IMO 2020, the regulation to cut marine fuel sulphur emissions from 3.5% to 0.5%, will set off a tsunami.
“It’s over the horizon. We are not seeing the effects yet, but it’s a three-million-barrel-a-day wave that is going to hit us very soon,” says Rick Joswick, head of oil pricing & trade flow analysis at S&P Global Platts, who has worked with the refining industry for 35 years.
“It’s analogous to a tsunami.
“Right now, people who are dismissing it as not likely to affect markets very much are like fishermen walking around on the seabed picking up the fish flopping around, thinking how fortunate they are that the ocean has pulled back.”
The price of distillate marine gasoil (MGO) was at relatively normal levels in May, and oil majors developing new 0.5% fuels were refusing to comment on its pricing.
But even before the new regulations kick in on 1 January, Joswick says the shift in demand away from 3.5% fuel — alongside many ship operators taking the advised route to buy 0.1% MGO until concerns about the availability and quality of low-sulphur fuels have settled — will have a sudden and dramatic effect in the last quarter of this year.
“I am worried about the surge in MGO demand rather than how much low-sulphur residual fuel will be around,” he says.
“The key thing about pricing is that the demand has not changed yet. So, when we see low-sulphur residual fuels going for modest premiums over high-sulphur residual fuels, that is not how it will be.”
The price of distillate fuels will soar, and that will pull up the price of the new low-sulphur fuels, he predicts. The current lack of price incentive means refiners are not building stocks in readiness for a demand surge in the fourth quarter that he estimates will amount to between one million and 1.5 million barrels per day of MGO.
“That’s when the tsunami hits.”
Joswick is not alone in predicting this. SEB Merchant Banking chief commodities analyst Bjarne Schieldrop, who has been looking into the effects of IMO 2020 for a couple of years, says 0.5% compliant fuel will need to trade close to gasoil 0.1% because it will have a strong refining relationship.
“I think Q4 will be one of the most interesting events of the whole period because there will be a lot of transitional demand for gasoil 0.1% because of the concerns over 0.5% — and with good reason, because they are less stable than the 3.5% fuels. It will maybe run through Q1 2020 because of the prospect of a disaster from engine failure in stormy weather.”
Historically, gasoil has a crack (price differential) over Brent crude of about $85 per tonne. Schieldrop says SEB is looking at that to average $125 in 2020-22 but adds: “This will blow out much more in Q4.”
Schieldrop says the issues he and Joswick are identifying “are creating a mini-2008 in Q4 this year”. Midway through that year, just before the economic crash, the oil price hit $140 per barrel from around $90 at the beginning of 2008.
“The forward markets always react to spot developments. So I think gasoil prices might really spike,” Schieldrop says. “All the issues that the market is concerned about for 2020-21-22 might actually play out in Q4 2019 and early Q1 2020. The gasoil crack might just go crazy in relative and absolute terms.
“And the refineries will run very hard in Q4 to make enough of these products and consume a huge amount of crude, driving up demand.” That will most likely rally gasoil forward cracks even further.
The irony is that neither man believes the global refinery system could not produce sufficient 0.5% fuel or that long-term price differentials, even with high-sulphur fuels, will necessarily persist, even though they expect the price of 3.5% fuel to fall off a cliff during that transition period.
But few people think there will be enough immediately available low-sulphur fuels. Lack of transparency in bunker markets does not help.
“The biggest concern I have is a serious potential in the industry for overestimating how much very-low-sulphur fuel oil [VLSFO] is available,” says Adrian Tolson, senior partner at 20|20 Marine Energy.
Despite his long experience in the bunker market, Tolson admits nobody knows how big it is; estimates run from 250 million to 300 million tonnes per year. On the higher number, it could mean the shipping industry needs between 150 million and 160 million tonnes of VLSFO.
“If we are overestimating [VLSFO availability] the backfill will come from the diesel market, and that means we will see prices go up on VLSFO and diesel. We will see much more price spiking on those price curves,” Tolson says.
“To fill the gap, we think the balance will be filled by people, like commodity players, blending fuels. But I think that is wishful thinking because we don’t know the appetite for the commodity players for this market, and they themselves do not know what the appetite is going to be for the product post-2020, so you end up with a potential shortfall in supply and too much demand.”
Former senior broking analyst Mark Williams, now managing director of his own consultancy, Shipping Strategy, is more pessimistic: “Let’s say the bunker industry sells five million barrels a day of marine fuels and 80% is currently 3.5% fuel oil as opposed to distillates. There is no way the refining industry can produce enough low-sulphur fuel oil as a direct run or a blend for 1 January 2020.
Low-sulphur marine fuel products will suit US Gulf and modern Chinese and South Korean refineries, which have deep conversion capacities, says Mark Williams of Shipping Strategy. “The good news is it can massively increase the tonne miles for shipping compliant products into the markets short of them, which will be Europe and Africa,” he predicts.
A study Williams did on shipments of marine diesel oil and MGO from east of Suez to the western Mediterranean showed the number of tonnes moved increased tenfold between 2014 and 2018 but the tonne miles went up by a factor of 23. “It’s very good news for MR product carrier earnings,” he says.
“That will reduce demand for VLSFO and might keep the price differential down to the point that the easiest way to be compliant is to burn distillates because you can’t be certain that a delivery of low-sulphur fuel in port A will be compatible with your next delivery in port B.” But Williams agrees that if distillates are diverted to produce low-sulphur blends, it will drive up the price of MGO.
A rather nasty short-term price spike seems inevitable, but nobody knows for certain. Petrospot director Lesley Bankes-Hughes says a lot of wild guesses are being bandied about over estimates for price differentials, but they are likely to be predicated on the price oil majors set initially for 0.5% fuel.
“Obviously they have to pitch it [VLSFO] at an attractive price below MGO/marine diesel oil but they don’t necessarily have to make it a big differential. They hold all the price cards at the beginning, so to some degree it could be seen as an artificial construct between the two products at the outset,” she notes.
“In terms of initial supply, the majors are going to dominate the market. They are not giving any price information away, but we know that the quality assurance they are offering will add a premium. It will be their ace card on price, how competitive they can be, can they produce slightly more cheaply than their competitors. They can set the price in Q1/Q2 2020.
“But once the market sees where the price is, and the oil majors haven’t got blanket coverage of all ports, supply will have to be met by smaller suppliers — and they will know where to pitch their prices, and we will see a more competitive market.”
Oil majors now have the opportunity to regain much more control over the bunker market, if they have the appetite, but analysts and suppliers agree they will primarily want to supply the biggest ports and not try to cover myriad smaller terminals around the world.
Total, which boasts of its ability as an integrated group able to source, refine and supply oil, freely admits this. “Our customers say they will start switching over from September, so we need to have the right products available. We are present in 100 countries and 1,000 ports, so the product will not be in all the ports, but will be in major hubs,” says Total Lubmarine boss Robert Joore.
“We are comfortable about being able to supply our current customer base,” adds Total Marine Fuels Global Solutions managing director Jerome Leprince-Ringuet. “This fuel [VLSFO] is a new product — it is not about MGO. MGO is a fallback. The question of availability is about directing streams in a refinery to the bunker market, taking from the diesel and gasoline markets. We believe this will be highly manageable by optimisation of refinery capabilities.”
Tolson, like almost everyone, agrees supplies should be available in bunker hubs such as Rotterdam and Singapore, but problems will be felt in smaller ports. This is partly because commodity players, like Vitol, Trafigura and Glencore, which have brought liquidity to the market by buying heavy fuel oil (HFO) at distressed prices to supply wherever there is a need and so a margin to be made, are finding it difficult to set strategy because they do not know where shortfalls will arise.
HFO availability may also be a problem in smaller ports, and its price potentially spiky after rising from an initial 2020 floor, if there are just 3,000 ships burning it with scrubbers, amounting to an estimated 20% of the bunker market.
The absence of traders adds another factor. Who is going to provide the credit that shipowners use to buy bunkers if oil companies and refiners don’t want to or cannot do it?
“Look at some of the failures in the bunker market over the past few years, and the new regulations will surely have some effect,” Williams says. “The physical bunker suppliers and traders are going to have to find another $4bn-$5bn of credit lines next year to shipowners trading in what looks like it is going to be a weak market.
“The refining process is extremely complex, with a lot of moving parts,” says Bjarne Schieldrop of SEB Merchant Banking. Refiners, he adds, live in a spot-oriented world in which they are basically price takers. “As you move around the gasoline crack, it is a massively moving puzzle and influences the fuel oil and diesel cracks. But over time the market can produce 0.5% at a premium of $75-$100 over 3.5% when I look at refinery economics.”
“The oil majors are the only ones who can really afford the levels of investment to produce the new compliant products and the only ones who can supply the credit lines to act as a secondary banking market to sell those products. The role of the independent bunker trader becomes reduced and so we are likely to see further departures from their ranks.”
The bunker market is undoubtedly set for significant change.
“There is a very clear play on the part of the majors to reassert their position in the marine fuel sector, from the refining standpoint right down to deliveries,” Bankes-Hughes says. “But they may not have the barging infrastructure in place by January. You could see them chartering more bunkering tonnage in the second part of this year. You can see what they are trying to do, but whether they can join up all the dots in time in terms of final delivery to the end user is a bit of an unknown.
“Initially the smaller and medium players in Europe don’t really know what their position will be in the 0.5% supply market, and for many of them the HFO market will drop out, so they may look to focus on the higher-value products like distillates or MGO, so they can make a higher margin.”
But Bankes-Hughes also believes smaller suppliers and traders have a big opportunity in second-tier and niche ports. They are making the right noises, putting plans and storage agreements in place, and she thinks they may move back into the bigger ports once they see how the land lies.
“This is a huge opportunity for the oil majors,” adds Tolson, who says they could return to the dominant position they held in the 1980s. “But it’s not so much the majors as integrated refiners — the majors do not own much refining capacity these days — who are looking to optimise their refineries, because the production of 0.5% fuel is no longer a residual fuel and has more cost.”
He estimates the refiners will go from supplying between 80 million and 100 million tonnes to supplying 160 million to 170 million tonnes at the expense of some commodity players and independent bunkering companies.
“The problem with the majors is we don’t know how committed they are, what their price sensitivity is. If this product suddenly becomes a lot cheaper vis-a-vis diesel, do they lose interest? Company strategies change and it’s [marine fuel] not core, so how long does it remain important for them?” Tolson asks.
“It took 60 years to create the global bunker market as it is today. How long will it take to remake it based on a whole new set of parameters? I hope it’s only a year or two, but maybe it’s five, maybe it’s 10. Nobody can model this because there are so many variables.”US will have compliant fuel but it may not be VLSFO
By Michael Juliano
The US should have enough IMO 2020-compliant fuel but it may not be all very-low-sulphur fuel oil (VLSFO) when 90% of ships burning 3.5% sulphur bunkers switch to 0.5% at midnight on 1 January.
US Gulf Coast (USGC) refiners and suppliers are expected to meet demand, partly through the abundance of distillates, says Texas-based Gulf Coast Commodities spokesman Zach Stansbury.
“The market will balance with distillates, if VLSFO is in short supply, as distillates are well supplied in the USGC,” he tells TW+. “Either way, there is no concern that the USGC will be short compliant fuel in 2020.”
Stansbury says the market may be short of 0.5% sulphur fuel until 2020 unless gasoline-crude oil price spreads are low and catalyst low-sulphur vacuum gasoil (LS-VGO) is blended into VLSFO.
“However, we are concerned that blending LS-VGO into the VLSFO supply pool in 2020 will cause compatibility and stability problems for shipowners, as well as for suppliers who do not have full control of their supply chain,” he adds.
Gulf Coast Commodities plans to start making 0.5% fuel in the first quarter of 2020 but may store some from third-party suppliers ahead of the switch-over, depending on the market.
This is in line with observers suggesting smaller bunker blenders might hold back until they can see how the market is behaving and pricing itself. That could add to a shortage of 0.5% fuel, which in turn pushes up distillate prices.
The ports of Los Angeles and Panama may find it difficult to provide 0.5% fuel because they have bought cheap 3.5% for years from Latin America and the Bahamas, neither of which has refining capabilities, says Adrian Tolson of 20|20 Marine Energy. “That’s allowed Panama and Los Angeles to have a market” that could be challenged by bunker ports in Asia, such as Singapore, which do have that capability.
Gulf Coast Commodities will not produce 3.5% sulphur fuel after September 2019, so scrubber-fitted ships will have to go elsewhere for supplies.
Stansbury says: "We will supply directly to vessels, and expect to supply to three to four additional suppliers in the USGC. We suspect there will be enough fuel in the market to supply the limited number of scrubber-fitted vessels calling at the USGC after 2020.”
But Tim Wilson, Lloyd’s Register’s principal specialist on marine fuels and exhaust emissions, says that although the main bunker ports might carry 3.5% high-sulphur fuel oil for some period, many smaller ports may not have it at all because they lack storage capacity. The big ports may not even want it if they are not assured there will be a sufficient market for it.
“If I’m a supplier of high-sulphur fuel, I’ll want to know that and sell that fuel within a certain period of time,” Wilson tells TW+.
“If no one is telling me that they’re coming to provide it, then I won’t store it because I want something that I can sell, and 0.5% I can sell.”
One thing is certain, Wilson reckons: “It’ll be frantic leading up to IMO 2020, as ships will want to start getting their 0.5% fuels.”
This article is from TW+ magazine, which will be distributed with TradeWinds on 24 June