Category: IMO2020

As we are now in the second quarter of 2020 it is time to look back on the introduction of the IMO legislation on the regulation of sulphur emissions from bunker fuels. The dust has settled with respect to the implementation of these new rules. But as this happened a ‘black swan’ arrived on the global oil scene: COVID-19 or the Corona virus. This virus and the international crisis it evoked is gripping international trade and impacting shipping and bunker sales like nothing we’ve ever seen before. So, this article will also look forward to estimating the medium-term impact on bunker markets and in particular on bunker storage markets.

Running up to 2020

The International Maritime Organization (IMO) has implemented its global legislation to limit sulphur emissions as a result of marine fuels. The legislation calls for a reduction of the sulphur content in marine fuels to less than 0.5%, which has started January 1st, 2020. Until the start of 2020 the limit was 3.5%.

Leading up to the start of this new era in marine fuels there have been multiple opinions or scenarios about which bunker fuels would become dominant. In first instance, most stakeholders thought HSFO would remain the dominant bunker fuel because of the expected uptake of scrubbers. Other stakeholders assumed that MGO would become the dominant bunker fuel as there wouldn’t be enough supply of 0.5% FO. In 2018/2019 some oil majors, IEA and consultants changed their opinion believing that VLSFO would become the dominant fuel. There were other stakeholders, like the gasoil traders, who thought that the demand of MGO would increase significantly because of IMO 2020.

The first months of 2020

The first months of 2020 show that VLSFO seems to be the dominating bunker fuel. Consumption of MGO increased only slightly by around +10%. HFO is about 20% of total fuel oil consumption, with the rest being mostly VLSFO.

The introduction of the new 0.5%FO, called VLSFO, has led to some compatibility concerns. VLSFO blends can come from residual components and distillate components. Residual components are mostly aromatic due to the asphaltenes in the bottom of the barrel. Distillates are high on paraffins. Blending these two streams together can lead to compatibility issues. This can occur if a ship switches between different batches and the fuel is mixed in the ship’s fuel tank, a process also known as co-mingling. Co-mingling bunker fuels from different origins could lead to serious damage to engines or clogging of fuel lines. VLSFO residue blends, being more aromatic and hydrotreated vacuum gasoil (VGO), being less aromatic have these compatibility issues.

These compatibility issues also have a positive impact on the demand for storage capacity as some product owners avoid co-mingling new fuels in their tanks. So, this calls for segregated tanks, which will increase demand for tanks.

An important and lucrative business for oil traders in the ARA-region used to be the transhipment of fuel oil from Russia to the Far East. However, this transit flow has largely disappeared. On the one hand supply of Russian fuel oil has gone down whereas demand for fuel oil in Asia has dropped significantly. Furthermore, Asian bunker demand for fuel oil is currently be supplied from other sources more nearby. Nowadays, Russian export are directly exported in smaller tankers, with as main destination the US. ARA is not the place anymore where making bulk for HFO takes place.

Looking forward

Our assumption in the post 2020 era is that the shipping industry will keep on using FO as the dominant marine fuel (80%). Unclear is what the share of each VLSFO and HSFO will be.

In our forecasting models the Corona effect is incorporated. Assumption is that the current lockdown lasts three months and has a negative impact on marine fuel bunker consumption levels. After the lockdown, consumption level will gradually normalise, which will take five years. Our assumption of five years is based on experience in the past and the enormous fall of GDP which influences the consumption of fuel oil. IMF forecasts a contraction of the global GDP of 3% in 2020, while the Eurozone will see a decline of 7.5% in 2020. It will take several years of GDP growth to be back at the same GDP level as in 2019. The consumption of bunker fuel is heavily correlated with global trade, so we expect it will take several years before bunker fuel market is at the same level as in 2019.

Due to growing bunker fuel consumption and declining average production, surplus in NW Europe will change into a deficit. Terminals in ARA specialized in fuel oil will benefit from the growing size of the fuel oil bunker market. As the number of grades has increased and more components are needed to blend into the 0.5% FO / HSFO / MGO, more storage capacity is needed.

Additionally, on top of these structural effects on fuel oil supply, demand and imbalances, there is an enormous oversupply in the market due to the COVID-19 / Corona crisis. This has resulted in a steep contango in fuel oil forward prices and is stimulating traders to buy and store excess fuel oil supply. This provides major support for fuel oil storage rates in the short to medium term.

Figure 1: NWE HFO demand Forecast

So summarizing, the introduction of IMO 2020 fuel oil regulations and the COVID-19 / Corona crisis have had the following impact:
1) More tanks needed to segregate blend and fuel grades
2) Less arbitrage flows limit demand for large tanks
3) Long term bunker demand growth and rising imbalances will support tank demand
4) Short to medium term support of fuel oil storage rates due to steep contango

The real impact of Corona on the global and regional GDP’s is not clear yet, but we may conclude that the IMO 2020 regulation have had a positive impact on the ARA tank storage demand. Also in the short to medium term, the COVID-19 / Corona crisis have had a positive effect on the tank terminal business.

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About the authors

Patrick Kulsen, Managing Director of Insights Global
René Loozen, Consultancy Director of Insights Global
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Click here to read part 1.

A Change for the ARA bunker markets

Insights Global structurally forecasts the future supply and demand of oil products in the ARA region and naturally incorporates IMO 2020 into its models. In our forecasting models we predict an annual growth rate for marine fuels that is adjusted for efficiency gains of ships, while the split between HSFO and MGO in bunker demand switches in 2020 and is submissive to price changes and upcoming alternative fuels. We predict a sharp decline in heavy fuel oil demand with simultaneously a jump in the demand for (marine) gasoil in 2020. The heavy fuel oil demand is expected to more than half in size, whereas MGO demand is predicted to quadruple. Our assumption for the post-2020 era is that the shipping industry will gradually switch back to fuel oil using scrubbers or 0.5% LSFO. Furthermore, LNG will take in a more dominant position, up to 11% in 2030. This will diminish the share of gasoil used and lead to a slight decline in gasoil demand between 2020 and 2030.

The transition from high sulphur fuel oil to marine gasoil and the changing demands for both products can be seen in the futures markets. The forward curve for HFO makes a steep dive towards the beginning of 2020 when the regulation comes into force. The gasoil prices show an inverted pattern: a small contango until the start of 2020 can be seen as demand for the product will be the largest when the legislation becomes active. After these initial price extremities of gasoil and HFO the markets settle down as HFO prices recover slightly while gasoil prices enter a backwardated situation. This is in line with our demand forecasts and resembles the extent to which alternatives such as scrubbers gain an increasingly larger share. We expect subsequent waves of investments in shipping but also in refining, as the production of 0.5% fuel oil becomes more profitable. For more complex refineries with a certain crude slate this will offer opportunities while for other, more simply configured refineries, their continuity is at stake.

A Change for the Tank Storage Business

The ARA region currently is a net-importer of gasoil and is the final destination for many of the world’s gasoil flows. Estimates are that in 2022 the deficit would increase by between +12% and +34% relative to 2018 values, primarily driven by IMO 2020. The changing imbalances of gasoil and fuel oil in the ARA region will have an impact on the ARA tank storage business. The lower fuel oil demand will increase the oversupply of fuel oil in the region and as such affect all tank terminals who lend their facility to this product. The changing environment for fuel oil tank storage will eventually lead to higher fuel oil storage rates in the region. Fuel oil storage rates are likely to remain depressed in 2019, but when the IMO regulation hits the markets in 2020 the oversupply of fuel oil is likely to switch the markets into a contango, supporting the storage business. This effect is expected to be reinforced when the crude markets switch to contango as well.

Higher storage rates for fuel oil are thus expected, but the current fuel oil tank storage business nevertheless faces a tough time from a logistical point of view. Terminals in ARA specialized in fuel oil are either busy in the bunkering market or in the transit business. In the first case these terminals will suffer from the reduced size of the HFO bunker market. In the second case the business is more related to the flow from Russia towards Far-East. This transit flow is also expected to be marginalized in the medium term and long term. Therefore tank terminal operators storing HFO will need to anticipate on these changes and explore options in order to cope with possible oversupply of fuel oil tanks. Less tanks for fuel oil storage will be needed, but opportunities lie in diversification. From 2020 onwards more grades of bunker fuel (a.o. ULSFO, 0.5% LSFO, 3.5% HSFO) will need to be stored, while smaller tanks as well as blending capabilities will become more important.

Running up to the bunker fuel spec change in 2020 the fundamentals for the gasoil storage market are likely to improve following more interest in middle distillate tanks and the need for more grades of gasoil. The contango that is developing in the gasoil markets supports the storage rates as well. In 2020 however we expect a halt to the growth of gasoil storage rates caused by a backwardated market structure following the higher spot prices. After 2020 we expect storage rates to improve with the gasoil markets following the contango formation in the crude markets, albeit to a smaller extent. More tanks are needed in this bunker market to store middle distillates which could increase competition, but occupancy rates in the medium term will remain high due to increased demand.

In 2020 the international marine bunker fuel markets are in for a big change. For environmental concerns the International Maritime Organization will implement a new policy that limits the sulphur content of fuels burnt in maritime traffic. High sulphur fuel oil has been historically the most widely used fuel for maritime transport, but will most likely lose this position to low sulphur fuels such as marine gasoil or LSFO when the new regulation comes into force. This article dives deeper into the subject, and shares our vision on how the ARA bunkering market and international oil markets will change under the new policy.

As of January 1^st 2020 the International Maritime Organization (IMO) requires all marine fuels to have a sulphur content of at most 0.5% of the total mass, down from the current maximum allowed 3.5%. With the exception of a few areas that already have special IMO requirements in place, the new IMO standard will hold globally. Traditionally the bunker fuel market has been a sink for refiners to unload their high sulphur refining resids into. In 2018 an average of seven million barrels of such heavy resids were produced every day, half of which was absorbed by ship bunkers. But the global refining system is not yet equipped to produce such quantities of fuel oil at a sulphur level of 0.5%. The impact of this new regulation is therefore big as most vessels will have to abandon their current fuel oil consumption, therewith completely changing the market dynamics for existing marine fuels and creating opportunities for alternatives.

An important decision for shipowners

The shipping industry faces an important decision for their fuel use under the IMO 2020 regulation, and several options exist for shipowners who need to replace their HSFO consumption.

The most likely scenario is that the majority of the shipping industry switches to using marine gasoil (MGO), which doesn’t require any technical modifications nor upfront investments.

Second, the shipping industry could switch to a new 0.5% low sulphur fuel oil (LSFO) grade. Current global LSFO production capacity is however insufficient to cover a transition from HSFO to LSFO in the bunkering industry, and this change would need vast refinery investments.

The third option is to install scrubbers on board of ships and continue to burn HSFO while the exhaust gasses are being filtered. This is an expensive and lengthy investment for the shipowner, as installation costs range between 2-3 million per vessel and the delivery time to install the scrubber will have the vessel out of operation for a long time.

The fourth option is that the shipping industry switches to burning LNG. Significant investments and concerns about the availability of LNG as a bunker fuel however challenge the implementation.

The fifth option is that the shipping industry switches to methanol. Methanol has a low energy density however and in addition requires a multi-million investment. Given the ease of the transition to marine gasoil compared to the other products the market will initially shift its bunker demand by using marine gasoil when the new regulation goes into effect.

Read part 2 of the article here.

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