IMO 2020: Current Futures Prices and Refiner Processing Options

Ralph Grimmer of Stillwater Associates. Image Credit: Stillwater Associates

IMO 2020 implementation is six months away, and shipowners will likely start purchasing IMO 2020-compliant marine fuel (for vessels without onboard scrubbers) in the next three months. Stillwater Associates has offered a series of articles on various aspects of IMO 2020 over the past two years. In this month's article, we provide an update on futures prices in Rotterdam, Singapore, and the U.S. for IMO 2020-related commodities. We also provide our assessment of refiners' options to optimize individual refineries and refining networks. (If you need some background before you dive into these futures prices and refinery options, check out our explainer on the IMO 2020 regulation.)

Current Spot and Futures Prices

Marine Fuel 0.5%, also known as Very Low Sulfur Fuel Oil (VLSFO), is the primary IMO 2020-compliant distillate/residual product blend. CME Group (parent company of the NYMEX) and Intercontinental Exchange (ICE, parent company of the New York Stock Exchange) have each launched futures contracts for Marine Fuel 0.5% in Singapore, Rotterdam, and the U.S. Gulf Coast. Thus far, all three VLSFO contracts on both exchanges have struggled to gain traction due to the lack of trading volume. Over the coming months, these contracts should begin trading in volumes sufficient to provide market pricing direction insights and hedging opportunities.

Similarly, reporting services Argus, Platts, and OPIS are moving towards publishing daily spot prices for IMO 2020-compliant marine fuels based on actual transactions. As with the VLSFO futures contracts, these spot market assessments will become meaningful market indicators as transaction volumes increase.

With the new futures contracts for VLSFO and spot market transactions lacking adequate trading volumes, traditional published futures market prices are the most visible indicator of market direction in the interim. Stillwater has put together a summary of IMO 2020-related futures prices from August 2019 through 2021. We've included marker crude oils (Brent, WTI Cushing, and Dubai) and relevant refined products prices in Northwest Europe, Singapore, and the U.S. (Note: there are currently no futures prices for U.S. high sulfur fuel oil (HSFO).) In addition to prices, our summary of IMO 2020-related futures prices also includes a number of key crude and refined product market price differentials.

Futures contracts pricing relationships among key crude oils and refined products have been surprisingly stable over the past six months. Whether current futures contract price differentials will accurately predict actual market behavior is a key question. Some market observers suggest that current futures contract price differentials may understate marketplace price changes that actually occur, driven by IMO 2020.

Figure 1 tracks current futures contracts price differentials for diesel products relative to Brent over the August 2019 through December 2021 timeframe.

Futures contract diesel price differentials to Brent in Northwest Europe, Singapore, and the U.S. have been relatively stable over the past six months. Mid-2020 diesel-Brent price differentials for futures contracts continue to reflect widening versus mid-2019 of only about $2.00-3.00 per barrel (bbl), as shown in Table 1 below.

Figure 2 tracks current futures contracts price differentials for Brent crude relative to HSFO over the August 2019 through December 2021 timeframe.

Futures contract HSFO price differentials to Brent in Northwest Europe and Singapore have also been relatively stable over the past six months. March 2020 Brent-HSFO price differentials for futures contracts continue to reflect widening versus August/September 2019 of $5.00-6.00/bbl, as shown in Table 2 below.

Figure 3 displays current futures contracts price differentials for diesel products relative to HSFO over the August 2019 through December 2021 timeframe.

Futures contract diesel products price differentials to HSFO in Northwest Europe and Singapore have been relatively stable over the past six months. June 2020 Brent-HSFO price differentials for futures contracts continue to reflect widening versus August/September 2019 of $6.30-7.40/bbl, as shown in Table 3 below.

Figure 4 displays current futures contracts price differentials for WTI Cushing and Dubai crudes versus Brent crude over the August 2019 through December 2021 timeframe.

Futures contract price differentials for marker crudes have shown a bit more change than for refined products over the past six months. December 2018 futures contract prices reflected the Brent-WTI Cushing price differential relatively stable in the $7.70-8.00/bbl range from August 2019 through June 2020. Current futures prices reflect this differential decreasing by $1.13/bbl (from $7.77/bbl to $6.64/bbl) over the same timeframe, indicating a more positive market expectation on forward WTI pricing. Meanwhile, December 2018 futures contract prices reflected the Brent – Dubai price differential widening by $0.53/bbl over the August 2019 through June 2020 timeframe. Current futures prices reflect this differential decreasing by $0.16/bbl over the same timeframe, a swing of almost $0.70/bbl over the past six months.

Given where future prices currently appear to be pointing crude oil and refined products prices, what can refiners do to optimize financial performance? What adjustments should be made to best navigate the changes that IMO 2020 will spark?

Refiner Processing Options

Refineries routinely re-optimize crude oil and other raw materials to be acquired, processing strategy within each refinery, and the mix of refined products that should be produced and moved to market. Linear programming (LP) models and other tools are employed in this critical optimization process. Understanding what the marketplace options and refinery capabilities are and incorporating these options in the LP models are is critical to the optimization process.

With major refinery capital projects requiring notionally five years for engineering, permitting, and construction, it is too late for a refiner to initiate a capital project aimed at capitalizing on market changes driven by IMO 2020. Unless a refinery also has a major capital project well underway, that refinery will be focused on optimizing its strategies for crude oil purchases, refinery processing, and refined products disposition with the assets currently in place or that can readily be modified with minor capital investment.

Refineries will have a strong incentive to work closely with their trading counterparts to build and maintain a clear picture of forward market prices and available supply and trading options. Less complex refineries will tend to be more exposed to sweet crude dependence and HS resid placement issues. All refineries (especially those without resid upgrading facilities such as cokers and resid hydrocrackers) will be driven to identify and evaluate processing options such as:

• Continually optimizing refinery crude slate as light/heavy crude price spreads widen
• Optimizing processing modes and fractionation cutpoints (e.g. max distillate vs max gasoline)
• Evaluating the economics of processing vacuum resid on FCC
  • Resid cat cracking will look the most attractive for refineries with low sulfur crude slates
• Blending and sales of on-spec VLSFO over refinery dock
• Sales of VLSFO blend components over refinery dock
  • Include consideration of non-traditional marine fuel blendstocks (e.g. low sulfur VGO, lower sulfur decanted oil)
  • Sales of these "new" products may require minor piping and tankage CAPEX
• For a multi-refinery company, optimizing the refinery network rather than just individual refineries
• Initiate a dialogue with neighbor competitor refineries to surface new options and points of flexibility
• Evaluating other non-capital or minor capital changes that will maximize refinery gross margins

Refineries that have already invested in resid upgrading facilities should see IMO 2020 as an opportunity rather than as a threat. High sulfur crudes should become less expensive relative to marker crudes such as Brent and WTI. Clean refined products (not only diesel but very likely jet fuel and gasoline) should become more valuable. Refinery gross margins for more complex refineries should improve as a result of IMO 2020.

For the more complex refineries with resid upgrading, there are additional processing strategies that should be considered beyond those listed above:

• Optimize crude slate and other raw materials purchases
  • Heavy-up the crude slate versus purchasing coker and resid hydrocracker feedstocks to utilize currently unfilled capacity
  • Consider blending purchased resid with light sweet crudes to create pseudo crude blends (if the resid has too many light ends to feed directly to the coker)
  • Inter-refinery residual feedstock movements may become common, especially between countries
• Increase resid upgrading capacity without major capital investment
  • Enable marine and rail car receipts of resid upgrading feedstocks
  • Improve crude unit vacuum tower performance
  • Debottleneck cokers (e.g. shorten coke drum cycle length)
  • Debottleneck hydrocrackers and hydrotreaters (e.g. catalyst changeout; higher severity operations)
  • Solvent extraction units gross margin uplift should increase

Conclusion

IMO 2020 is likely to be the most impactful refined product specification change ever, largely because the change will be both global and instantaneous. Marketplace valuation of Marine Fuel 0.5% (aka VLSFO) blends of IMO 2020-compliant fuel should gain significant liquidity over the next six months. The rollout of IMO 2020 is quite likely going to be a bumpy ride from a key price differentials perspective. Stillwater Associates stands ready to partner with you to better understand IMO 2020, explore options, and help in identifying the most beneficial strategy and tactics for your situation. Contact us to see how we can add value to your business.