IMO 2019

Published at 10:50 23 Feb 2018 by

Much of the oil market is starting to accept that the IMO 2020 specification shift for marine fuels is going to happen, but forward prices still have not totally adjusted because the market has not fully digested the fact that the effects of the specification change will be felt long before 1 January 2020. Ships might burn the fuel right up to the deadline, but trade patterns will shift long before then. Wholesale buying will dry up from mid-2019 and bunker sellers will be dumping inventory to be able clean tanks and other infrastructure. The dearth of buying from mid-2019 makes the current massive backwardation in 2019 look odd. Forward prices need to come off and may need to be in contango before 2020 to incentivise the storage of surplus material.

To put this in context, we think at least 2 mb/d of fuel oil demand will be destroyed by IMO 2020. The market is currently in a slight deficit and drew stocks by just under 30 mb in 2017, so over the next 18 months (or less), fuel oil supplies will need to fall by roughly 25%. The only way to accomplish this is for prices to realign. European HSFO cracks for calendar year 2019 are still nearly $8 per barrel higher than for 2020 but, as noted above, supply will need to be rationalised long before January 2020.

The burden will fall on refiners. For the cash-strapped ship owners, doing nothing is an economically rational response in most cases, as the cost of fuel can be passed on to charterers. Thus, the shipping industry does not appear to be embracing exhaust gas scrubbers at anywhere near the pace that would be needed to ensure a business-as-usual case for fuel oil. Perhaps 1,500 scrubbers have been installed. This figure could more than double by 2020, but with 120,000 ships plying the high seas, this is merely a drop in the ocean.

There are several high-profile billion-dollar refinery investment projects underway or recently concluded in Europe, and US refiners are also beefing up coking and diesel-making capacity with an eye to capitalising on the market shift. There is no longer enough time for big projects to come online by January 2020, but refiners will use forthcoming turnarounds used to optimise hardware ahead of the switch, so some of the supply decline required will be accomplished on the sidelines, but the market will likely need to knockout some simple refining capacity.

Price will also have to a lot of work. The crudes with the most sulphur and highest fuel oil content will need to be made cheap enough to get into the most sophisticated refineries, while unprepared refiners will need to fight for light sweet crude or face closure. This means that clean fuels output may fall too. Given the very attractive returns likely to be available from even partially desulphurising heavy fuel oil, marine fuels demand will compete heavily with gasoline for space in VGO hydrotreaters. Concerns about gasoil tightness in 2020 will likely encourage some forward buying as well.

We do not expect lax enforcement to save the fuel oil market. If anything, the shift to marine gasoil may be larger than expected. Far from backing down on its commitment to cleaner fuels regulation, the IMO is strengthening rules to improve compliance. A proposal to ban the carriage of high-sulphur fuel oil in the bunker tanks of ships that are not fitted with scrubbers is working its way through the IMO apparatus, and more measures are being actively considered.

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