Oil Markets Could See Volatility, Arbitrage As Shipping Fuel Shifts
A United Nations mandate on the shipping industry to remove up to 85% of the sulfur content from its fuel to cut 3% of global carbon dioxide emissions could throw the industry into massive disruption.
Some analysts argue it could lead to fuel supply and demand imbalances and arbitrage opportunities that could extend crude oil price volatility.
“The industry is still in a financial tailspin since the financial crisis, but the technology is ready and mandates being enforced by each country will make this a reality,” Jigar Shah, co-founder and president of Generate Capital told Forbes.
Shah, who also founded SunEdison and helps host Greentech Media’s Energy Gang podcast said, “Moving to new infrastructure will create winners and losers. The losers will fight back and the winners will seek to include the losers to make the transition occur faster. Sometimes it works as designed and other times it takes a few more years, but there will be no stopping this transition.”
In 2016, the United Nations’ International Maritime Organization (IMO) gave the global shipping industry four years to make sure the 90,000 vessels at sea burn 85% less sulfur by Jan. 1, 2020.
The IMO standard requires ships to produce a maximum of 0.5% in sulfur emissions rather than the present 3.5% limit.
“Implications go beyond shipping and refining. Changes will be felt in the entire commodity landscape, including petrochemicals, road fuels, and airlines,” said Aftab Saleem, KPMG’s director of its risk analytics advisory, which helps a large swath of the global shipping industry comply with the standard. “Costs are going to go up. This has huge, huge implications across the supply chain, all the way back to producers.”
“It’s interesting that in one of the smallest corners of the oil market—the bunker market—this one rule can have a ripple effect and cause a seismic shift in the shipping industry,” said Chris Cote, oil market analyst at ESAI Energy LLC in Washington.
Many analysts report the shipping industry is not yet ready. Bloomberg Intelligence has reported that as of May, about 67% of the shipping industry is not compliant and 65% of refiners are not ready for the new fuel oil.
The global shipping industry uses three million barrels/day of high-sulfur fuel oil, which must now be replaced or scrubbed.
Marine fuel oil, known as bunker fuel, is any fuel used to power deep sea cargo ships, but it has historically been heavy, residual oil after crude oil is refined for other products like gasoline or diesel.
As he advises the industry to ready itself, Saleem said there are few options for fuel with low-sulfur output—marine diesel, very low-sulfur fuel oil, or high-sulfur fuel oil with a scrubber, which costs as much as $5 million per ship and a month at port for the scrubber to be installed.
Diesel is already used for jet fuel, truck fuel and home heating oil and costs about 63% more than high-sulfur fuel oil. The very low-sulfur fuel oil is still being tested in ships. But the industry does not seem to be moving toward scrubbers as a first option.
By several accounts only 5% or less of the shipping industry will have been fitted for scrubbers by January, and at this stage, many say there’s not much time left for the retrofit.
What’s worse, most of the scrubbers installed are open-loop, which pull the sulfur out of the ship exhaust and then throw it into port waters. Cleaning up the air only to pollute the water is something many ports, among the 170 nations signed onto the mandate, oppose; several major ports have banned open-loop scrubbers.
New Market For New Fuels
Shah said, “From biofuels to natural gas, there are many solutions. More importantly, there are so many ship owners who are taking these regulations seriously that the momentum is unstoppable.”
Greg Dolan, CEO of the trade association Methanol Institute, says the UN rule opens the market for alternative fuels like methanol.
Methanol, or wood alcohol, is produced from coal, natural gas or renewable feedstocks. For years it has been used as a fuel for transportation and a chemical feedstock for solvents, paints and plastics, and more recently it’s been a carrier for hydrogen for fuel cell technology applications.
Methanex, one of Dolan’s member companies, has seven duel-fuel chemical tankers that can run on methanol or any diesel bunker fuels. They have four more entering the fleet soon, two this month. There is also a large “ro-pax” (cargo and passenger) ferry running on methanol, along with a pilot boat, dry bulk barge, and tourist ferry.
“It’s early days. These vessels are the only ones running on methanol. There are others coming into the market,” Dolan said.
That’s what Dr. Steven Kadiev, founder and CEO of Neo-H2, is looking forward to. His Charlotte-based company has developed portable fuel generators that convert methanol into hydrogen-blended gas that can displace diesel in a duel-fuel engine. Kadiev said the technology is used for stationary diesel engines for power generation, but also marine vessels. Kadiev is seeking $500,000 to $1 million for seed money to ramp up production.
Liquefied natural gas is also an option to replace heavy bunker fuel; ships would have to retrofit their fuel tanks completely and LNG storage tanks take up a lot of space on a shipping vessel, Dolan said.
“Methanol has half the energy content of diesel so you need more of it, but you can use the double hull and ballast tanks to store methanol,” Dolan said. “A lot of vessels are LNG capable or LNG ready, and the engines may be dual fuel, but they’re not putting the LNG storage tank on the vessel.”
The cost of converting an existing vessel to be able to use methanol is about the same as adding a scrubber, and as the world’s most widely shipped chemical commodity methanol is already stored in most major ports around the world, Dolan said.
He offered the example of chemical tanker ships that pump methanol from the cargo tank to a service tank on the deck, and gravity feeds it into the engine room.
Methanol biodegrades faster than gasoline or diesel, Dolan said.
Diesel is cheaper and has more energy, so it’s preferred. “But refiners are finding a lot more ways to upgrade bottom-of-the-barrel than just producing heavy fuel oil as a bunker fuel,” Dolan said.
“The shipping market is so large–350 million metric tons of bunker fuel a year,” Dolan said. “Methanol has half the energy content of diesel fuel. If we captured 5% of that market, we would need 70 million tons of methanol. We would have to nearly double global methanol production, which can be done.”
The Methanol Institute is working with Lloyds Register on an economic analysis expected out this fall that compares various marine fuels.
Dolan is also conducting a study on the top 100 ports in the world and identifying how much methanol storage exists at each port. “Two-thirds of methanol is going from one continent to another,” Dolan said. “[The] shipping industry thinks of methanol as big cargo. They don’t think of it as a bunker fuel, but that’s changing.”
Marine vessels account for 4% of global oil demand, so the UN regulation will affect petroleum supply, demand, and trade flows on a more long-term basis, according to the U.S. Energy Information Administration.
The Energy Department’s statistical arm expects the share of high-sulfur residual fuel oil consumed by U.S. ocean-going bunker fuel markets to drop from 58% in 2019 to 3% in 2020. It rebounds to 24% in 2022, which indicates shippers are not veering toward scrubbers as a first choice or simply delaying compliance.
EIA said, “A recovery in high-sulfur residual fuel oil consumption driven by scrubber installations does not occur until 2022 but at levels far lower than before the 2020 IMO rule implementation.”
After 2023, high-sulfur residual fuel oil consumption declines down to a 22% share of U.S. ocean-going marine vessel bunker fuel by 2025, according to EIA.
“While finding an outlet for displaced high sulfur fuel oil, the demand for very low sulfur fuel oil will create the demand for sweet crude,” Saleem said.
Three barrels of sweet crude will produce one barrel of distillate. Complex refineries with hydrocracking and coking units could see expanding margins, he said.
But the demand for sour crude which refines into the higher-sulfur fuel will be lower. This could disadvantage sour crude producers in Alaska, Mexico, Venezuela, Colombia, Ecuador, Saudi Arabia, Iraq, Kuwait, Iran, Syria, Egypt and Canada, the world’s largest sour crude producer.
Refineries On The Ready
The American Fuel and Petrochemical Manufacturers said the refining industry is ready.
Marine vessels operating in U.S. waters are already required to burn fuel meeting a sulfur standard of 0.1%, which is more aggressive than the U.N. mandate, AFPM said.
AFPM said the US refining industry produces only a small volume of high sulfur fuel oil and that fuel oil is only a small fraction of the petroleum products that US refineries produce. The demand has diminished.
The refining industry has invested more than $100 billion over the past decade to produce clean fuels, including the low sulfur distillate fuel expected to be in demand as the shipping industry transitions to lower sulfur fuels.
In 2018, residual fuel oil made up only 2.5% of the product yield from US refineries, as compared with 46% for gasoline, 29% for diesel fuel, 10% for jet fuel with the balance other products such as petroleum coke, lubricants and feedstocks for petrochemical manufacturing.
In 2018, US refineries produced about 400,000 barrels per day of residual fuel, of which 300,000 barrels per day had sulfur content greater than 1%.
AFPM noted that the market expects there will be continued demand by marine vessels for high-sulfur fuel oil–800,000 barrels/day for use by ships with scrubbers and 600,000 barrels/day for customers that would be in noncompliance because of unavailability of low-sulfur fuel in smaller ports.
Refiners expect demand for very low-sulfur fuel oil will be nearly 1 million barrels/day, and 1.5 million barrels/day for marine distillates and LNG.
According to S&P Global Platts Analytics there will still be a large market for high-sulfur fuel oil. About 500 million barrels/day is expected for on-shore thermal uses. Saudi Arabia and Russia are expected to buy the high-sulfur fuel oil for power generation.
And the International Energy Agency projects Mideast demand for fuel oil for power generation will grow 3.1% from the period 2017-2023.
A large supply would likely come from Trinidad & Tobago, Mexico, Venezuela, Colombia, and Peru which collectively produced an average of 650,000 barrels/day of residual fuel oil from 2011 to 2015.
KPMG’s Saleem said because of the price differential between high-sulfur fuel oil and the low-sulfur varieties, the market will be rife for arbitrage.
Against the opacity of supply and demand of the various fuels starting in 2020, commodity traders will inevitably exploit the situation, betting on one over another.
The volatility in prices will create trading opportunities and fuel consumers will need increased credit lines from fuel producers, Saleem said.
Fuel suppliers will need infrastructure to deliver fuel to ships at the ports.
Like most analysts, Saleem says supply-demand equilibrium will eventually be reached and the regulatory environment will continue to evolve.
But for the near term, expect some bumps.
“From an energy-market perspective, there hasn’t been a one-time regulatory change in recent memory,” Cote said. “This is a big and unique event for the oil industry.”
Aside from a tacit understanding among flag states that they will enforce the mandate and impose fines for noncompliance, there is no consistent enforcement among port authorities, which Saleem said leaves an opportunity for corruption and bribery at ports and arbitrage among commodity investors.
“There will be compliance arbitrage and people will try to get away with noncompliance,” Saleem said.
Cote agrees. “There’s possibilities for corruption and bribery at ports. We don’t expect there to be a full fuel shift overnight.”
Cote thinks enforcement will be smoothed out over a year and a half.
Enforcement is handled at flag states. Some ports will be stricter than others, Saleem said. Denmark and Norway already plan to use sniffer drones to detect sulfur in emissions.
For the Good of the Climate
“IMO 2020 is a game-changer in the making,” Saleem said. “Why is this being mandated? To save human lives.”
In its 2016 standard, the IMO said switching fuels by 2020 would save 570,000 people in coastal areas for the most part who would otherwise die from the pollution at port cities. The IMO said switching from high-sulfur fuel oil to low-sulfur alternatives would save more than 150,000 lives annually by reducing lung cancer, cardiovascular disease, asthma, stroke and other diseases.
Oceana says if global shipping were a country, only the U.S., China, Russia, India and Japan would emit more carbon into the atmosphere than the global shipping industry.
KPMG Global says 15 of the biggest ships emit more sulfur dioxide and nitrogen dioxide than all of the world’s cars combined, and one million cars emit as much particulate matter as one cruise ship produces.
Though the UN mandate is making waves across the shipping supply chain, it can be met, and the industry is showing the world how, said Peter Fusaro, chairman and founder of Global Change Associates in New York.
“The shipping industry will probably double in greenhouse gas emissions as world trade continues to grow. [Companies] need to either buy the ecotankers or retrofit,” Fusaro said.
Fusaro, an author, Columbia University professor and expert on emerging energy and environmental financial markets, said industries often complain during times of big regulatory changes.
Fusaro worked with the Environmental Protection Agency in the 1980s to get lead out of gasoline. Refiners and the industry knew the mandate was imminent, and “they always cry wolf,” he said.
They thought there would be gasoline shortages. “Never happened,” Fusaro said.