shift in the oil market from a period of excess supply to a new equilibrium near five-year average inventory levels has made it difficult for vessel owners to shrug aside scrubbers and, as recent headlines have shown, has encouraged some to adjust their strategies for compliance.

Underlying data supporting the continuation of strong performance from the middle of the refined barrel has been encouraging news for those installing scrubbers, too. Weekly EIA inventory reports continue to show distillate stocks remain below five-year averages despite US refinery output persisting above 5.3 million barrels per day late in September.

OECD data collectively share a similar story of significant draws during the past calendar year, which have been supported by sustained economic expansion across most developed and emerging economies. Much of this data supports a growing premium for middle distillates, which has materialized through widening crack spreads. This behavior, when paired with the anticipated, steeply discounted crack spreads for residual fuel oil, represents an increasing ROI for scrubber adoption.

But while interest in scrubbing technology has grown as the differential between high-  and low-sulfur fuels has materialized, plenty of resistance toward adopting the technology has lingered. Capital investment, specialized maintenance, fuel availability and reduced environmental benefits have been cited as reasons to consume the 0.5 percent S bunker instead, and the range of market expectations for HSFO demand, seemingly 20-35 percent when including noncompliance, is quite speculative.

While the adoption of scrubbers ahead of IMO 2020 has surged of late, risks to sustained scrubber investment post 2020 will challenge longer-term HSFO projections. Current energy prices, including the growing crack spreads for low-sulfur fuels, have been supported by economic expansion across most major developed and emerging market economies. Reduced demand from downside risks, such as trade disputes, emerging market currency crises or tightening monetary policy, could reduce energy prices in the next one to three years, making vessel owners less sensitive to low-sulfur bunker costs.

The North American truckload market is all too familiar with fuel market dynamics quickly influencing fuel choice. The steep crash of the oil market in 2014-2015 stole momentum from the adoption of CNG and has helped heavy-duty trucking remain largely fixed on diesel fuel. In addition to energy market risks, tightening monetary policy is anticipated across major financial markets, so the cost of debt from such projects as scrubber installation will climb, too.

Transparency offers a competitive advantage

While energy market dynamics continue to push a "wait and see" mantra into IMO compliance decision making, industry developments over the past couple weeks have quickly revealed the value of transparency for fuel reimbursement moving forward. Existing BAF and fuel surcharge programs that push a single fuel reimbursement amount for vessels operating through the consumption of low-sulfur marine fuel and/or scrubbers and/or LNG in the future should continue to be questioned by shippers.

Compliance solutions are being determined on a trade lane by trade lane, vessel by vessel basis. Fuel cost reimbursement should be calculated in this manner, too, since the cost of fuel consumption and reimbursement should match.

For example, consider a manufacturer that repeatedly moves goods from Shanghai to LA/Long Beach over the course of a year. These shipments will likely use a host of different vessels with different operational profiles and fuel consumption patterns.

Each of these characteristics can create a competitive advantage in the market for carriers who approach these decisions strategically. Shippers who choose to manage fuel as a transparent, pass-through cost will be positioned to realize these competitive advantages.

Conventional fuels will continue to become cleaner with price implications. In addition, the number of alternative fuels and their pace of adoption is likely to pick up. IMO 2020 is another step along the path toward cleaner oceans and ports, and demonstrates the growing complexity of managing the cost of energy.