Photo: Zheltikov Dmitry / Shutterstock
By Jack Wittels (Bloomberg) –Two weeks ago, the vast majority of the world’s ships were forced to change the fuel they use. Some big winners — and potential losers — are starting to emerge from what was a historic switch for the world’s oil refining and maritime industries.
Regulations began on Jan. 1 forcing vessels to sharply reduce emissions of sulfur oxides from burning so-called bunker fuel. If successful, the rules could turn out to be the single-biggest, globally mandated improvement to air quality ever. The pollutant is blamed for worsening human health conditions like cardiovascular disease and asthma, and causing acid rain.
But the cost of the new fuel has skyrocketed to the point where it recently surpassed diesel and gasoline in Singapore, Asia’s oil-trading hub. The dynamic adds to the cost of transporting goods and raw materials — a potential impediment to global supply chains since fuel represents the maritime industry’s single-biggest expense.
“The cost of world trade is rising when the bunker costs go up,” said Peter Sand, chief shipping analyst at BIMCO, a trade group for many of the world’s vessel operators. Even if the hike will be largely invisible to end consumers, it’s important to owners, some of whom may end up in financial difficulty if fuel prices stay high, he said.
IMO 2020, as the rule is known, is a global sulfur cap on marine fuel of 0.5%, down from 3.5% in most parts of the world. The Jan. 1 start date was set back in October 2016.
The price surge points to significant support for those refineries that make the new product. Likewise, some shipowners are making fortunes because they invested in kit allowing them to burn the old sulfur-rich variety, which is several hundred dollars a ton cheaper.
Before the rules took effect, some shipowners plowed billions of dollars into exhaust-gas cleaning systems that prevent the sulfur from being released into the air. The equipment allows their vessels to keep using the old fuel without breaking the rules.
Those who invested appear to be gleaning a competitive advantage because the discount for the old fuel is so big.
Supertankers hauling 2 million barrels earned about $20,000 a day more so far this year if they were fitted with scrubbers, according to data from Clarkson Research Services Ltd., a unit of the world’s largest shipbroker. That’s about $7 million a year in savings if the current market were to continue.
Scrubber investments could pay off in less than a year, according to Richard Matthews, head of research at E.A. Gibson Shipbrokers Ltd.
Rates for the oil tankers are very high by historical standards, meaning even those without are doing well.
However, where it may become more of an issue is in freight markets that are weak. For example, giant iron-ore carrying Capesizes bulkers built in 2010 earned about $4,000 a day so far this year. That’s not enough to even cover operating costs including crewing and repairs. The same carriers fitted with scrubbers earned about $10,000 a day more than that. Not great, but a level they can survive at.
If the current market doesn’t improve, those lower earnings might eventually discourage some ship operators from transporting cargoes, something that would help the owners of vessels that do have scrubbers.
Sand, from BIMCO, says that there could even be loan defaults if the price of compliant fuel doesn’t drop.
For oil refiners, IMO 2020 has transformed marine fuel from essentially a waste material sold at a discount to crude into one of the industry’s most valuable products. What’s widely now seen as the dominant new propellant — very low-sulfur fuel oil, or VLSFO — is about twice the price of the old material in Singapore and Rotterdam. A similar trend is playing out for marine gasoil, the other main clean-fuel shippers can use to comply with IMO 2020.
The main new fuel’s high price is in some ways hard to explain. In theory, it shouldn’t be more expensive than products like gasoline and diesel because it’s easier to make.
Today’s sky-high prices are the result of both the refining and shipping sectors wanting the other to invest in making it, said Alan Gelder, vice president for refining and chemicals, at Wood Mackenzie Ltd., an energy consultant.
There have also been fuel availability issues at some ports around the world, as well as a shortage of barges to deliver, according to Melissa Williams, a marine fuel sales and marketing manager at Royal Dutch Shell Plc.
Standard Club, a marine and energy insurer, said Tuesday that it’s been notified of concerns about a lack of compliant fuel at some ports, without identifying which ones.
“The impact on refiners isn’t the same across the board,” said Mark Williams, principal refining analyst at Wood Mackenzie. Refiners in the U.S. Gulf coast which can process high-sulfur fuel oil — the old propellant that has become much cheaper since the switch — are doing very well, he said. But any refiners that lack upgrading equipment and process sulfur-rich crudes will be feeling squeezed.
More broadly, refiners are having to rethink their whole approach to fuel production as other margins are pulled around by the IMO 2020 effect. Low-sulfur feedstocks like vacuum gasoil and straight-run fuel oil that, among other things, can be used to make the new product, have shot up in value relative to crude. If large volumes get diverted to the maritime market, more traditional outputs like gasoline, that can also be made from them, could tighten.
The diesel market, meanwhile, has largely shrugged off the IMO 2020 boost many were expecting. Warm weather across the globe is partly to blame, along with recent downward revisions to oil demand growth forecasts, said Steve Sawyer, director of refining at FGE. The result is VLSFO rising above diesel in Singapore, a “bizarre” pricing dynamic, he said.
Looking forward, Sawyer expects VLSFO to remain at a premium to crude as long the crude oil price remains in a $60-70 a barrel range.
Gelder and Williams expect the VLSFO price to fall going forward, while the price of HSFO is set to rise by about 20% by the fourth quarter as more shippers fit scrubbers. The IMO transition period, meanwhile, is set to last for a couple more years, they said.
So the current price surge is just the start of a process. Refineries will need to decide if it’s worth spending the money on equipment to make new fuels, and shipping companies will have to consider buying more scrubbers.
“If you’re going to reduce the impact of these extra costs on the overall economy, there’s more investment needed,” Gelder said.
–With assistance from Jeffrey Bair.
© 2019 Bloomberg L.P
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