High-sulphur fuel oil timespreads have rolled down and cracks are pricing like it is already 2020, making IMO 2020 more like IMO August 2019. In many ways, things are proceeding as the market has expected, although few expected the current strength in sour crudes. Though short covering provides some support, the current strength in sours is rooted in fundamentals.
The world’s crude oil production has been growing lighter and sweeter for some time now. Net gains in crude oil production in recent years have come entirely from light sweet crudes with low-sulphur vacuum residue (VR) cuts. Moreover, the US has knocked 1.9 mb/d of heavy sour OPEC production out of the market through its economic sanctions on Venezuela and Iran. Losing this much sour crude means losing perhaps 0.38 mb/d of HSFO.
While the present strength of crude grades with a relatively high VR cut might appear paradoxical as HSFO prices plunge, the simple fact is the market clearing mechanism for sour crudes appears to no longer depend on simple refineries. While the value of a sour grade for a simple refinery has fallen with the decline of HSFO prices, complex refiners that can upgrade the VR are willing to pay up to be able to run. And if sour crudes are tight worldwide, the arbitrage between different sour grades means that sour crude prices in all regions must rise to reflect conversion rather than simple economics.
Moreover, while sour crude availability has been falling, the ability of the world’s refineries to convert high-sulphur VR into clean products has been growing. For instance, by the end of 2020, global residual fuel hydrotreating capacity will be 0.9 mb/d higher than in early 2018. Most of these gains are due to capacities at brand new refineries that are seeking to fully upgrade VR into clean products rather than make LSFO, but the key point is the ability of the world to absorb HSFO is growing.
There are other capacities being added beyond resid hydrotreating. Between expansions of the world’s capacity to upgrade VR in refineries and the loss of heavy crude supplies, the global VR balance will tighten by roughly 1 mb/d this year. This could easily represent a difference of 4 mb/d in heavy crude balances and explains how sours can be paradoxically strong. The shift in world crude slates required by IMO is being aided these trends.
Furthermore, considering the large amount of light crude available that is suitable for making lower-sulphur fuel oil in the Atlantic basin, it seems increasingly likely that VLSFO production could easily be at least 1.2–1.4 mb/d in 2020. Indeed, strong LSFO pricing is allowing some of the simplest refineries to consider reopening or ramping up in some places.
The ball is now in the court of the shipping industry. Vessel owners will only start to nibble at the new IMO 2020-compliant fuel blends in September and October—they have no real incentive to switch to the more costly fuels until November at least. But with scrubber installations reportedly taking longer than many owners expected, IMO-compliant fuels should find enough buyers.