Marine Fuel Compliance Options as IMO Commits to 0.5% Sulphur Global Cap from 2020
After much deliberation and consultancy work, the IMO has finally decided that the Global Cap on ship’s fuel oil sulphur be set at 0.5% max. This limit shall come into force from 1 January 2020.
Furthermore in a parallel action, the Chinese authorities have decided to implement the 0.5% sulphur limit at 11 major Chinese ports with effect from 1 January 2017. These include Shenzen and Shanghai. It would be interesting to see if this is followed by other countries in the Pacific Rim.
As always this 2020 limit will apply to signatory states. We have not yet seen the full list of signatory states, but at the last round in the application of Annex VI we noted that Russia was a significant non signatory.
The implications of this global cap are very significant and will have a number of unintended consequences which will only emerge after the passage of time.
The refining industry will endeavour to meet the demand for 0.5% sulphur bunker fuel and this will probably be achieved by changing crude oil slate, rather than investing in very expensive heavy fuel oil desulphurisation. The reason for this is, that history has shown that where premiums on new grades are initially high, they tend to reduce markedly within 1-2 year as the industry adjusts to new relative values between grades and blending components. Refiners not already committed to capital investment in upgrading solutions may be wise to adopt a wait and see approach to confirm the economics.
The current sulphur content within the defined ECAs was set at 0.1% max in 2015. There was a lot of debate as to how this was to be met at the time. However the oil industry coped and some of the demand was met from the distillate stream and other refiners were able to extract a compliant fuel from residues via the vacuum distillation route. However the price for this fuel was greater than the price of crude oil, whereas HSFO traded at below the price of crude oil.
Refiners are currently most concerned to try and find ways of upgrading heavy fuel oil to lighter and more valuable distillates. We are seeing large investments in upgrading schemes such as cokers and hydrocrackers. The basis for these investments is that fuel oil has been for a long time returning less than the price of crude oil. Furthermore fuel oil has been a price taker, in so far as a refiner just wants to get rid of it. The refiners will not make much effort to blend fuel oils and thus it is left to the traders or bunker blenders to meet the specifications demand by the ship owners. The key issue is that refiners will not invest in storage of components/finished grades and blending facilities for post 2020 Bunker Fuels – Black Oil terminals with modern blending facilities will be in considerable demand from 2019.
The result of all this investment activity is to reduce the availability of fuel oil, particularly in mature markets such as ARA and the Middle East and in Singapore.
The other potential issue is the fact that the residuals emanating from these sophisticated refineries will be of whatever quality results. Some of these residual will not be compatible with the middle distillates available in the market. If the blends are made by unscrupulous blenders or traders, unwary ship’s engineers may end up with serious compatibility problems, even to the point of total engine failure.
If these fuels start to appear on the market, it will become necessary to ensure quality control is rigorous and that pre-sampling and sealing of tanks takes place prior to delivery of the bunker parcel.
Bunker suppliers are not going to like this.
Crude oil producers
One of the ways that refiners have in meeting the ULSFO, would be to change crude oil slates. However as we stated above the refiners objective is always to increase refining margin and unless the ULSFO commands a constant premium to crude oil, it is unlikely that they will make an effort to meet the ULSFO demand. Changing the crude oil slate will also have implications for the crude oil producers. With increased demand for sweet crudes increasing at the expense of sour grades, the sweet-sour differentials could widen substantially giving the sweet producers a boost to income at the expense of the sour producers.
This will mean that demand for Algerian, Libyan, Nigerian, Indonesian, Malaysian and Caspian Blends will increase and the Middle East grades will suffer, except for the condensate producers. It will also benefit the remaining N Sea grades and the WTI exporters.
However if this ULSFO is going to be attractive for the refiners to produce, the differential between HSFO and ULSFO will need to widen by about 30% of the price of the crude oil (basis Brent).
Bunker Blenders and Suppliers
It could also mean that bunker blenders who are currently supplied by refineries that run sour grades may be affected – a port such as Fujairah may become disadvantaged when compared to a Houston or Rotterdam.
We see a major role for condensate refiners in this regard; as the role of liquid hydrocarbons transitions more and more towards road fuels and chemicals feedstocks, large condensate fields such as the S Pars region of Iran and the Qatar adjacent fields, will be sought after once the bunker markets demand lower sulphur fuel.
Alternatives – LNG, Methanol and Scrubbers
Alternatives to low sulphur fuel are being sought and these are mainly driven by LNG or methanol or by the addition of flue gas scrubbing technology.
The proposals for LNG are well advanced and a number of ports are gearing up to supplying LNG bunkers. The use of LNG is particularly suited to point to point business, such as ferry routes and in river transportation. We think this is a very fertile field for the oil companies, as they have the technology and the investment capability. It will be a long haul, as it takes some 30 years to change the world’s shipping fleet. However should the price of crude oil rise out of line with LNG, it might be worthwhile to ship owners in retrofitting their fleet. We do not see this happening soon but work on ferries and coasters could be relatively easy to justify.
It is worth noting that it took more than 30 years to change from coal to oil.
Methanol is in its infancy and a lot of safety issues are involved that may not be easy to overcome. However it is a liquid, it is easy to produce from methane and is sourced from the same fields as the LNG currently being mooted.
Finally we come to flue gas scrubbing. On current price differentials between 3.5 % S and 0.5% sulphur the manufacturers of scrubbing units forecast a payback in 2 years. This is fine except, that as we said above, there is no guarantee that the current differentials will stand the test of time. Crude oil differentials would encourage more production of ULSFO and thus we would see the HSFO to ULSFO differentials narrowing as fuel oil demand remains solely the province of the bunker grades. Almost all of the world’s primary energy needs are likely to be produced more and more from renewables and or nuclear in the future and the demand for fossil fuels will end up largely in road and aviation transport fuel and chemical feedstock demand. Most forecasters see this transition happening between 2030 and 2050.
The big question hanging over scrubbing technology is what to do with the liquor that will have scrubbed out the pollutants extracted by the scrubbers? There is no coordinated view on this and unless this issue is solved, we could end up with this material ending up in our seas in high concentrations. This would surely be an issue of robbing Peter to pay Paul, that is, take it out of the atmosphere and dump it in the sea.
Until such time as this issue is resolved we see very little incentive for principled ship owners to install scrubbers. Even though some owners such as Maersk and others are installing scrubbers on new LR2&LR3. Any data available shows that scrubbers cost around $2,000 per day to run, take up cargo space and cost around $250 a tonne to remove the scrubbed liquid.
If we take a logical view as to how the marine industry will achieve compliance, then we see three scenarios: Middle Distillate substitution, LSFO supplies, scrubbers and of course there will be rogue owners who will cheat and not comply. This will be in the regions where policing of the specification could be lax or non-existent.
Most forecasters think that the likely outcome would be that the demand would split three ways between the distillate, LSFO and HFO to scrubbers, with about 10% noncompliance.
On this basis they believe that supplies will be available and there should be no problems for ship owners.
The more severe problems are going to be for the bunkering terminals. A lot of terminals around the world are relatively small and have limited tankage. The usual pattern is to have tankage for HFO, MDO, MGO and in some cases cutter stock. The HFO tankage is usually big enough to accommodate the largest supply tanker that the terminal owner can accommodate or the supply pattern demands.
After 2020 this type of terminal is going to have to split its tankage between ULSFO and HSFO. This will require that supplies are received in smaller quantities or that the supplying tanker is loaded with two grades. In either of these cases it is likely that costs will be higher for this type of operation. If the bunker terminal owner is not able to pass these costs on the ship owner it is likely that they will suffer a reduction in the already thin margins in the bunker supply business.
The Future outlook
The outlook for fuels and distillate prices is confused due to a number of ‘known unknowns’.
– Amongst others these are the uptake of renewable fuels
– The uptake of electric cars and their impact on power generation
– The impact of potential Carbon Capture and Sequestration (CCS)
– The growth in coker investments
– The growth in LNG/LPG/Methanol as a bunker fuels.
– The impact of incompatibility of new bended fuels.
– The potential for cheaper scrubber technology
– Other technological breakthroughs.
Just as with the forecast growth of electric and hybrid cars, we already see forecasts being pushed upwards and upwards. The effect of 1.0 million electric cars is to reduce demand by 1.0mmbd. Current forecasts are based on a 2035 horizon. However we are conscious of the fact that car pools are rotated every 7 years. If the fashion for electric cars catches on, then the electric car population could increase at a much higher and quicker rate. As we have seen with the French and UK Governments a major target is to reduce the population of diesel cars in the first instance. A big reduction in diesel engines will have an immediate effect on the price of middle distillate and if the coker investments carry on, then it is possible to imagine a scenario where the differential between diesel and HFO will narrow.
The use of diesel in marine engines is well proven and there are considerable savings to be made by a ship owner using diesel. The savings will come from the lack of need to preheat the fuel oil and a saving in filter cleanliness and the pre filter replacement cycle. We also believe there will be a positive, if small, gain from a reduced displacement from the density of diesel.
However we also believe that from an energy intensity point of view owners will come round to seeing that using diesel is not only simpler but also more economic. The chart below shows the relative cost of energy in $/mmbtu that a ship owner should be aware of in making his decision for post 2020 fuel. It seems that even if we assume that diesel will increase in price from 125% of the price of crude oil to 140% post 2020, we still see diesel being the more effective fuel.
From the charts below it can be seen that at present HSFO is marginally cheaper than diesel in terms of energy cost but much cheaper than ULSFO. By 2020 HSFO should no longer be an option and the gap between diesel and ULSFO is distinctively in favour of diesel.
We believe that the fears of shortage of ULSFO supply are somewhat overdone and that given a value, refiners will make the grade. However it might be that as diesel is shunned as a car fuel, ship owners might find it the best option.
Source: Charles L. Daly, Channoil Consulting Ltd