Grace Quinn, Baringa Partners
The shipping and refining industries are in the eve of a new regulation which will affect marine fuel specifications and in turn the global market.
Effective January 1st 2020 the International Maritime Organizations (IMO) global cap will come into effect which sees a reduction in the maximum sulphur emissions limit for all vessels operating outside of existing emission control areas (ECAs) As a result all vessels will be forced to shift to burning low sulphur fuels or alternatively stimulate exhaust gas scrubbing to remain compliant.
Both of these actions will have significant economic and financial implications for the global refining, bunkering and commercial shipping industries, not to mention a knock-on effect across the global economy . For instance this cost is expected to be passed on to the customer, with freight rates increasing as a result.
A move towards this global cap has been in play for many years, as seen from the timeline in Table 1 below. Globally, the sulphur emissions limit was reduced in 2012 with further reductions scoped and publicised for 2020. It also comes on the heels of 2015 requirements which enforced a more stringent 0.1% limit within ECA zones.
The complexity of the 2020 regulation compared with 2015 limits imposed lies in the sheer magnitude of the switchover and the extension of fuel types in scope
With regulators providing significant lead time and phased limitations since 2012 why is the 2020 cap causing such a stir?
The complexity of the 2020 regulation compared with 2015 limits imposed lies in the sheer magnitude of the switchover and the extension of fuel types in scope. Couple this with uncertainty on supply security, price differentials and bunker compatibility and you have an industry on tenterhooks.
There is a wide range of potential outcomes depending upon how the shipping and refining sectors respond to this legislative change.
This is the first of three articles which will discuss the uncertainties, impact, challenges and points for consideration for those in the shipping and refining sectors.
The Waves of Uncertainty
There are a number of areas relating to IMO 2020 which have roused particular controversy and debate due to the lack of clarity.
Compliance and Repercussions
The success of this regulation will come down to the strength and consistency in governance and penalties applied for non-compliance. Policing and enforcement actually falls on Government and national authorities of Port and Flag States, and not the IMO as many assume. As a result the risk of disparity between how this regulation is enforced and the consequences for non-compliance is a growing concern.
in Denmark, an ECA region, the largest fine to date is USD $60,000 which is significantly less costly when compared with the substantial cost of investing in a scrubber or purchasing a higher priced compliant bunker fuel
This disparity can be seen today in ECA regions and is to a degree down to a lack of clarity on enforcement. Having sniffers, port inspections and satellites to track vessel compliance is all very well but if the punishment for breaching sulphur limits is not strong enough then there is no real incentive to comply, when it may seem cheaper and easier not to.
For example in Denmark, an ECA region, the largest fine to date is USD $60,000 which is significantly less costly when compared with the substantial cost of investing in a scrubber or purchasing a higher priced compliant bunker fuel for example.
The impact of a fine will vary by entity, therefore the challenge on those enforcing the regulation is assigning appropriate penalties and repercussions, which act as an incentive to drive the right behaviour. No easy feat. There has been a call from some industry stakeholders to extend the scope of this framework beyond the financial, to include operational restrictions.
The success of whatever model prevails will be determined by its ability to ensure a level playing field and avoid creating a market arbitrage.
A recent survey by Galbraith's showed that the main area of concern for charterers and refiners was enforcement of the regulation.
Use of open-loop scrubbers
Further controversy and uncertainty surrounds the optional use of scrubbers as a compliance option.
Many have questioned why regulators did not impose the sulphur limit at source- placing the obligation on oil companies and refineries, which would have required oil refiners to make large investments up-front, providing some confidence in supply security. Instead the optional use of scrubbers allows ship-owners to continue burning cheaper HSFO, providing a potential economic advantage for those using them, particularly as industry analysis suggests initial investment costs could be recovered in the first year.
From an environmental perspective the use of scrubbers has sparked controversy as it is claimed that they are merely transferring sulphur pollutants from air to sea, as waste water is discharged into the ocean. Those who have heavily invested in scrubbers, specifically open-loop scrubbers, will no doubt be growing more concerned as an increasing number of ports and regions have taken the position to ban or place condition on their use. This is despite IMO guidelines, including wash-water discharge and monitoring criteria, which are supposed to safeguard against environmental damage.
The risk of contamination as those in the industry will appreciate, cannot be underestimated. It direct impacts a vessels performance, profitability and can pose a threat to on-board
This behaviour threatens the sustainability of scrubber use beyond 2020.
As many choose to steer away from scrubbers (uptake expected to be only 4% of global shipping fleet) and look to low sulphur fuels as the most viable option for compliance, the importance of supply security and fuel compatibility grows in significance. New blends of low-sulphur fuels have come on the market in anticipation of 2020 and in the face of limited global standardization regarding composition and quality, this presents a potential risk.
The risk of contamination as those in the industry will appreciate, cannot be underestimated. It direct impacts a vessels performance, profitability and can pose a threat to on-board safety. Not to mention the reputational damage associated.
Fuelling this uncertainty further is the lack of testing being done on compliant fuels/ blends on seagoing vessels. This is surprising given Galbraith's survey also showed this to be the main area of concern for owners and an area refiners anticipate problems. Ship owners can avoid this uncertainty by increased testing or stick to burning known specifications like MDO and MGO.
Supply Security and Price Differentials
How the shipping industry responds to IMO 2020 will have a direct impact on the demand of marine bunker fuels. Likewise the response of the refining industry to customer requirements will affect the availability and pricing of these marine fuels. Undoubtedly fuel costs will increase and this cost is expected to be passed onto the customer, with freight rates increasing as a consequence.
The displacement of HSFO will need to be managed as will new demand for low-sulphur fuels such as middle distillates
The displacement of HSFO will need to be managed as will new demand for low-sulphur fuels such as middle distillates. It is estimated that there is approximately 1.5 million barrels per day of new compliant supply (gasoil and LSFO) needed to enter the bunker market in 2020 . It is this increased demand and uncertainty regarding availability of supply which will drive up the price and cause refineries to reconfigure their product slate to meet demand. Not an easy ask- for instance smaller more complex refineries will have to undertake considerable investment. Undoubtedly for some refineries and traders IMO 2020 will present an opportunity and for others a challenge.
Charterers have already begun to secure bunkers from 2020 onwards for time- charter tonnage in a bid to manage supply and price risk. A move which is not surprising in the current environment. Additionally, commodity trading houses will no doubt be looking to take advantage of potential regional arbitrage opportunities as a result of the inevitable shift in trade patterns.
Early market signals would indicate that the supply of compliant 0.5% LSFO will not be readily available by early next year and will be priced at a significant premium to HSFO. However with so many open questions and new information coming available every month, the second half of 2019 should provide a more accurate view of the landscape.
Some comfort for industry stakeholders can be drawn from a study commissioned by IMO into the "Assessment of fuel oil availability" which concluded that the refinery sector has the capability to supply sufficient quantities of marine fuels with a sulphur content of 0.50% or less and with a sulphur content of 0.10% or less to meet demand for these products, while also meeting demand for non-marine fuels .
The Long Game
With so many uncertainties surrounding market fundamentals (supply, demand, price, technology and regulations) one can only make assumptions and speculate on how various scenarios will impact their operational structure and bottom line in the future. This applies to ship-owners, refiners, charters, bunker suppliers and traders alike.
Like most industry disruptions, regardless of where you sit in the value chain, making the right move at the right time will have big economic consequences. Similarly adopting a 'wait and see' approach can leave you heavily exposed.
The challenge today is making decisions which optimize operations and comply in the short term but do not restrict the opportunity to sustain margin in the long term, regardless of the future landscape. The competitive landscape will change as supply and demand balances even out, prices become more stable and new information becomes available.
Table 1 - Sulphur Emission Timeline of Limits
in Denmark, an ECA region, the largest fine to date is USD $60,000