IMO Low Sulfur Rule Could Mean Bumpy Road Ahead For Trump, Truckers
Crude oil and diesel prices have been on the march lately, with the former up nearly 40% since late December. The Brent international benchmark price for oil topped $70 per barrel last week for the first time in months, while the U.S. West Texas Intermediate price is closing in this week on $65 a barrel.
Retail diesel prices, now averaging $3.08 a gallon, should be watched closely as the 2020 deadline for implementing new international marine fuel standards draws near. The International Maritime Organization (IMO) environmental regulations, aimed at lowering the sulfur content in marine fuels, could create a supply gap and price spike for similar grades of petroleum products, including diesel.
Diesel would be the first hit as a rising portion of the pool of distillates used to produce over-the-road diesel will be diverted into making either more of a product known as marine diesel or to be blended into a new family of products known as very low sulfur fuel oil (VLSO). Both would substitute for the high-sulfur fuel oil, also known as bunker fuel, that now powers most vessels.
The IMO’s stricter sulfur rules could spell bad news for the American trucking industry, and potentially provide an unwelcome talking point to the opponents of President Donald Trump as he seeks re-election in the November 2020 elections.
Trump has won praise from the U.S. energy industry for his deregulatory domestic agenda and his commitment to American “energy dominance,” particularly in fossil fuels, a sector where the United States has become the world’s largest oil producer and a major exporter.
All this good work could get overshadowed if a fuel price spike upends the trucking industry and the broader transportation sector. Larger trucking fleets are better positioned mitigate any increase in fuel costs by negotiating longer-term fuel contracts and through hedging. The same can’t be said for small and midsize trucking companies. Any increase in the cost of the delivery of goods, including increased fuel costs, would likely be passed downstream to consumers in the form of higher retail prices.
Overseas shippers are already starting to build in IMO pricing into future contracts. The airline industry is expected to follow suit, building IMO cost increases into ticket prices.
The stricter sulfur limits will also impact the price of domestic home heating fuel and are expected to hit at the same time as the peak heating season. Consumers in the Northeast, upper Midwest and Alaska who depend on heating fuel will be hit the hardest since they can’t pass on the additional costs.
Although many analysts see the IMO 2020 rules as creating a supply gap for compliant fuels by pushing diesel’s price premium against crude oil to historic highs, the market currently does not see it that way. Future prices for diesel in January 2020, when IMO rules cap marine sulfur content at 0.5% from 3.5% now, are not much different than they are today. That means big investors like hedge funds and commodity funds don’t foresee a market dislocation emerging. At least not yet.
That could change. Markets have yet to assess just how much additional demand for diesel, marine diesel and low-sulfur fuel oil the IMO 2020 will generate. And if it’s anything close to the worst-case scenario some analysts are predicting, investors could adjust their positions dramatically.
Trump’s own economic advisors have flagged the issue as a potential problem headed into the 2020 reelection campaign. The president’s Council of Economic Advisors touched on IMO 2020 in its latest annual report, saying the regulation may create a supply shortfall that “will likely trigger higher prices, though estimates of price shocks to fuels, including diesel, gasoline, and jet fuel vary substantially.”
The Paris-based International Energy Agency (IEA), the energy watchdog for developed countries, predicts a 20 to 30 percent increase in diesel prices next year as a result of IMO 2020
The U.S. Energy Information Administration (EIA) is much more sanguine: it expects retail diesel prices to rise from $3.01 a gallon this year to $3.15 in 2020, though that increase is not wholly attributed to IMO 2020. The EIA’s March 2019 IMO report states margins resulting from IMO will increase by $.05 in 2019 and $.22 in 2020. Price increases are expected to be moderate after 2020 as the market adjusts to the new demand.
The Trump administration has worked to delay the implementation of the IMO regulation and has pushed for an “experience building phase,” but the international body has rejected the motion. Because the IMO is an international treaty, the Trump administration would need to find a majority of signatories to amend it. Something that looks extremely unlikely.
Trump has had more success pushing OPEC (the Organization of the Petroleum Exporting Countries) on Twitter for more production when U.S. prices get too high for his tastes. The IMO is likely to get the same treatment as the implementation date nears. Streamlining environmental regulations has been a theme of Trump’s first term and has increased investor confidence in the economy. It must be remembered that the president pulled the United States out of the Paris Climate Agreement over economic concerns.
He could do the same with the IMO but there are problems with such a move. For starters, insurers for shipowners could be unlikely to insure companies that choose not to comply with IMO 2020. The U.S. oil industry, which has become a big exporter not only of crude oil but also of refined products like diesel, jet fuel and marine fuel, mostly supports the new rule because most have already invested in upgrading their refining assets.
That leaves the president with limited options to respond. The administration could exercise emergency waiver provisions under the Jones Act for crude and product shipments between ports. Trump could also issue an emergency release of crude oil from the Strategic Petroleum Reserve, as well as emergency releases from the Northeast Home Heating Oil Reserve if the situation warranted.
The president could also limit U.S. exports of refined products but that probably would not sit well with industry or free-market conservatives on Capitol Hill. It would, though, probably sit well with voters.