Event

In a move to reduce air pollution by ships, the International Maritime Organisation (IMO), the United Nations’ specialised agency responsible for the safety of shipping and the prevention of marine and atmospheric pollution by ships, decided to lower the limit of the sulphur content of the marine fuel to 0.5% mass by mass (m/m) from the current 3.5% cap, which has been in vigour since 1 January 2012. The new regulation, called IMO 2020, was adopted in October 2016 and will come into force as from 1 January 2020. While the use of marine fuel in some designated Emission Control Areas is already subject to a cap of 0.1% m/m of sulphur, the new IMO 2020 measure applies worldwide. The measure is considered as a major shake-up for the shipping and the oil refining sectors.
In case of non-compliance with the sulphur cap rule by carriers, the IMO itself has no authority to enforce the regulation but enforcement is being left to the discretion of individual member states, meaning to port authorities, in practice. Although there is some lobbying to delay the implementation date of the measure, the IMO website announces that there can be no change in the 1 January 2020 implementation date.
Carriers are left with 3 main possibilities to comply with the regulation: burning compliant low-sulphur marine fuel, installing scrubbers or using LNG or methanol as fuels.

The adoption of the third option will be neglected by carriers because sufficient LNG or methanol supply infrastructures are still missing in ports around the world, as the use of gas for powering ships is in its infancy. Retrofitting an existing fuel oil vessel with an LNG engine is also a complicated, costly operation. As a result, this option makes more economical sense for new watercrafts.
The use of exhaust gas cleaning systems, also called scrubbers, is another option for the shipping industry. Ships equipped with scrubbers can continue to burn high-sulphur bunker fuel and comply with the 0.5% m/m sulphur limit. The cost of installing scrubbers is reported to vary from USD 1 m to USD 10 m per vessel, depending on the number and capacity of the main engines. The share of vessels equipped with scrubbers is expected to remain limited to a small percentage of the global fleet, at least in the first years following the implementation of IMO 2020. Due to the increased demand, scrubber manufacturers will not be able to deliver enough devices on time. It is also worth noting that the use of open-loop scrubbers, which is probably the cheapest way to comply with the IMO 2020, has already been prohibited in some regions and ports, such as China’s coastline and Fujairah, and will be banned in Singapore as from the beginning of 2020. More ports are expected to follow. Open-loop scrubbers, contrary to closed-loop scrubbers, pump water in the sea to clean the fuel and drop out the waste in the sea. Closed-loop scrubbers, which store wash water for later discharge, are still accepted in most ports.
Burning compliant low-sulphur marine fuel will therefore be the most straightforward way to comply with the new regulation. Heavy fuel oil (HFO) with a high sulphur content represents the vast majority of marine fuel currently sold. In order to comply with the IMO 2020 regulation, carriers can switch to burning either marine gas oil (MGO), a pure distillate product, or ultra-low sulphur fuel oil (ULSFO) of 0.1% maximum sulphur content. Although ULSFO is inexpensive in comparison to MGO, its lower availability as well as concerns about fuel stability issues risking to damage engines with sediments should prevent it from being used to a large extent following the start of the IMO 2020 period.

Impact

Therefore, switching to MGO will probably be the preferred solution in the first months (or even years) following the enforcement of the IMO 2020. Today, prices of MGO with a maximum sulphur content of 0.5% are about 40% higher than those of IFO 180 (a high-sulphur fuel oil type), according to the ‘Global 20 Ports Average’ bunker fuel prices (see chart 1). Consequently, fuel costs for the shipping sector should increase by several tens of percent as a result of the higher fuel prices and the switch from HFO with a high sulphur fuel content to MGO. According to estimates made by the energy consultancy agency Wood Mackenzie, global shipping fuel costs are likely to rise by 25% and, if no vessels added scrubbers and all ships complied with the rules, the spike could be as high as 60%.

Whatever the way to comply, marine transport costs will significantly increase while fuel costs already represent more than half of the operating costs of the shipping sector. As a result, freight rates will increase, as many shipping companies have announced that the rise in costs will have to be passed on to customers. Some are already doing this through the adjustment of their fuel surcharges. For the remaining increase in cost, they will have to cut into profit. As the IMO is also pushing for the imposition of stricter targets of CO2 emissions from ships, shipowners could be further shaken by other environmental regulations. Investment decisions are difficult to take. Indeed, in terms of CO2 impact, LNG- or methanol-propelled vessels are more interesting.

Another major risk related to relying to a large extent on the use of compliant fuel is the fact that the refining industry could be unable to supply enough of the compliant fuels as from 1 January 2020, leading to shortages. In that respect, refineries able to extract a higher share of the compliant MGO and heavy fuel oil will benefit from the move, as the demand and refining margins for those products will increase and as they could gain market shares from small, independent refiners. US Gulf Coast refineries and complex ones in the Middle East are well placed for the shift as they produce a higher share of lighter, low-sulphur fuels from each barrel of crude. European refineries that supply a high portion of middle distillates should also benefit. On the contrary, refineries in Russia could lose market shares as the country, which is among the top exporters of marine fuels, deals with the high-sulphur Ural crude.

Regarding the bunkering companies (i.e. the industry supplying the fuel used by ships), besides the necessary adaptation in terms of the range of products sold and in bunkering infrastructures, the IMO 2020 could impact their financial structure, as a large proportion of bunker fuel sales are made to shipowners and carriers on credit. The question remains as to whether the sector will be able to face that heightened demand of credit.

Analyst: Florence Thiéry – f.thiery@credendo.com