No longer afraid

Published at 09:34 27 Sep 2019 by

VLSFO is surging into contention as the main solution to IMO 2020. Indeed, if the near total lack of discussion of MGO fundamentals at this month’s big oil market gathering in Singapore is any guide, MGO is yesterday’s news. Fuel oil traders may not have to retire just yet, as VLSFO means blending savvy is going to be more important than ever.

Back in 2018, our IMO base case pegged VLSFO as the ultimate winner from the transition to clean fuels, but we expected the rate of adoption in 2020 would be slow at first due to concerns about VLSFO stability and compatibility. And it is only in recent weeks that shipowners have begun to get over these fears. We now estimate VLSFO demand in 2020 could average 1.5 mb/d or more, while some players are even predicting it could hit 2 mb/d. While high as an average, this level could well be hit by end-2020 so long as there are no ‘bad bunker’ episodes.

There will, however, be huge variations in VLSFO properties so there will be a broad spectrum of VLSFO grades. Still, Singapore will set the tone for VLSFO pricing and arbitrage flows owing to its size and the fact that the city-state’s mandatory mass flow meter use means that minimum viscosity standards will be set for Singapore VLSFO. All other grades will price relative to Singapore and ultimately arbitrage flows of VLSFO components from the west will be done with reference to Singapore prices.

In short, VLSFO will almost always be a blend of components and will sit on a spectrum with MGO. Conversations with bunker industry leaders confirm that the MGO many are planning to offer will be more likely following the DMB specification, which allows more high-density material to be blended into the fuel mixture and requires a ‘clear and bright’ appearance. This means there will be some heavy (perhaps even residual) components included in DMB-type MGO blends. Oil statistics will still cling to the rigid distinction between middle distillates and fuel oil, but marine fuels will in reality occupy the space in the middle, skewing product balances.

VLSFO will continue to follow the ISO 8217 specifications for marine residual fuel, so it cannot be exclusively made of low-sulphur residual fractions because of specifications such as pour point. This will require VGO feeds to be backed out of FCCs and RFCCs into the bunker pool. At a time where European forward FCC margins are negative, VGO will have no issue pricing itself into the bunker pool, but whether this means that VGO will flow from west to east is unclear at current swap values. VGO will also find its way into the MGO pool. Compliant 0.5% marine fuel demand in 2020 will be around 3 mb/d and VGO could easily make up 0.5 mb/d (2.1 Mt) or more of the pool.

The bottom line is that a lot more blending is going to be going on than some assume and the key area of competition will be the grey zone between traditional diesel barrels and residual fuel. This will firmly link marine fuel markets to the gasoline price by increasing competition for VGO and other feedstocks.

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