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Feature: Power sector's thirst for fuel oil after IMO low sulfur cap shifts bunker demand

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Finland's Neste to produce 0.5% sulfur bunker fuel

Feature: Power sector's thirst for fuel oil after IMO low sulfur cap shifts bunker demand

Fuel oil traders are turning to the power sector to assess how muchdemand may remain for their product after the International MaritimeOrganization's tighter bunker sulfur limits leave most ship operators buyingcleaner fuels in 2020.

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Only about 10%-15% of the fleet are expected to have scrubbers installedthat would then allow shipowners to burn 3.5% fuel oil, according to a studyfrom consultants CE Delft. Bunker fuel demand is currently estimated at over300 million mt/year globally, according to industry estimates.

From the CE Delft study, commissioned as part of the sulfur proposal's mandatory review, the IMO predicts that heavy fuel oil-based products willmake up around 84% of the bunker market in 2020, out of about 320 million mtannually, of which 233 million mt will be 0.50% compliant fuel oil. Thereforea vast amount of excess heavy fuel oil will be available, most likely at ahefty discount.

Most of the power sector globally has largely shifted to cleaner, moreefficient fuels and away from fuel-oil-fired generation for environmentaland cost reasons, particularly in the developed world. However, developingnations are more price-focused about fuels for generation and the likelyreduction in the price of HSFO from 2020 could encourage the use of fuel oilin power plants, once most shipowners do not have a use for the product.

If there is an appropriate discount for fuel oil, approximately 500million b/d of HSFO is expected to go into on-shore thermal uses, displacingcrude and gas, according to S&P Global Platts Analytics.

EAST OF SUEZ

Fuel oil is predicted to be one of the fastest-growing components in theMiddle East in the coming years, as the appetite for fuel oil-generatedelectricity soars. The International Energy Agency projected in its Oil 2018report in March that Middle East demand for fuel oil for power generation willincrease by 3.1% from 2017-23.

The agency projected demand for residual fuel oil in the Middle Eastwould rise from 1,559,000 b/d to 1,876,000 b/d in 2023.

Saudi Arabia's fuel oil demand from 2016-17 was predicted to rise by80,000 b/d due to fuel switching in the power sector, the IEA said. This wascoupled with a decline in gasoil demand by 105,000 b/d as Saudi Arabia hadbegun to replace gasoil-fired generation with natural gas and had increasedthe use of fuel oil in new generating capacities to accommodate coming changesin the structure of oil demand. The Saudis will also take advantage of cheapfuel oil for desalination purposes.

Bangladesh and Pakistan have also been highlighted by traders aspotential outlets for fuel oil from Europe for power generation and cementplants. Nonetheless, others believe the high sulfur volumes pulled by thesecountries will be minimal in comparison to volumes drawn currently by thebunker market.

Russia will also likely take advantage of the lower HSFO netbacks torefineries and will use its domestic fuel oil production in power generation,displacing gas, Platts Analytics said.

"I think the demand for HSFO will be greater east of Suez," a tradersaid. "Maybe the east-west spread will be wide enough for the arb to beworkable over summer [for power generation demand]."

In the fuel oil paper market, the east-west spread -- 380 CST SG vs FOBRotterdam 3.5% FO Barge Diff -- was last traded on ICE at $19.25/mt for Cal19, and $13.70/mt for Cal 20, showing a heavily backwardated structure.

"If you look at the east-west curve in Cal 19/Cal 20, it is inbackwardation," a second trader said. "The arb from west to east will bereduced."

The lack of demand for 380 CST bunker fuel oil from the world'slargest consumer of the product, Singapore, will result in a decrease ofbarrels being pulled in by the eastern region, the trader added.

WEST OF SUEZ

Latin American and Caribbean countries Mexico, Venezuela, Colombia, Peru,and Trinidad & Tobago produce large volumes of fuel oil due to their intake ofheavy sour crudes and lack of coking capacity.

These five countries alone produced an average of around 650,000 b/d ofresidual fuel oil from 2011 to 2015, S&P Global Platts Analytics data showed.Mexico and Venezuela have fuel oil yields from their refineries of around 22%and 30%, respectively. Both countries produce high volumes of sour crudes fromwells, and use much of these sour crude grades in their own refineries.

US Energy Information Administration import data showed only 961,000 ofthe 91.828 million barrels of fuel oil imported from Mexico since 2012 hadsulfur content below 2%. Around 14% of the fuel oil imported from Venezuela tothe US since 2012 was below 2% in sulfur content.

The question of where this fuel oil will go once HSFO bunker demandevaporates in 2020 is still open.

In other regions, a less dramatic turn of events could be that HSFO willcompete with coal if the price discounts are favorable. Even with low prices,a lack of oil-fired power generation infrastructure in some countries couldlimit or prevent large purchases of HSFO.

In addition, territories and countries that still use fuel oil for powergeneration like Puerto Rico, Brazil and Argentina have strict sulfurregulations that would prevent burning of HSFO from Mexico and Venezuela.

Any large-scale move to fuel oil for power generation will likely be aslow one and will not be enough to absorb all the excess product globally.

"There are not that many oil-powered or dual capability power gens leftin the world and everyone is trying to get rid of them," an analyst said.

US fuel oil traders and refiners said some domestic refineries may haveto cope with excess fuel oil, but the prevalence of delayed coking andrefinery complexity would limit any major impact post-2020. US delayed cokingcapacity rose from 1.9 million barrels/stream day in 2000 to 2.8 millionbarrels/stream day in 2017, EIA data shows.

US EIA data shows the fuel oil yield of US refineries has averaged 2.5%in 2018, down from around 4.1% a decade earlier, even as more heavy sourcrudes have been run into refineries.

--Patrick Burns, patrick.burns@spglobal.com

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

--Tamara Sleiman, tamara.sleiman@spglobal.com

--Jack Jordan, jack.jordan@spglobal.com

--Edited by Richard Rubin, richard.rubin@spglobal.com