On January 1st, 2020, the global shipping industry will undergo a radical change, with all ships having to reduce the sulfur content within marine fuels from 3.5% to 0.5%, as mandated by the International Maritime Organization (IMO). As with all radical changes, winners and losers await, meaning there is significant opportunity everywhere.
Bunker fuels are a 5.5 MMBbl/d market and IMO 2020 is likely to have a significant impact on financial commodity markets now and over the next few years, with shipping companies facing the choices of utilizing lower sulfur fuels, installing scrubbers, or switching to alternative fuels such as liquefied natural gas (LNG). In this paper, Drillinginfo looks at what to expect.
What is happening? What are the options for shippers?
The IMO is decreasing the sulfur content specification of bunker fuels in non-emission control areas (ECAs) from 3.5% to 0.5% effective January 1st, 2020 (Figure 1). Although the IMO considered a possible delay of the implementation until 2025, the studies they commissioned indicated that there would not be a shortage of 0.5% bunker fuel oil, paving the way for the new specification to make its mark at the turn of next year. To deal with the lower sulfur specification, there are several choices that can be considered.
An Increased Demand and Higher Prices for Low Sulphur Distillates
The obvious choice is using fuels with lower sulfur content (e.g. marine gas oil, intermediate fuel oil). However, to do so, many refineries would need to install upgrading equipment to deal with the heavy end of the barrel, as high sulfur fuel oil will no longer have a market, with most demand for it wiped out over New Year’s night. Even if these refineries wished to change feedstock to accommodate, there is a limited amount of crude oil light and sweet enough for use in non-complex, topping refineries.
This option means that the cost of bunker fuels will certainly increase as the lighter components needed to blend the low sulfur product will compete as blendstock for other high-value distillate products. This will in effect increase distillate-level product demand more than 2 MMBbl/d, as this is the amount necessary to blend 0.5% sulfur specification. Conversely, 2 MMBbl/d of high sulfur resid would not have a home. Refiners with coking capacity will benefit, as they have the capability to refine the bottom of the barrel.
Given that refiners will have to meet the increased demand for the lower sulfur distillate level products that need to be blended into the bunker fuels, this will mean that the price of bunker fuels will move closer to the price of lower sulfur distillates. To put the numbers in perspective, since the middle of 2018, lower sulfur distillate content No. 2 fuel oil has been trading at a 30%+ premium to No. 6 3.0% sulfur bunker fuel (Figure 3). However, the higher demand that the IMO 2020 regulations will create starting January 2020 will mean that distillate prices will increase to incentivize refineries to produce more distillates as well.
Refiners who produce high sulfur resid, on the other hand, need to change their configuration or switch their crude supply. There are very few crudes that have the chemical composition that make the resid possible to blend away easily. These are light, sweet crude oils with atmospheric residue sulfur content below 0.5% and vacuum residue content below ~0.75% like Cabinda (Angola), Qua Iboe (Nigeria), & Eagle Ford (USA) (Figure 4). Even benchmark crudes like WTI (USA), LLS (USA), & Brent (UK/Norway) require further processing before the whole bottom of the barrel can be saleable (Figure 5). There is only a limited amount of these crudes available, however, meaning that the value of these crudes should increase for refiners that don’t have the downstream refining capacity to upgrade the bottom of the barrel.
In the end, more refinery investment will be necessary with the new specification coming into effect. These refinery solutions include solvent extraction, resid hydrotreating, & coking. Since solvent extraction and resid hydrotreating still have their limitation from a feedstock selection and sulfur reduction perspective. Coking will be the preferred option, as it has the ability to make the most valuable end products from the vacuum residue stream. However, these units will require significant refiner investment as they are the most complex unit.
What Else Can Be Done?
There are a couple more options with regards to how specifications can be met or avoided altogether. One of them is to remove sulfur post-combustion. This would require installing scrubbers on the ships. Only a fraction (less than 5%) of vessels are currently operating with scrubbers and this is only set to increase minimally by January 2020. Hence, scrubbers require significant investment as well, with costs upwards of $5MM to install. Some shops, like Mercuria, are offering their clients financing options for scrubbers in package deals that include providing them with compliant fuels and fuel hedging.
Scrubbers will certainly be a part of the larger equation as shippers navigate the IMO 2020, as they can be installed in less than a year (much faster than a coker in a refinery). They also provide a way to meet the new specification in parts of the world where there may not exist the capacity or investment potential for much more capital-intensive refinery related projects. Another option for shippers is to switch to another fuel source. This would mean switching to LNG or nuclear power to fuel ships. The concept remains largely untested and unproven in commercial uses. Also, the retrofit costs and necessary infrastructure make this a very unlikely option for widespread implementation.
Significant Opportunities for Traders
IMO 2020 will lead to significant opportunities for traders, due to the price dislocations between different refined products and crude grades in different regions. Market volatility and constrained supplies can be expected until the market can figure out the fundamental impacts and work out the issues. Trading instruments are already in place, with the NYME listing 11 marine fuel 0.5% futures contracts for trading on the CME Globex electronic platform and the Intercontinental Exchange launching a 0.5% futures contract this February. This is in response to a strong demand for marine fuel 0.5% specific derivative contracts, allowing market participants to hedge forward positions in what is a growing industry.
It is not just the crude oil and refined product markets that will be impacted by IMO 2020 either. All commodities – from steel to sugar – will be subject to the inflationary pressure that higher fuel costs will put on shipping costs.
What is clear is that interesting times lie ahead for the commodity markets as a result of IMO 2020. It could be quite a ride!
 ‘Big oil traders set to cash in on shipping fuel overhaul’, Reuters, Nov 2 2018, https://www.reuters.com/article/us-commodities-summit-imo/big-oil-traders-set-to-cash-in-on-shipping-fuel-overhaul-idUSKCN1N70QD
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