New Low-Sulfur Requirements for Marine Bunker Fuels Causing Scramble for Refiners and Shippers, IHS Markit Says

International Maritime Organization changes will disrupt industries
as 2020 looms

HOUSTON–(BUSINESS WIRE)–The International Maritime Organization (IMO) recently confirmed that
global refiners and shippers must comply with new regulations to reduce
the sulfur content in marine bunker fuels by January 2020—five years
earlier than many expected. As a result, both the global refining and
shipping industries will experience rapid change and significant cost
and operational impacts, according to new analysis from IHS
Markit (Nasdaq: INFO), the leading global source of critical
information and insight.

“While the IMO is taking positive action to address the environmental
impacts of air pollution from ships, the rapid change creates
significant disruption for both the refining and shipping industries,”
said Kurt Barrow, vice president of downstream research at IHS Markit.
Barrow, along with Sandeep Sayal, senior director of refining and
marketing research at IHS Markit, are two authors of an IHS
Markit report entitled Refining and Shipping Industries Will
Scramble to Meet the 2020 IMO Bunker Fuel Rules.

“The two industries are vastly unprepared,” Sayal said. “Neither has
made the necessary investments for compliance, which means that the 2020
implementation date will result in a scramble. Both industries are
taking a wait-and-see approach until firm signals are in place by the
IMO for compliance with the regulation."

“Shippers will face significant compliance costs by having to upgrade
equipment or switch to more expensive fuels,” Barrow said. “Refiners
will experience significant price impacts as they shift production to
deliver more lower-sulfur fuels to the market and, at the same time,
find a market for the higher-sulfur fuels they produce. Refineries, like
ships, do not turn on a dime, so it takes significant investment and
market demand to retool a refinery to deliver new supply.”

Shippers will have several options to meet the new IMO regulations, IHS
Markit said. Low-sulfur bunker fuels (primarily for smaller vessels),
and liquefied natural gas (LNG) (primarily for new builds) will be part
of the solution. However, IHS Markit researchers expect that on-board
ship scrubbers, devices that clear harmful pollutants from exhaust gas,
will be the primary compliance path for ships, which could continue to
burn higher-sulfur fuels.

“From the shipping industry point of view, IHS Markit estimates that
about 20,000 ships account for around 80 percent of heavy fuel-oil
bunker fuel use,” said Krispen Atkinson, senior consultant, IHS Markit
Maritime & Trade research. “Currently only about 360 ships have
installed scrubbers, since there is currently no economic incentive for
the ships to add scrubbers. However, based on the price spreads between
low-sulfur bunker fuel and high-sulfur fuel oil during the scramble
period, it will be economic for many of them to install scrubbers.” The
payback period for installing a scrubber on the largest vessels,
Atkinson said, would be two-to-four years in 2022-2025, and less than
one year based on peak-price spreads in 2020.

A key uncertainty also lies in the actual level of compliance to the IMO
regulation in 2020. “Not only is it hard to enforce compliance in the
open seas, but it is still uncertain if sufficient supplies of compliant
bunker fuels will be broadly available in all ports,” Sayal said.

Overall, the installations of scrubbers and some level of noncompliance
will not be in time to halt the disruption on refined products markets,
IHS Markit said. According to the IHS Markit report, the primary
challenge with the bunker fuel quality change (which requires sulfur
content to be reduced from 3.50 percent by weight to 0.5 percent by
weight) is the disposal of high-sulfur residual fuel—not the production
of low-sulfur bunker fuel.

“When we account for all the supply and demand factors for the sour
residual balance, including new conversion projects, capacity creep,
scrubber and LNG capacity, as well as quality compliance, our bottom
line is that a sizable portion of today’s fuel oil will be pushed into
lower-price tiers, notably oil-fired power-generation plants,” Barrow
said. “Refining capacity will most likely exist in 2020 to produce the
low-sulfur bunker fuel, but higher overall crude runs will be required.”

The largest refinery margin disruption will be significant but fleeting,
according to the IHS Markit report, with impacts felt most notably in
2020 and 2021. IHS Markit expects an unprecedented light-heavy price
spread during 2020 to 2021. During these years, pricing for high-sulfur
fuel oil (HSFO) will have to be near thermal parity with coal to clear
into the power market—a very low price relative even to today’s fuel oil
price, IHS Markit said.

As ship owners respond to the large-scrubber investment incentives,
high-sulfur bunker fuel demand will rebound, although not to prior 2020
levels. Due to increasing demand and addition of debottlenecking
capacity for residue conversion, IHS Markit estimates price spreads will
moderate within a few years, but the timing of price recovery will be
dependent upon a number of variables.

Refiners will produce more distillates (higher-value components derived
from crude) as new demand arises for these products during the disrupted
years, IHS Markit said. With HSFO priced at coal-thermal parity and
demand for middle distillates (kerosene, jet fuel, diesel) increasing to
blend to low-sulfur bunker fuel, refining margins will benefit, but in
different ways.

“Refiners of sour-crude will be negatively impacted by the nearly
valueless sour-crude residue, while refiners of sweet-crude conversion
will experience moderately higher margins, but sweet-crude prices will
reflect the low-sulfur residue value,” Barrow said. “It is the
high-conversion refiners of sour crude that are expected to have
extraordinary margins.”

Highly complex refineries will benefit the most from the IMO
specification change, IHS Markit said. Highly complex refiners will
produce the least amount of residual fuel oil and the highest amount of
distillate and gasoline as compared to lower-complexity refiners.

Crude-price relationships, specifically between light-sweet and
heavy-sour crude, will widen around the compliance timeframe, IHS Markit
said. Assuming the specification change implements as announced on a
global and instantaneous basis with no phase-in timing or quality
transition allowances, the margin uplift will be acute in the compliance
period from 2020 to 2021.

To speak with Kurt Barrow or Sandeep Sayal, please contact [email protected],
or [email protected]. For more
information about the IHS
Markit report entitled, Refining and Shipping Industries Will
Scramble to Meet the 2020 IMO Bunker Fuel Rules, please
contact [email protected].

About IHS Markit (www.ihsmarkit.com)

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