By Philip K. Verleger (Bloomberg View) — In “Poor Richard’s Almanack,” Ben Franklin imparts a centuries-old proverb about a kingdom lost by a series of events that starts with a shortage of horseshoe nails. A similar catastrophic cascade could be in the works today for the world oil market. It began in 2008 with the International Maritime Organization’s decision to limit the sulfur content of marine bunker fuel to 0.5 percent. It accelerated in 2016 when the IMO proposed an effective date of January 1, 2020. This past November, the organization affirmed that deadline.
The missing nail in this case will be the low-sulfur fuel that ships plying international waters will soon require. And the consequence could be a spike in oil prices large enough to threaten global recession.
How could a little known bureaucratic organization cause such a catastrophe? By doing the right thing too fast.
Full Coverage: IMO’s Low Sulphur Fuel Switch
Most oceangoing vessels burn residual fuel oil with a high sulfur content. Emissions from ships, which include sulfur oxides and nitrous oxides, present “major risks to both the environment and human health,” in the IMO’s words. The agency lowered the allowable sulfur content in marine fuel to 3.5 percent in 2012, aiming to get it down to 0.5 percent between 2020 and 2025. But when a 2016 study found that not lowering the limit by 2020 would contribute to more than 570,000 additional premature deaths by 2025, the IMO tightened the deadline.
The problem is that oil refiners may not be able to supply enough of the low-sulfur fuel by 2020. There are too few sophisticated plants that can make the required marine gasoil without also churning out noncompliant fuel oil as a byproduct.
The shipping industry uses some 6-8 million barrels of fuel oil a day. To lower all its sulfur content to 0.5 percent, from today’s average of 2.2 percent, the refining industry would need to build 25 more cokers — processing units that upgrade residual products from oil distillation. These take years to design and billions of dollars to build. If ordered today, they might be ready in 2022.
If the 0.5 percent limit is not postponed and goes into effect 21 months from now, the price of shipping fuel could increase by as much as 30 percent.
That could lift crude oil prices to $150 per barrel, from about $60 today. Something similar happened a decade ago, when a European Union mandate for low-sulfur diesel fuel coincided with an unexpected decrease in the supply of crude needed to produce it: In 18 months, diesel prices rose to $4.60 a gallon, from $2.50, and crude prices went up to nearly $145 per barrel, from $55.
The oil market has also shifted in the two years since the IMO decided to move ahead with the 0.5-percent limit — in ways that exacerbate the problem. OPEC members and Russia have agreed to restrain output. And both Venezuelan and Canadian heavy-crude producers are having trouble getting their barrels to market. The U.S. is producing more oil from fracking, but this contains little of the medium-, heavy- and extra heavy-grade crudes that yield the kind of residual fuel oil that can be converted to low-sulfur distillates.
A doubling of crude oil prices caused by the IMO’s capricious action could subtract 2 to 4 percent from global gross domestic product. Ocean transport of goods would decrease sharply, raising consumer prices. Commodity producers, especially farmers, would see their incomes drop. U.S. consumers could see the price of gasoline rise to $6 per gallon.
No doubt, the IMO policy makers hope that none of this will come to pass. But as Ben Franklin also said, “He that lives upon hope will die fasting.”
Philip K. Verleger is an economist and consultant focusing on the energy markets.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
© 2018 Bloomberg L.P