Houston, TX — The refining and shipping industries are ill-prepared for a massive change in fuel regulation set to go into effect next year. The resulting market impacts will be major, costly and far-reaching, says a new report from IHS Markit.
The impending regulation by the International Maritime Organization (IMO), a sanctioning body for the world’s shipping fleet, aims to significantly reduce the amount of sulfur in bunker fuels that are relied on for commercial shipping. Collectively, these ships burn more than 3 million barrels a day of residual fuel oil, which has a sulfur content that exceeds levels found in automotive gasoline by more than 1,000 times.
Burning fuels with a higher sulfur content leads to a greater level of toxic air emissions, including sulfur oxides, which are considered a threat to the environment and human health. IHS Markit expects the majority of the demand for high-sulfur residual fuel oil will switch to demand for the new lower sulfur fuel in 2020.
First announced by the IMO in 2008, the IMO confirmed in 2016 that global refiners and shippers would have to comply with these new environmental regulations by 2020—five years earlier than many anticipated, which sent tidal waves through two industries that typically take many years to adapt to such significant change that requires tens of billions in investment.
The new report, titled, Navigating Choppy Waters: Marine Bunker Fuel in a Low-Sulfur, Low-Carbon World, says that compliance remains the greatest uncertainty with the new regulation and that there is concern whether sufficient supplies of compliant fuels will be available in the world’s many ports. The result will be higher freight costs for most cargoes—including electronics, autos, petrochemicals and even cruise ship fares. Ultimately, those costs will be passed to consumers, IHS Markit said.
“Shippers will face significant compliance costs to either upgrade equipment or switch to more expensive, cleaner fuels,” said Spencer Welch executive director, oil, midstream and downstream for Europe, CIS and Africa at IHS Markit, and manager of the study. “Refiners – and fuel buyers – will experience significant price impacts as they shift production to deliver greater volumes of very low-sulfur fuel oil (VLSFO) and find a market for their less valuable fuels.”
“The IMO is taking positive action to address shipping pollution, but the rapid pace of the implementation of this new regulation is making it very challenging for the refining and shipping industries to respond,” said Sandeep Sayal, vice president of downstream research at IHS Markit. “The global scope, the significant uncertainty in fuel-formulations, and the volume of new lower-sulfur fuel demand, are causing a scramble.”
The IMO has signaled that it plans to take enforcement of the new regulation—which goes into effect January 1, 2020—seriously. Non-compliant vessels could suffer loss of charter to sail. And major insurance companies have also indicated compliance assurance would be essential to vessel insurability.
Shippers have several options for compliance, including low-sulfur bunker fuels and liquefied natural gas. However, IHS Markit researchers expect on-board ship scrubbers, devices that clear harmful pollutants from exhaust gas, will be the primary compliance path for larger ships which could continue to burn cheaper, higher-sulfur fuels. However, until those scrubbers can be installed—which for numerous ships will not happen before the IMO January 2020 deadline, many ships will have to burn the more expensive, IMO-compliant VLSFO fuels.
“We estimate between 5,000 and 10,000 ships will undergo scrubber installation at a cost of between $2 million and $7 million each, plus increased operations costs,” said Krispen Atkinson, senior consultant, IHS Markit maritime & trade research. “To date, the industry has spent or committed more than $6.6 billion to fit more than 2,000 ships with scrubbers.”
Other ships will convert to compliant fuels with sulfur levels below 0.50 percent. But those ship owners will see fuel costs escalate significantly due to the higher-quality fuel required and may face fuel compatibility issues, IHS Markit said. Each refinery complex could produce different – but compliant – regional formulations to meet the new fuel standard based on available crude oils, product slates, costs and supply chain logistics, presenting operational and continuity challenges for shippers.
Refiners will produce more distillates (higher-value components derived from crude) as new demand arises, with about half of the new compliant fuel coming from non-distillate sources within the refinery, but the remaining 50 percent will need to be sourced from refinery distillates. However, these same distillates are also needed for other growing diesel markets. As a result, refiners will likely have to make significant operational changes and ultimately invest billions to shift their existing product slates, increasing costs and distillate prices (relative to crude oil prices).
“Highly complex refineries, which have the flexibility to convert various grades of crude oil into a wide range of refined products to meet market demand, will benefit most from the IMO-specification change,” Welch said. “Highly complex refiners produce the least amount of residual fuel oil and the highest amount of distillate and gasoline compared to lower-complexity refiners. Less integrated and less complex refiners will likely experience the greatest market risk,” Welch said.