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Marine fuel standards could create sea change in global oil refining market

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Marine fuel standards could create sea change in global oil refining market

The global maritime shipping industry's impending shift to a low-sulfur fuel standard has the potential to disrupt the global flow of crude oil and refined products and create winners and losers among global oil refiners. But the potential magnitude and timing of that disruption depend largely on the level of compliance with regulations drafted by a regulatory body with no enforcement authority.

The International Maritime Organization, a specialized agency of the United Nations, adopted the regulations, known as IMO 2020, in 2016. At the start of 2020, the regulation requires vessels to burn marine fuels containing no more than 0.5% sulfur, down from the current standard of 3.5%.

"When these were first announced there was an expectation that there would be some significant changes to both the global refining industry and the maritime industry in preparation [for] the implementation date," John Mayes, vice president at Turner Mason and Co., an engineer consulting firm, said March 13 at the American Fuel and Petrochemical Manufacturers annual meeting in New Orleans. "The IMO was expecting the refineries to gear up to make low-sulfur bunker fuel. The maritime industry was supposed to install scrubbers."

"We had an expectation we would see more coker completions in 2019, early 2020. We didn't see any such thing," he said. "When the regulations first came out, there were some initial somewhat pessimistic forecasts of what scrubber penetration would likely be in the vessel fleet. The only change that we've seen is that forecast is substantially high."

The "wait-and-see approach" has increased the risk of a "more exaggerated swing" in crude oil and product prices.

Mayes said global fuel oil demand is about 7.8 million barrels per day, with bunker fuel oil demand accounting for 3.4 MMbbl/d.

"The non-bunker component of fuel oil demand has been declining for decades," he said. "It's being driven lower by regulatory and environmental factors. And so there's a problem assigning [bunker fuel] to homeland use."

Mayes said there would be a "significant diversion" of distillate into the marine fuel market as vessel operators sought to comply with the new standard, which the International Energy Agency pegged at 1.8 MMbbl/d.

"If we see a spike of nearly 2 MMbbl/d, that's almost a four-year demand increase compressed into a few weeks," he said. "It's hard to see how when you have a demand spike on the distillate side of this magnitude, you're not going to have a pretty sharp increase in prices. It all depends how fast this will play out. …Unfortunately, unlike gasoline, demand for distillate is not elastic to price."

Mayes said since commercial entities cannot reduce their consumption, diesel prices could increase fast enough to slow economic growth.

While Mayes expects the distillate issue will be solved by pricing, he does not believe that to be the case for refiners that produce large volumes of fuel oil.

One way he expects refiners will try to address the problem is by running lighter crudes.

"One or two refineries can do that, but 100 refineries can't do that," he said. "We're expecting an increase in the light-heavy crude differential [in addition to] the product pricing shifts."

Most refiners can only hold 60 to 90 days of production so "something has to happen at that point," he said. "At the bottom of the food chain are the high-sulfur fuel oil refiners. … It's not what price can they get for their fuel oil, but can they find a buyer before their tanks fill up."

Mayes said refiners with a lot of coking capacity, which are concentrated in the U.S., India and China, will profit from the widening light-heavy differential as they produce hardly any residual fuel oil.

He warned that asphalt producers may have to contend with increased competition from new entrants as other refiners that had not been asphalt producers seek a market for their lower-value products. Meanwhile, low-sulfur oil refiners may not have as secure of a supply of oil as competitors try to outbid them to procure supply.

Mayes said he expects national oil companies will be insulated from the impact of IMO 2020 because of political considerations, but he expects free market refineries in Europe will be at risk.

"There are a lot of things that are set in motion when you start a program like this. … Be prepared for the unexpected because that's what's going to come back and get you," he said.

Will marine vessels cheat?

Industry experts differ widely in their expectations of the level of compliance with the new bunker fuel standards, bringing the level of market disruption into question.

Jason Breslaw, head of BP's distillate trading origination across the Americas, expects "a bit shy of 9%" of marine fuel demand noncompliance.

"We had about 20 analysts within our trading organization [look] at the entire fleet of 19,000 vessels," he said.

Ralph Grimmer, senior associate at Stillwater Associates, said lack of enforcement could lead to greater noncompliance.

"Bear in mind that IMO itself cannot enforce this regulation. The only power to enforce is vested with the flag states like Liberia," Grimmer said. "You look at the top 10 flag states, most of them are not Denmark, Great Brittain, [or the] United States. If the flag states are the only place where policing can be done, you have a problem. … The IMO is trying to address that … but if IMO doesn't manage to get the enforcement piece right, you're going to see 9% be a number that's double or triple that number."

Breslaw disagreed, arguing port states have "significant authority" to detain vessels and levy fines.

"[The U.S. and the EU] have had … emission control areas enforced for a number of years," he said. "There are many ways to try to counteract [cheating], [such as] naming and shaming [or] blacklisting of flag states that ... don't look to enforce."