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Feature: IMO 2020 preparations and their impacts on US exports

Houston — Ahead of IMO 2020, shipowners are increasingly taking ships off the water for scrubber installations, reducing tonnage availability in the Americas and supporting expectations that freight will firm in the coming months, impacting US export competitiveness.

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On January 1, 2020, the International Maritime Organization will implement a global 0.5% sulfur cap for marine fuels. Many shipowners are choosing to comply by burning cleaner, more costly fuels, while others are installing scrubber systems.

Bullish expectations surround tanker freight moving into the second half of third and fourth quarter, especially for the larger ships such as VLCCs and Suezmaxes.

In the dirty tanker sector, approximately 244 VLCCs and 145 Suezmaxes either have been installed with scrubbers or have scrubbers on order, according to the most recent S&P Global Platts Analytics data. Additionally, about 175 Aframaxes and Long Range 2 tankers, split between the dirty and clean tanker markets, are slated for scrubbers.

Moreover, an increasing number of owners could position their ships in the East for future scrubber and ballast water system installations, taking tonnage away from the western markets, shipowners have said.

Scrubber installations, in combination with typical newbuild orders, have taken up shipyard capacity. Teekay Tankers' CEO Kevin Mackay said in their Q2 earnings call August 1 that shipyards were booked until mid-2021. The dirty tanker order book, or the number of newbuilds slated to hit the water in the near future, stands at 8.7%, the lowest level since 1997.

The upcoming IMO 2020 implementation is also expected to increase the demand for ships for floating storage as market participants prepare for shifts in crude and product trade flows. Tonnage demand is also expected to move higher as refineries return from earlier-than-normal refinery maintenance in Q3.

FREIGHT PRICING

Both the spot and paper markets have been reflecting the bullish sentiment for freight rates.

In futures, the VLCC 270,000 mt USGC-China route last traded at $22.2222/mt, or a lump-sum equivalent of $6 million for the August contract, and $25.7408/mt, or $6.95 million for September. Freight for VLCCs on the spot USGC-China VLCC route has averaged lump sum $6.08 million so far in August after averaging $5.21 million in July. Q4 2019 futures last traded on July 25 at $29.2593/mt, or a lump-sum equivalent of $7.9 million.

Paper trades for the Aframax 70,000 mt USGC-UK Continent route have also seen a similar pattern, with September contracts last trading at $17.0190/mt, or an equivalent of w93 on August 12, up w23 from Thursday's spot rate of w70.

US EXPORT COMPETITIVENESS

The ability of the US crude to come down to the point where they are competitive to export will be important as IMO 2020 disrupts the shipping industry.

US crude prices have been resilient to changes in competitiveness by strengthening or weakening as arbitrage opportunities change.

"USGC crude exporters have continually shown that they're willing to set the floor on prices to remain competitive in the global market, and that could continue in the foreseeable future," said Emmanuel Belostrino, crude oil market analyst at Kpler, a data intelligence firm.

Usually, only large integrated companies are able to export "equity barrels" -- barrels that are brought to international markets by the company that produces them and on vessels and pipeline space owned by those companies -- in tight arbitrage situations.

"Some of the majors are so integrated that they use their [pipeline space], their storage and their vessels to bring crude to their refineries overseas," one market source said. "Everyone I heard shipping has equity barrels," another source added.

While US crude exports have grown in 2019, export levels have fallen slightly in recent weeks amid changes in arbitrage opportunities. The four-week moving average of US exports was at just over 2.6 million b/d for the week ending on August 9, according to the US Energy Information Administration data. This was down by 210,000 b/d from the year-to-date average of 2.815 million b/d.

Furthermore, US exports to Europe have fallen in recent weeks, with the four-week moving average for the week ended August 9 at 711,000 b/d, down from the year-to-date average of 838,300 b/d, according to Kpler data.

US exports to the east have also fallen of late, with crude shipments to East and Southeast Asia, and India averaging 579,500 b/d over the last four weeks, well below the year-to-date average of 1.032 million b/d, according to Kpler data.

While it is unclear how long this trend will continue, recent tight arbitrage economics and faltering global growth outlook will likely depress spot cargoes.

"[It's the] tight arbitrage and also demand, I think," one broker said. "Demand growth is being underestimated in my opinion."

Global demand concerns have been bearish for the oil complex of late, driven by the ongoing trade battle between the US and China.

Recent economic data has painted a more bearish picture for growth in Asia and Europe. Chinese industrial output growth slowed in July to 4.8%, the lowest in 17 years and well below the forecast of 6%. As the world's largest crude oil importer, any economic slowdown in China would translate to a fall in oil demand growth. Additionally, German economic data has been lackluster, with June industrial production down 1.5% month-over-month, beating the expectation of only a 0.5% decrease. As the largest economy in Europe, a slowdown in Germany could be a harbinger for a wider European slowdown.

However, the US export market is still projected to grow, with Enterprise Product Partners CEO Jim Teague expecting US oil exports to increase to over 8 million b/d in the "next few years," as new export terminals come online.

Currently there are nine new export terminals proposed in the USGC that would be able to fully load a VLCC but market expectations point to just a couple of these projections actually coming to fruition. As it stands, the US Gulf Coast has the capacity to handle some 5.92 million b/d of crude.

"While there might be uncertainty on shipping markets amid IMO 2020, the outlook for US crude exports remains positive. Increasing pipeline takeaway capacity from production regions in addition to increasing export capacity will further propel US exports," Belostrino said.

MORE CRUDE TO THE COAST

Three new pipelines are expected to become operational during H2 2019 and Q1 2020, bringing more crude directly from the Permian to the USGC.

The 670,000 b/d Cactus II pipeline began service this week to Ingleside, Texas, according to a press release Monday from commodity trading house Trafigura. Cactus II service to Corpus Christi is expected to start in the first quarter of 2020, Plains All American said last week.

The 400,000 b/d EPIC crude pipeline and 900,000 b/d Gray Oak pipeline are expected to start up by the end of 2019.

Given the added pipelines, the Permian will have sufficient takeaway capacity through 2020, according Platts Analytics. The added capacity will be welcomed by many West Texas producers that have seen their storage levels balloon as US production has climbed.

In the last year, West Texas inventory levels have shot up by over 6 million barrels, from just over 14.3 million barrels in the four-week moving average for the week of August 13, 2018, to nearly 20.5 million barrels in the four-week moving average for the week of August 12, according to inventory data from Kpler.

As more crude reaches the US Gulf Coast and refinery inputs in PADD III remain stable on the year, the additional barrels will need to either find homes in the international market or be placed in PADD III storage.

If freight rates indeed rise ahead of IMO 2020, storage costs will also be impacted.

"I think it's going to take exports lower for a while," one crude broker said, "and it will also impact storage costs as they will have to store more crude, waiting to be exported."

While PADD III crude oil stocks are below the levels sustained in 2016 and 2017, July 2019 stocks were nearly 11.17 million barrels higher at 223.57 million barrels.

--Kristian Paris Tialios, kristian.tialios@spglobal.com

--Catherine Wood, catherine.wood@spglobal.com

--Edited by Pankti Mehta, pankti.mehta1@spglobal.com