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Shipping and refiners in catch-22 over 0.5% sulphur rule

Shipping and refiners in catch-22 over 0.5% sulphur rule
The 0.5% fuel sulphur content cap regulation by the IMO is less than three years away from the enforcement date of 1 January 2020, leaving the refining and shipping industries caught in a catch-22 situation.

The problem with the 0.5% sulphur cap regulation is indeed a textbook conundrum for refiners (the fuel suppliers), and shipowners (the fuel buyers), caught in a quandary whereby suppliers are unable to commit on how much to produce as buyers do not know how much is needed, vice versa.

In July this year, the IMO will meet and present a more detailed roadmap, with help from independent research and consultancy organisation CE Delft, on how the fuel sulphur regulation should be appropriately implemented in order to ensure a smooth transition and mitigate disruption to the market, according to Sushant Gupta, director - Asia Pacific, refining and chemicals research, Wood Mackenzie.

“The IMO could possibly be looking at a phased introduction of the regulation rather than instant compliance,” Sushant believed.

Heavy fuel oil (HFO), which is high in sulphur content and considered the bane for environmentalists, is the traditional source of energy to power ships. In 2016, global demand for high-sulphur HFO stood at almost 70% of overall bunker fuels, including the low-sulphur marine gas oil (MGO), or distillates, with below 0.5% sulphur content.

The switch to burning MGO is an option for shipowners to be in compliant with the IMO regulation, and two other alternatives are installing abatement technology such as scrubbers or using LNG as fuel. The use of LNG as fuel, however, is considered a distant option due to the global lack of LNG bunkering infrastructure, not to mention a great deal of uncertainty regarding supplies.

“Installing scrubbers may be an economically attractive option. Although there is an initial investment, shippers can expect a high rate of return of between 20-50% depending on investment cost, MGO-fuel oil spread and ships’ fuel consumption,” Gupta said.

“Despite attractive returns, penetration rate for scrubbers could be limited by access to finance, scrubber manufacturing capacity, dry-dock space and technological uncertainties. The shipping industry is traditionally slow to move, but in this case, early adopters may hugely benefit,” he said.

Wood Mackenzie forecast that the retrofitting or installation of scrubbers will not pick up substantially until 2020 due to the costly investments ranging from $5-10m per vessel. Analyst McQuilling Services said in a recent industry note that players with difficult access to financing for a scrubber can look to potential cooperation with trading companies as alternatives to banks and investors.

Scrubber manufacturer DuPont Clean Technologies estimated that up to 25% of the world’s fleet would be fitted with abatement technology by 2025, and in the run up to 2020 between 500 to 2,000 additional ships will retrofit with scrubbers.

“Switching to MGO is a more costly solution. In full compliance, we expect shippers to try to pass the cost to consumers and freight rates from the Middle East to Singapore could increase by up to $1 a barrel,” Gupta said.

JBC Energy, a boutique oil market research company, also noted that tonne-kilometres and freight rates for dirty tankers are likely to receive a boost with the 0.5% sulphur regulation. The research firm sees potential for crude runs to have additional upside resulting from the specification switch, while the need to optimise the global distribution of HFO should unlock extra demand for dirty freight.

“On top of that, requirements for floating storage of low and high sulphur residue streams are expected to be an additional pillar of support for freight rates over the crucial period from 2019 through 2021,” JBC Energy said.

In terms of demand, Wood Mackenzie’s data showed that MGO sales are currently at approximately 700,000-800,000 barrels per day (bpd), and they are forecast to skyrocket to 2.8m bpd by 2020. Demand levels for HFO, on the other hand, are at around 3.2m bpd and are projected to plunge to 700,000 bpd by 2020.

Gupta pointed out that the change in supply landscape would then create a dilemma for scrubber users who would question if there will be enough HFO to burn if refiners significantly restrict the sale of the high-sulphur product as they reap higher margins from selling MGO. Refiners also have their worries that any extra production of MGO would be stranded if the more ships equipped with scrubbers continue to consume the less costly HFO.

“The options for refiners and ship operators will depend on the course of action decided by each of them. At the end of the day, the shipping industry and refineries need to communicate and find middle ground, and time, unfortunately, is running out,” Gupta said.

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