The Fuse

How Changes in Maritime Fuels Markets Will Affect Demand, the Oil Industry

by Nick Cunningham | April 18, 2018

The International Maritime Organization (IMO) announced last week a strategy to cut greenhouse gas emissions in the international shipping sector by at least 50 percent below 2008 levels by 2050. If it comes to pass, it could have large ramifications for long-term crude oil demand and refiners around the world.

Besides cutting down on air pollution, new rules for maritime fuels have the potential to stimulate the use of LNG, disrupting the refining sector.

The shipping industry also has a more immediate deadline looming. By January 1, 2020, new IMO rules take effect, significantly curtailing the amount of sulfur contained in maritime fuels. Shipowners could meet these goals several different ways, and a mixed approach is likely. Besides cutting down on air pollution, the rules have the potential to stimulate the use of LNG, disrupting the refining sector.

Implications for fuel demand

The shipping industry accounts for about five million barrels per day (Mbd), or five percent of global oil demand. Most tankers and cargo ships run on heavy fuel oil with a high sulfur content (HSFO), a particularly dirty form of fuel. “It is the bottom of the oil barrel, the residue of simple refining. It is the dirtiest and heaviest product produced by refineries worldwide,” Bjarne Schieldrop, chief commodities analyst at SEB, wrote in a March research note. “Basically, it is a waste product with little use outside the shipping market.” Current standards allow marine fuels to have a sulfur content of 3.5 percent, which is several orders of magnitude higher than the 10 parts per million allowed in gasoline on U.S. roadways.

The IMO regulations set to take effect at the start of 2020 will require maritime fuels to cut sulfur concentrations from 3.5 percent to just 0.5 percent. To meet these stringent standards, shipowners have three main options at their disposal: Install costly scrubbers to cleanse sulfur from heavy fuels, switch to low-sulfur fuels, or use LNG as an alternative. The maritime industry says the rules will cost $40 billion, according to the Wall Street Journal.

“It’s a highly-charged debate to find acceptable pollution levels that could cost the industry hundreds of billions of dollars,” Basil Karatzas, a New York-based shipping consultant, told the Wall Street Journal in early April. “The IMO emission cuts are necessary and must be adopted, but a number of operators won’t be able afford it and could either go belly up or get out of shipping altogether.”

The economics of retrofitting tens of thousands of ships with scrubbers looks daunting.

Some shipping executives see the upside to scrubbers because they save on fuel costs and offer a payback period of just a few years. But, the economics of retrofitting tens of thousands of ships with scrubbers looks daunting. “It’s like installing small refineries in approximately 60,000 vessels and it’s not a very sensible way of doing things,” Soren Toft, COO of Maersk Line, told the Wall Street Journal in a March interview. Retrofitting ships with this technology can cost $5 to $10 million. Faced with that price tag, many ship-owners will opt for alternative approaches.

A study by the IMO projected that only 6.7 percent of the global commercial maritime fleet will be using scrubbers after the regulations go into effect. Of course, if product prices rise high enough, scrubbers may ultimately make sense, especially if costs of the technology decline over time. The use of LNG as a fuel for the global commercial shipping fleet is also an option, although an expensive one. The high cost, long lead times for building new ships, and lack of infrastructure will likely confine LNG to small regional short-haul routes.

Fallout for refiners

A large portion of the global shipping fleet will begin using cleaner fuels, such as gasoil, a distillate fuel similar to diesel, or 0.5 percent ultra-low sulfur fuel oil (ULSFO). The switchover will benefit complex refineries at the expense of smaller, simpler units that are not as flexible. Large complex refineries can produce gasoil without the by-product of heavy fuel oil, according to Wood Mackenzie. Older and less sophisticated refineries process a barrel of crude into different component parts, a portion of which is residual fuel oil used in the maritime industry. These dirtier products will steadily decline in value as the IMO regulations take effect.

The IMO regulations will dramatically shift market demand away from dirty fuels to ULSFO and gasoil. Demand for gasoil is expected to jump to 1.74 million Mbd by 2020, according to the IEA, an increase of over 1 Mbd from 2018. Meanwhile, demand for high-sulfur fuel oil (HSFO) will plunge from 3.2 Mbd in 2019 to just 1.3 Mbd in 2020.

The changes in the fuel mix will be acutely felt by refiners as they need to invest in reconfiguring their plants.

The changes in the fuel mix will be acutely felt by refiners as they need to invest in reconfiguring their plants. “As demand for HSFO almost evaporates in 2020 and instead shifts to ULSFO 0.5 percent or gasoil, we forecast global refinery upgrading capacity utilization will be stretched to its maximum,” Bjarne Schieldrop of SEB, said in a note. The implications for the global refining industry are profound, as 3-3.7 Mbd of HSFO will suddenly need to be upgraded, Schieldrop said.

In other words, a certain portion of the global refining industry will see a windfall from the new maritime fuel standards while others will suffer a significant financial hit. “They’ll print money,” Alan Gelder, vice president for refining, chemicals and oil markets at Wood Mackenzie, told Bloomberg in an interview, referring to complex refiners best equipped to handle the changes. “If the shipping industry needs more clean fuels, then that’s good for refining.”

The refineries set to gain from the new rules are clustered along the U.S. Gulf Coast, in Europe, and in parts of Asia. JPMorgan estimates that the IMO rules will boost refining margins in Europe by 60 cents per barrel.

Meanwhile, simpler refineries that tend to produce high-sulfur fuel oil will lose out and ultimately might be “forced to cut runs or close,” Energy Aspects said in March. The consultancy singled out refineries in Mexico, which “will pose a growing financial headache to the Mexican government and likely prove unsustainable.”

Targets for 2050

While shipping and refining industries have their eyes on the 2020 regulations, the IMO just agreed to 2050 targets that would cut greenhouse gas emissions in half. To meet those limits, the IEA says the shipping industry will need to adopt a variety of measures, including efficiency standards, investment in retrofits, a CO2 price for shipping fuel, and some sort of policy framework, such as a low-carbon emission standards. The date is far enough away that LNG could play a larger role in the fuel mix, yet the emissions profile of LNG might make it non-compliant with the 2050 limits, according to JBC Energy, although the specifics still need to be worked out.

For the oil industry, there is a lot at stake in the long term, as the entire bunker fuels (fuel oil, gasoil, and gasoline) demand of over 5 Mbd would effectively cease to exist.”

The wider implications of both the changes coming in 2020 and the 2050 target will be enormous for refiners, oil companies, and commercial shipowners. Ultimately, five Mbd of crude oil demand is at stake over the next three decades and looms large over global oil markets. “For the oil industry, there is a lot at stake in the long term [if LNG becomes a viable substitute], as the entire bunker fuels (fuel oil, gasoil, and gasoline) demand of over 5 Mbd would effectively cease to exist,” said JBC Energy. 

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