The L train

Published at 09:54 26 Jul 2019 by . Last edited 11:18 22 Aug 2019.

As the market for low-sulphur bunker fuels slowly takes shape, the broad contours of an IMO world are becoming clearer. While LSFO has strengthened—if the swaps market for 0.5% sulphur fuel oil in Asia is any guide—LSFO values should continue to rise relative to HSFO and converge with diesel over the coming months. This should incentivise more refineries to switch crude slates and help build supply for IMO 2020.

Physical fuel oil supply is starting to dwindle quite rapidly in some places. In Europe, the incentive to cut HSFO output is the strongest; HSFO is predominantly oversupplied in the Atlantic basin, meaning European refiners must try to cut output. Global HSFO bunker demand is set to fall by 2.5-3 mb/d come 2020.

For now, gains are limited by the fact that the only real buyers are storage players. VLSFO currently prices $100 per tonne over HSFO bunkers, giving shipowners little buying incentive beyond the desire to gain experience with the new fuel. As HSFO prices are expected to continue declining into Q4 19, and LSFO prices should continue to converge with 2020 swaps values, the impetus to switch will have to come from the desire to comply with the new rules. This means VLSFO and MGO buying is unlikely to pick up before October.

Though Europe has made strides to reduce its output, especially in countries where investments in upgrading projects have already been completed, it is too early to say that Europe has dealt with its HSFO problem or that it is on track to cut sufficient production. Mediterranean countries, which account for over 40% of European HSFO production, are particularly lagging, whereas countries with major ports will easily find a home for their excess HSFO output.

The present strength in LSFO prices amid growing appetite for storing LSFO ahead of IMO 2020 should help stimulate shifts in crude slates in Europe, supported further by the deterioration of HSFO swaps values due to the steep backwardation in the HSFO curve. However, the pace at which European LSFO can be put into storage is not great. After accounting for power generation and domestic demand, there is not much surplus European LSFO supply today—certainly not enough to enable a massive storage play.

Asian refiners, on the other hand, have already been incentivised to offer low-viscosity LSFO-type blendstocks for sale to the storage market—largely LCO from FCC units that is low enough in sulphur and can function as a potential marine fuel component. Indeed, the relatively low viscosity of the fuels on offer in the region—sometimes as low as 30 cst—suggests the compliant marine fuels offered by certain Asian refiners will contain some distillate and some residual components.

Though Asia may have low-sulphur LCO and other distillates available in significant quantities, Europe remains the main supplier of straight-run LSFO due to its crude slate, which is expected to get lighter and sweeter. Refineries in the Mediterranean will shift to new production profiles over the next several months by processing more imported US light sweet crude and reducing consumption of sour grades such as Urals.

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