London — There is likely to be a sharp increase in demand for 1% sulfur fuel oil in the coming year as a blendstock to produce 0.5% sulfur marine fuel complying with the International Maritime Organization's new global sulfur limits, pushing up premiums for utility companies in Europe. But new projects to interconnect islands in the key market of the Mediterranean, where low sulfur fuel oil is used for power generation, will eventually reduce demand.
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In recent months, the 1% LSFO market has failed to maintain a strong premium to 3.5% high sulfur fuel oil, due to pressure from refiners running hefty volumes of low sulfur crude, increasing the production of 1% fuel oil, with supply simply outweighing demand through 2019.
However, the impending IMO 2020 0.5% global marine sulfur cap and island interconnection projects are likely to shift LSFO market dynamics in the coming years.
In terms of the implementation of the 0.5% global marine sulfur cap, 1% fuel oil will become an attractive blendstock to produce compliant 0.5% bunker fuel.
S&P Global Platts Analytics expect that 1.3 million b/d of 1% LSFO will need to be created to meet bunker demand. This is alongside destroying 3 million b/d of HSFO used currently and creating 2 million b/d of distillates to meet bunker demand.
Refiners and blenders will need to blend expensive low sulfur components -- such as low sulfur VGO and gasoil -- along with low/medium sulfur residuals -- such as 1% LSFO -- to comply with the 0.5% bunker specification.
The current spread between Calendar 2020 ICE gasoil futures and 1% fuel oil is around $260/mt, but the market expects the spread between 0.5% and 1% fuel oil to be much narrower, thus making 0.5% an attractive fuel to shipowners due to the discount to distillates. Therefore, 1% fuel becomes an attractive blendstock for refiners to produce 0.5% marine fuel.
The main headache for the marine industry in terms of blending is achieving a homogeneous product, as there are likely to be issues around compatibility and stability.
Unstable fuels can separate on their own and incompatible ones, when mixed in a single bunker tank, can form sludge that can block filters and ultimately cause engine failures.
"Some 1% will definitely make way to the 0.5% blends, but that's a hard one to get them to fit together in the blend," a fuel oil trader said. "Stability is the main issue."
Many traders do not expect a new lease of life for the LSFO market until mid-2019.
KEEPING THE LIGHTS ON
At present, 1% LSFO is used primarily for utility power generation purposes on Mediterranean islands, and is transported to the islands on sea-going tankers.
Most of Europe no longer runs oil-fired power stations, having switched power generation operations to cleaner -- and usually cheaper -- natural gas.
However, this is much harder to do on islands that are remote from mainland gas pipeline and electricity networks.
Demand for LSFO currently stands at just under 700,000 mt/month in the Mediterranean, according to 1% LSFO buyers, with a large portion of this attributable to power generation. But these volumes are expected to decline to meet the EU's new Industrial Emissions Directive (IED) for combustion plants to be enforced by 2020.
The requirements for the main demand centers of Greece and Cyprus are met through annual tenders from Public Power Corporation SA Hellas and Hellenic Petroleum in Greece, and the Electricity Authority of Cyprus.
However, while there is a plan to connect the Greek islands to the mainland -- which will gradually decrease the volumes of LSFO required to keep the lights on -- in 2020 the islands will have to compete with blenders for product.
Nonetheless, the battle with blenders will likely see utility companies slapped with hefty premiums on their annual tenders by suppliers that know the islands will have to cough up in order to power their grids and not lose volumes to the blending market, sources said.
In some circumstances, traders believe refiners will not want to be locked into a tender for a year when they can maximize margins in the blending market.
"I won't sell 1% fuel to the utilities, I have something which can be upgraded to 0.5% for a better premium," a second fuel oil trader said.
During the first half of 2018, the connection of Syros, Paros and Mykonos in the Central Cylades took place, resulting in a drop in demand of approximately 55,000 mt/year of LSFO and 40,000 mt/year of ultra-low sulfur diesel.
There is a further plan to connect the primary demand centers of Rhodes and Crete with electricity cables to the mainland, although the Crete-Peloponnese connection remains under evaluation, with a final decision expected in the coming months.
"Once you start mentioning Crete, Santorini and Rhodes connections then yes it's important but for the little islands it's not a lot," a third fuel oil trader said.
PPC's annual 1% LSFO tender in 2018 for island demand stipulated the requirement of 650,000 mt/year to be delivered into Lavrion and 240,000 mt/year into Atherinolakkos, with Petroineos as the current contract holder.
The 2019 LSFO tender volume is expected to drop by about 15,000 mt, according to the company.
Crete and Rhodes will take longer to connect to the mainland grid, as there are geographical and technological obstacles that need to be addressed, such as frequent earthquakes and the fault lines of the tectonic plates between Asia, Europe and Africa.
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