London — The world's largest crude oil exporter could be the answer to the quandary that awaits the high sulfur fuel oil market once interest for this product wanes due to implementation of a global marine sulfur cap.

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As demand shifts away from 3.5% HSFO in the bunker market to cleaner marine fuels due to the International Maritime Organization's global 0.5% marine sulfur cap from 2020, Saudi Arabia could emerge as one of the main outlets for this product.

Resurgent Saudi Arabian demand has been the driving force behind the strength of the European fuel oil complex this summer, with demand centred on power generation for desalination and to meet increased air-conditioning requirements in the summer months.

Traditionally, the fuel oil arbitrage from Europe into the Red Sea is a seasonal summer trend from April to October when Saudi Arabia and other Middle Eastern nations buy fuel oil to power air-conditioning. But with Saudi significantly increasing its desalination capacity, buying interest is expected to emerge even in the winter months.

From 2020 onwards, excess HSFO will need to find a home, with S&P Global Platts Analytics expecting an initial displacement of about 3 million b/d of the product.

Analysts believe the power sector could end up playing a pivotal role in propping up the fuel oil market even though environmental policies in some countries might prevent this from becoming a major trend.

Goldman Sachs in its recent report 'IMO 2020 -- Challenging but Solvable,' said Saudi demand could help substitute fuel oil for crude in power generation.

"Saudi Arabia -- who stands to lose from the IMO regulation given the elevated sulfur content of its crude -- offers the largest potential source of such fuel oil absorption in our view," the Goldman Sachs report said.

Countries like Pakistan, Bangladesh, Iraq and Iran could also be potential candidates for such substitution as supply outweighs demand.

"I think cost is the main driver for energy options. In the absence of stringent environmental regulations, cheap and polluting fuels will certainly find a market regardless of their environmental impact," said Yousef Alshammari, CEO of UCERGY Analysts.

Saudi Arabian fuel oil consumption has been growing over the last three years and liquid fuels continue to account for half of the kingdom's energy mix, despite a commitment to raising gas production.

DESALINATION DRIVE

Saudi uses domestically produced crude for power generation and at its desalination plants, although cheap fuel oil is an attractive alternative feedstock when the kingdom is looking to sell crude at a premium.

Earlier this year, the kingdom announced plans to build nine desalination plants in the Red Sea area, with some of these units already online, according to market sources.

A source close to the energy ministry told S&P Global Platts that there are a total of 31 desalination plant projects in the country. "Four are under study, two are under construction, and five are private. The rest are all operational," the source said.

Saudi Arabia has the world's largest desalination capacity, accounting for around a fifth of global capacity, the International Water Summit said in a recent report titled 2018 Energy Efficient Desalination report.

With fuel oil prices expected to decline sharply post 2020 as demand slides for HSFO, the market is banking on the Middle East to take advantage of cheap fuel oil cargoes for power generation.

--Eleni Pittalis, eleni.pittalis@spglobal.com

--Eklavya Gupte, eklavya.gupte@spglobal.com

--Edited by Jonathan Loades-Carter, jonathan.carter@spglobal.com