Four experts weigh in on six potential outcomes for the shipping industry in the aftermath of sulphur cap implementation.
As the January 1st implementation date for the International Maritime Organisation’s 2020 sulphur cap approaches, a few things have become clearer, and much remains uncertain.
As many in the industry predicted, we know that the majority of the global fleet will switch over to compliant fuel oils like marine gasoil (MGO) and ultra-low sulphur fuel oil (ULSFO) in 2020.
This is viewed as the default compliance option for the sulphur cap, which will limit the maximum sulphur content permitted in marine fuels worldwide from 3.5 m/m to 0.5 m/m.
We also know that the proportion of the global fleet expected to have installed scrubbers by the implementation date will not amount to more than 5% or 10%. Scrubbers remove sulphur dioxide from exhaust gases, which permits scrubber equipped vessels to continue consuming high sulphur heavy fuel oil (HSHFO) after 2020.
The likelihood is that more shipowners will choose scrubber adoption as their preferred compliance route, but that the bulk of adoption will take place after 2020.
Similarly, the number of vessels fuelled by liquefied natural gas, although a rapidly growing segment, will by January remain low when considered as a percentage of the overall fleet. The prospects for LNG demand growth in the shipping industry are strong, but uptake will predominantly be limited to newbuilds entering into service after 2020.
Those are the known outcomes. What remains less clear are the details that will have the greatest impact upon the majority of the fleet choosing to rely upon compliant fuel oils.
These uncertainties include the availability and price of MGO and ULSFO in individual ports; the proportion of vessels choosing MGO over ULSFO and vice versa; the price differential between compliant fuels and HSHFO; and the variation in enforcement levels between different jurisdictions.
With these variables in mind, KNect365 Maritime has prepared six scenarios covering some of the outcomes likely in the direct aftermath of the sulphur cap. Not all of the scenarios are mutually exclusive, and they have been drafted with the understanding that the actual picture in early 2020 will probably be more complex – and more regionally divergent – than a single scenario could do justice to.
Nonetheless, they provide a useful lens through which to consider the range of possibilities likely to obtain in 2020. The scenarios are as follows:
- The limited fuel availability, low enforcement scenario.
- The limited fuel availability, high enforcement scenario.
- The high MGO, low ULSFO scenario.
- The low MGO, high ULSFO scenario.
- The adequate fuel availability, low enforcement scenario.
- The adequate fuel availability, high enforcement scenario.
We reached out to four experts on the sulphur cap and marine fuels (drawn from the shipping, legal, business intelligence and refining sectors) to get their thoughts on the above scenarios.
These experts were Julian Clark, Global Head of Shipping at Hill Dickinson, Richard Clayton, Chief Correspondent at Lloyd's List, Poul Woodall, Director of Environment & Sustainability at DFDS A/S, and Damien Valdenaire, Science Executive at Concawe.
Their remarks shed some light on the factors that will influence the state of the market in 2020, and on the secondary effects of the various outcomes outlined in this report. Unless quoted explicitly to the contrary, their contributions should not be taken to reflect an endorsement of any given outcome.
Using their input as a guide, we will begin by considering the issues of fuel availability, enforcement levels and preferred choice of compliant fuel in turn. This will be followed by an assessment of the likelihood and potential effects of the six scenarios.
KNect365 account holders can also access Richard Clayton and Julian Clark’s full responses to the six scenarios (registering for an account is free):
A shortage of compliant fuel is an eventuality the industry has been warning about ever since the 2020 implementation date was ratified at MEPC 70, in October 2016.
Disagreement focuses on whether there will be sufficient refining capacity available to produce the quantity of compliant fuels required to meet the rise in demand. The IMO’s position is that there will be.
This has been contested by a BIMCO / IPIECA sponsored study released in 2016, which made the case that the IMO’s findings assumed that existing refining capacity would be optimally utilised to meet the shipping industry’s needs.
Three years on, and commentators are still split over the fuel availability question. According to Damien Valdenaire, of the European refining industry research group Concawe, the group’s “simulations show that it is not easy to produce the required demand in terms of marine fuel at 0.5 m/m. To meet full compliance, our modelling software is severely constrained.”
That is not to say that fuel scarcity will be severe enough to cause significant disruption. But any constraints in supply will be reflected in the cost that shipping companies must pay for fuel. Wood Mackenzie’s estimate is that bunker costs may rise by as much as $60 billion per annum.
This is a particular problem because even in an adequate supply scenario, the industry will still have to contend with paying for fuels which are more expensive to produce.
For Poul Woodall of DFD A/S, severe limitation to the availability of compliant fuel is an unlikely outcome. But he agrees that stiff bunker prices could be on the table. “I don’t think that [a lack of available fuel] will ever happen because there are many different types of compliant fuel,” he says. “It’s really just a question of whether you would pay for it.”
Lloyd’s List’s Richard Clayton concurs that the risk of inadequate fuel availability is low, at least after the initial adjustment period. “If there is limited availability of compliant fuel in the immediate aftermath, this will be quickly sorted as the shipping industry works with the refinery companies,” he says. “Shortage will be for a limited duration.”
One factor which may complicate matters, however, is the difficulty of finding compliant fuels that match the specifications of the carrier. “Sourcing fuel qualities that will blend with what’s already on board might take some time to get right,” Clayton warns. “Not all low sulphur fuels are the same.”
The blending question poses a challenge for Woodall too. “If you’re going for the new fuels you have to get some tests made on what they look like, and can you blend, can you not blend, and how to handle them,” he says. “There’s an awful lot of work to be done here.”
Another complicating factor will be the variation in supply constraints between different locations. “The question of availability needs to be considered by reference to the vessel’s trading routes,” Hill Dickinson’s Julian Clark argues. “It is obvious that a wider range of bunkers will be available in large bunkering hubs such as Singapore or the US Gulf as opposed to (more) remote locations.”
It should also be said that the IMO is taking steps to safeguard against the potential impacts of a shortage of compliant fuels. The organisation is in the process of formulating its fuel oil non-availability report (FONAR), which will allow vessels to use HSHFO if there are no compliant bunkering options on offer.
There are still some questions about how FONARs will work in practice, however. The International Bunker Industry Association (IBIA) has pointed out that, once a FONAR is obtained, there ought to be provisions in place for vessels to debunker HSHFO after arriving at a different port.
If these provisions are not made, vessels could find themselves in a fix: unable to dispose of their existing fuel, and unable to bunker a compliant alternative.
IBIA has also suggested that FONARs could be used to cover situations of technical non-compliance, in which a fuel exceeding the 0.5 m/m limit has been supplied without the master’s prior knowledge.
It is hoped that these issues will be resolved at the 74th meeting of the IMO’s Marine Environment Protection Committee (MEPC 74) in May.
The interplay between fuel availability/pricing and enforcement will be one of the more intriguing consequences of the sulphur cap.
Low levels of enforcement – although a blow to the IMO’s authority – could alleviate some of the problems caused by low fuel availability, should this prove to be an issue. Likewise, high fuel prices could prompt some less scrupulous port authorities to turn a blind eye to infractions.
On the other hand, high levels of enforcement could place further upward pressure on ULSFO and MGO prices, exacerbating the costs of sulphur cap compliance for shipping companies.
Questions about enforcement are of course limited to the regions outside of which Emissions Control Areas (ECAs) have already been established. Existing areas comprise the Baltic and North Sea SECAs and the North American ECA (including the Hawaiian and US Caribbean islands).
These regions have had time to adapt to regulations restricting the sulphur content in fuels, and enforcement mechanisms are already well developed. Compliance levels will therefore continue to be high. Nonetheless, the experience of imposing ECAs perhaps provides an indication of how the enforcement landscape may look elsewhere in 2020.
“In Europe leading up to the SECA in 2015, we saw that there was virtually no enforcement in the first year in 2015,” says Woodall. “And that’s in Europe, which is supposed to be a fairly sophisticated marketplace. I fear that we will see the same in the rest of the world in 2020 - that there will be a lag between implementation and efficient enforcement.”
This stands in contrast to the IMO’s resolute messaging on the subject. The “IMO has stated categorically there will be immediate fines for non-compliance: no ifs, no buts, no experience-building phase,” says Clayton.
“In the unlikely event that Port State Control inspectors decide to ‘guide’ or ‘advise’ rather than prosecute, lessons will be learned very swiftly, otherwise consequences will be severe.”
Which outcome is more likely probably depends on where you happen to be looking. “Individual enforcement systems will vary,” Clark says. “Some will be experienced, well-resourced and efficient, others procedurally onerous with high levels of corruption and lenient penalties.”
It is also important to separate the issue of enforcement from that of non-compliance. Even in regions with low enforcement, there are real risks for major carriers caught flouting emissions regulations.
Clark points to the “potential reputational hit for any company which is publicly seen as breaching environmental regulations (irrespective of operating within low/high enforcement parameters) especially considering the increasingly environmentally friendly attitudes of the end users.”
He also observes that there could be wider reaching legal consequences for operators that disregard the rules, including the risk of charterparty claims and negative impacts on Hull and P&I insurance policies.
Choice of fuel
Price and availability will prove decisive in influencing shipping companies’ choice of fuel after January 1st.
The maritime sector has (until now) benefited from low fuel costs compared to other forms of transportation. As HSHFO is created as a residual by-product of the fractional distillation process used to separate out higher value fuels like petrol and diesel, it is both inexpensive and readily available.
MGO is derived through blending various distillates, meaning that it comes at a higher price. ULSFO also comes at a premium, as it requires further processing of HSHFO to reduce its sulphur content. Come 2020, it is likely that many refiners will not yet have allocated tank capacity to further process HSHFO.
Following the imposition of the sulphur cap, these refiners will “still have excess high sulphur fuel oil…. [and] it’s not clear where it’s going to be exported,” Valdenaire says. Some analysts have identified power generation, particularly in the Middle East, as a potential market for the unwanted HSHFO.
Whether refiners will decide in favour of MGO or ULSFO production is also largely guesswork. “We don’t know what the strategies of individual refiners will be, and which quantities they are planning to produce,” Valdenaire says.
Nonetheless, MGO is already used prevalently by smaller vessels and inland shipping, so there is an argument that availability could decide in favour of it in the short term. Although ULSFO is available at 0.1 m/m in the existing ECAs, ULSFO at 0.5 m/m has yet to reach the market.
Clark’s opinion is that “marine gas oil (MGO) (Below 0.5% m/m) is the most convenient route to compliance as it requires minimal investment from shipowners and is widely available. The downside is the higher cost, which will probably see a freight rate increase.”
The concern with ULSFO “is that there will only be a few suppliers which will be able to offer a reliable supply of this type of fuel, at least at the beginning,” he says. “Additionally, the high demand for this type of fuel is likely to bring up the cost.”
MGO also has the advantage of being similar in composition to automotive diesel. In theory, high MGO demand could to some extent be satisfied through the addition of automotive diesel to the marine fuel pool, if it is blended in order to raise its flash point.
Further on from the implementation date the picture may start to change, however. Refiners can be expected to adapt their strategies to meet the industry’s requirements, and ULSFO may start to become a more attractive option.
“Delivery of ULSFO will be more widespread than MGO when the dust settles, so this is likely to be the fuel of choice for most vessels,” Clayton says. “A battle between compliant fuels is likely to be decide in favour of price, and the most favourable price for ship owners will be ULSFO.”
Moving further out, other factors could also come into play. Continuing high prices for MGO and ULSFO, matched with continuing low prices for HSHFO, could incentivise scrubber adoption among the rest of the fleet, lowering the demand for compliant fuels
On the other hand, if more refiners choose to weight production towards ULSFO, HSHFO may become less readily available. That could cause scrubber adoption to falter.
Verdict on the six scenarios
The limited fuel availability, low enforcement scenario.
How likely is this scenario? Somewhat unlikely.
Why? Indications are that sufficient quantities of compliant fuels will be available at major ports.Any regional shortages will be priced into fuel costs, allowing shipping companies either to foot the bill or to adjust their bunkering patterns accordingly (if the price difference is high enough). In the case of an outright absence of compliant fuel, vessels should be able to fall back on FONARS, allowing them to burn HSHFO until complaint fuels become available.
Should fuel shortages become acute enough, however, there is a risk that outrageous bunkering costs could force non-compliance among some carriers. Port Authorities in regions suffering from a shortage of compliant fuels may not wish to scrutinise bunkering behaviour too closely. This makes the risk of a limited fuel availability, low enforcement scenario somewhat greater than the risk of a limited fuel availability, high enforcement scenario.
The limited fuel availability, high enforcement scenario.
How likely is this scenario? Most unlikely.
Why? As outlined above, even if there is less fuel available to shipping companies than the optimum, there should be enough flexibility in the system to prevent any major disruption to shipping operations.
There is also a degree of agreement among industry commentators that enforcement outside of the priorly existing ECAs and the East Asian seaboard will be staggered. Should fuel availability be highly constrained, it is difficult to see how incentives to move swiftly on enforcement action would be generated.
The high MGO, low ULSFO scenario.
How likely is this scenario? Moderately likely (in the short-term)
Why? Unlike ULSFO at 0.5 m/m, there are already substantial quantities of MGO in circulation, although these will need to be increased considerably.
Higher availability relative to ULSFO may make it a more convenient option for carriers in the early stages of sulphur cap compliance.
The low MGO, high ULSFO scenario.
How likely is this scenario? Moderately likely (in the medium-term)
Although individual refiners’ decisions are not yet known, supply restrictions and issues with fuel incompatibility may make ULSFO a problematic choice in early 2020.
As refiners respond to the changing demand profile of the bunker market, however, it can be expected that ULSFO will become a more favourable compliance option.
The adequate fuel availability, low enforcement scenario.
How likely is this scenario? Most likely
Why? Fuel availability is not a major source of concern among the experts consulted, and will become less of an issue as the market adapts to the new regulatory environment.
Depending on the region, enforcement levels may take longer to catch up, though. The severity with which penalties are enforced will depend upon the appetite for emissions reduction among individual member states, and questions remain to be answered about monitoring, testing, and accountability in cases of technical non-compliance
Positives are that adequate fuel availability should reduce the pressure placed on Port Authorities to overlook instances of non-compliance, and most major carriers should maintain high levels of compliance irrespective of enforcement levels in different jurisdictions.
The adequate fuel availability, high enforcement scenario.
How likely is this scenario? Somewhat likely
Why? The best case scenario for the IMO is not the most likely option, as enforcement in many regions will be a sticking point. However, as the industry adapts to the new regulations, the status quo will increasingly begin to resemble this scenario.
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