As a deadline that will bring tighter marine fuel sulfur standards approaches, industry experts say one of the biggest uncertainties is how the market will dispose of the fuel oil that most ships will no longer burn starting in 2020.
Experts expect some of the world's less-complex refining capacity will reduce crude oil runs and may even shut down as operators struggle to cope with the coming market changes.
"We cannot make all of the distillate the world needs when we are looking at refinery reductions or refining closures," Turner Mason Vice President John Mayes warned attendees March 18 at the American Fuel and Petrochemical Manufacturers annual meeting in San Antonio.
On Jan. 1, 2020, the International Maritime Organization, or IMO, will lower the marine fuel sulfur cap from 3.5% to 0.5%, and ships must either burn lower-sulfur fuel, install scrubbers or repower their ships to burn LNG to comply with the rule.
Sandeep Sayal, vice president of downstream energy research at IHS Markit, said he expects the marine fuel market to pull 1.4 million barrels per day or "even upwards of 1.7 million bbl/d" from the distillate market in order to produce compliant fuel, displacing the high-sulfur fuel oil the maritime industry currently burns.
"What we'll be talking about is a two-year demand increase equivalent all compressed into one step change occurring around the end of this year," Mayes said. "The current expectations are a lot of [the displaced fuel oil is] going to go into the inland markets, … [while] some of it goes back into the crude supply as a feedstock again. The problem with this scenario is global fuel oil demand has been declining for decades."
Mayes noted the global fuel oil market declined 45% over the past 33 years to approximately 7 million bbl/d and is split roughly evenly between the bunker fuel market and the inland fuel oil market, which consists of industrial and utility customers. Over the same period, driven by environmental initiatives around the world, the inland fuel oil market declined approximately 70%.
"At the end of this year, we expect global [inland fuel oil] demand to be only about 3.5 million bbl/d, and now we're trying to push another 1.4 million bbl/d into [that market]," Mayes said. "That's a 40% oversupply situation. It's likely that these numbers are going to be worse."
"A lot of people unfortunately have taken a wait-and-see approach," Mayes said. "This strikes us as a very dangerous situation, kind of like holding a stick of dynamite and hoping it's not going to blow up."
Mayes said most refineries that produce high volumes of fuel oil have anywhere from 10 days to 30 days of fuel oil storage capacity on site.
"This changes the dynamics of this whole problem considerably," Mayes said. "We would suggest that this is a January and February 2020 problem because there's simply not enough time for … refiners to work through this problem. Their tanks are going to fill up if demand collapses like it's expected to."
Mayes said fuel oil producers had options, including blending their fuel oil production into distillate production, storing fuel oil, cutting back refinery runs, and in the worst case, shutting down.
While the first option would mean increasing fuel oil sales at the expense of higher-value distillate sales, Mayes saw the storage option as unlikely: "When you see demand coming down for 33 years …, and you put fuel oil into a tank, when is the fuel oil ever going to come out? What value is it going to have if it ever can come out?"
"We don't see how we're going to escape some refinery closures as a result of this, particularly driven by the containment issue of fuel oil refiners," Mayes said. "They don't have an ability to survive for months when their tanks are going to fill up within days to weeks."
Baker & O'Brien Vice President Charles Kemp said refiners should plan ahead: "What could happen to your refinery if the traditional disposition of high-sulfur fuel oil simply went away? And if your backup disposition was also every other refiner's backup plan? Or what if the IMO 2020 implementation is delayed by several more years?"
A potential sea change in oil flows
Sayal said the price impact of IMO 2020 in fuel markets would "follow through … all the way to the crude markets."
Kemp noted that while the U.S. refining industry on average has a low residual fuel oil yield, over half of European refiners lack the equipment to upgrade fuel oil into higher-value products, which could alter the global oil trade flows.
"We expect that the market will direct the highest-sulfur crudes to the refineries most capable of upgrading those crudes," Kemp said. "To the extent that U.S. refineries can give up light sweet crudes and process the displaced high-sulfur crudes, we can envision a dedicated route of light sweet crude from the U.S. returning with a cargo of high-sulfur crude such as Urals."
"The problem once again is timing," Mayes said. "The refineries that are running some of these light sweet crudes today in the Gulf Coast aren't going to turn loose these barrels until they actually see the price changes. Even then it's going to take them a few months to react and make sure this is really more of a long-term trend."
Mayes said refineries with coking capacity are "largely immune" from the expected drop in high-sulfur fuel oil prices while "areas that have lower coking capacity … are going to suffer through this transition."
Sayal said he saw "a trifecta of issues" affecting Mexico, citing its refining industry's 30% to 40% fuel oil yield, spiking diesel prices amid their reliance on U.S. imports, and price pressure on higher-sulfur crude oil.
To scrub or not to scrub?
Uncertainty looms over the proportion of the merchant marine fleet that will install scrubbers in order to continue burning noncompliant fuel.
Sayal expects that between 2% and 3% of the global merchant vessel fleet of 70,000 to 80,000 ships will have scrubbers installed at the beginning of 2020, and he said the rate of scrubber adoption has increased significantly in the past four to five months.
But in addition to the cost of installing scrubbers and the related risk of the price spreads between compliant fuel and high-sulfur fuel collapsing before the investment is paid off, ship owners face the potential that changing fuel specs will not be compatible with their vessels and make them unseaworthy.
"There's going to be a significant shift in the quality of the distillates that are being blended in the bunker pool," Mayes said. "Right now … when environmental sulfur levels don't matter, there are a lot of higher-sulfur materials like … kerosene that [are] being blended into the bunker pool. But in 2020, expect a lot of those barrels to be backed out and [ultra-low sulfur diesel] to be blended in."
Sayal said the "slew of formulations" could lead shipowners to begin the transition to new fuel specs as early as September.
"The costs are huge, the shipping industry is running on razor-thin margins, and you've got this new spec change coming, and the cost is going to be pretty significant for the shipping industry to bear going forward," Sayal said.