Adrian Tolson, Senior Partner at 20|20 Marine Energy
The 2020 0.5% global sulphur cap is rightly seen as a transforming event for bunkering and the shipping industry. Its imminent arrival, in only 16 months, has been seen by many as the end of an era, taking the industry away from the 70 years of residual fuel supply and putting it firmly (if not entirely) in a new distillate fuel world. Coinciding with this event we are also seeing a shift to a more transparent bunkering industry. This is a consequence of the 2020 regulation, as well as a product of other forces impacting shipping and bunkering. Whatever, the industry is changing rapidly, and causing many companies and individuals to consider whether they wish to stay engaged or to leave in the coming months. It is the end of an era.
Well, at least that was the way it was going until the first half of 2018. Then seemingly, and without warning, the industry managed to generate a crisis that may hasten the demise of the residual fuel era for bunkers. In February this year, industry rumors started spreading regarding some unexplained isolated quality issues in Panama from Ecuadorian fuel. Within one month these rumors became a reality as quality issues found their way to Houston and other Texas ports.
The impact has been felt by almost every major shipowner, and justifiable demands for a clear explanation have come from both owners and their P&I Clubs
Usually these quality issues that go viral tend to burn themselves out as a tank or a cargo is finally cleared, but this one didn't go away. More and more problems developed in the Gulf Coast during April and May and soon the problems were back in Panama (again with some help from Ecuador). They then found their way to Curacao and on to Singapore and Asia. Meanwhile the Houston claims continued into July. More than 200 ships have been involved, the largest single bunker claim event that anyone can recall.
Initial ISO 8217 analysis showed nothing out of the ordinary and soon the ugly word of "contamination" was being used. Contamination that caused vessels to suffer operational issues or physical engine damage because of bunkering residual fuel that had been blended with one or more problem cutter stocks. The impact has been felt by almost every major shipowner, and justifiable demands for a clear explanation have come from both owners and their P&I Clubs.
Unlike any other bunker claim, the causes of these problems are being openly debated in the media. However, whether you prefer "tall oil" or "phenolic compounds" or a "byproduct of shale oil refining" or a combination of all three as your explanation, it seems less relevant than how to prevent this happening again. Almost every physical supplier in the most impacted areas are now offering detailed GC/MS reports as a way of proving the quality of their oil. However, GC/MS testing is great for telling you afterwards what "might" have caused your problem, but not great for telling you what "will" cause the problems before you bunker. In the end, supply chain security is all about knowing the counterparty and trusting their competence and honesty, which is entirely another separate debate from this fundamental issue.
Physical Supply Chain
Perhaps more interesting is how these claims are impacting the current and future bunker supply industry, temporarily altering supply patterns and potentially accelerating the demise of residual fuels. In the ports themselves we have seen disruption to normal bunkering patterns with sales volumes significantly reduced in both Houston, Panama and to a lesser extent Singapore as ship owners seek out "safer" ports to buy their residual fuel.
it should not be a total surprise that in the last few weeks we have seen personnel changes at one of the world's largest cargo traders, which was immersed in the Houston and Panama claims
Along the physical supply chain, we are seeing reaction to these claims as suppliers reduce their exposure to problems of residual fuel. Physical bunker suppliers with limited product quality guarantees see themselves significantly at risk from the warranties they must give to fuel purchasers. We have already seen one of Houston's biggest suppliers leave the market and we should expect to see other physical suppliers increasingly limit operations as financial and reputational damage becomes more apparent. Many of these physical bunker suppliers will look to legal or financial recourse from the large suppliers and cargo traders; it should not be a total surprise that in the last few weeks we have seen personnel changes at one of the world's largest cargo traders, which was immersed in the Houston and Panama claims, and also that we have seen another very large commodity trader give up storage tanks in Balboa. There is a key question around whether the marine energy supply chain is losing interest in residual fuel; with only 16 months to go, are they considering the point of continuing to take the risks and deal with all these problems? Are oil suppliers and traders just best to look forward to the distillate world?
However, it's not just suppliers and traders losing interest, ship owners and fuel purchasers are transferring their concern over the blending of high sulfur residual fuels to the potential blending of IMO 2020 compliant 0.5% VLSFO. It's hard to see the risk as any different from the current high sulfur residual era, as clearly contaminants can get into the supply chain today as well as in a post 2020 world. However, perhaps the recent concern is enough to make more ship owners lean in the direction of distillates, and away from blended fuels, altering the anticipated post 2020 demand picture.
most ship owners will still want to use high sulfur residual fuel for as long as they can
Unless of course VLSFO is significantly cheaper than the distillate alternative. And here’s the crucial point. Once ship owners receive assurances from suppliers on quality (of which they may still be skeptical), then as long as 0.5% VLSFO is much cheaper than MGO, will they be willing to take the quality claim risk? Will they just view the occasional claim (even a large one) as just an inevitable, sporadic ‘rub of the green’ when it comes to dabbling in using VLSFO for main engines, covered by insurance and possible legal recourse? And what is the price for this pound of flesh? A $200 differential would appear to be enough, because that’s the gap between HSFO and MGO today, and no one after these claims has switched from HSFO to MGO. $50 may be a little light, although a vessel burning 10,000 tonnes per annum would save $500,000, which is certainly not to be sniffed at when considered in the context of a direct hit to operating profit. Maybe it’s just a question of claims being better the devil you know after all!
Having said this, before 2020 and despite all the current claims and concerns, most ship owners will still want to use high sulfur residual fuel for as long as they can. From an operating cost point of view there is no other logical choice. Who will be left to supply them? How active will the residual fuel supply chain be once the real financial damage and law suits from bunker claims start? Do we need to factor in the predicted uplift in scrubber orders on the back of Clarksons recent report that one in four vessels on the $221 billion order book will be fitted with the technology ahead of 2020?
Scrubbers aside, we already know that suppliers of residual fuel will get scarcer as we head towards the end of 2019, as no-one will want to be caught with inventory. Now we need to be really concerned that fewer and fewer traders and suppliers will want to operate in the residual space next year, which will create tightness and the likelihood of much better supplier margins for 2019 than expected. Indeed, it is wholly possible that the end of the residual era will produce some of the best margins ever…as long as the contaminants stay away!