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Feature: Forward paper derivatives shine some light on HSFO's value post IMO 2020

Singapore — The fundamentals of the international bunker fuel market are set to recalibrate in 2020 when the International Maritime Organization tightens the global sulfur cap on marine fuel to 0.5% from the current 3.5%.

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As the industry prepares for the change, many questions surrounding the viability of alternative fuels like marine gasoil or LNG, installing scrubbers on vessels to continue using high sulfur fuel oil and the level of compliance by shipping companies with the stringent new standard are yet to find answers.

Amid the uncertainty, forward paper derivatives for fuel oil can provide some insight into the bets that market stakeholders are placing on the outcome.

"The Cal 2020 crack is a good indicator to show where the market values HSFO swap values," a Singapore-based market source said.

The crack value for 3.5% FOB Rotterdam Barge Calendar 2020 traded on the Intercontinental Exchange shows where the market views the value of HSFO relative to Brent in 2020.

Some market participants expect a sharp drop in demand for HSFO from the bunker industry in 2020 will result in Cal 2020 cracks slumping to large discounts. However, others argue the uncertainty surrounding the implementation, at least during the first year, and alternative uses for HSFO may provide some support.

The 3.5% FOB Rdam Bg Cal 2020 crack, which was bid on ICE at minus $24.00/mt and offered at minus $20.55/mt as of 4:30 pm Singapore time (0830 GMT) Monday, yields a value of more than $370/b for the 380 CST swap value in 2020, keeping Brent swaps at $76.56/b, according to data from S&P Global Platts.

"This is far too expensive and a clear sell," said a Singapore-based crude trader, referring to the value of 380 CST HSFO in 2020.

Demand for fuel oil with a sulfur limit of 3.5% is expected to drop to less than 70 million mt in 2020 from about 220 million mt in 2017. As a result, industry participants expect it to be valued much lower than where it is currently indicated on ICE.

OUTLETS FOR SURPLUS HSFO IN 2020

While demand for HSFO as a marine fuel will likely slump sharply in 2020, market participants believe the usage of scrubbers in ships and power generation could provide some outlets.

"Around 25%-50% of HSFO demand would continue to exist in 2020," said Goldman Sachs Executive Director Nikhil Bhandari, at the Singapore International Bunkering Conference and Exhibition last week.

"HSFO can be used in power plants in Saudi Arabia and some of the Chinese independent refineries have the capacity to process HSFO, which they were in fact doing until a few years ago before they switched to crude," he added.

However, this would largely depend on how competitive HSFO prices were in 2020 relative to crude or coal, market sources said.

Non-compliance with the new IMO standard and the use of scrubbers were also cited as possible outlets for HSFO supply by market sources.

Traders speaking at SIBCON noted that although a large portion of the industry would comply with the IMO standard and switch to LSFO, the possibility of installing scrubbers in ships and some level of non-compliance to the standard, at least in the first year, could support demand for HSFO.

Industry participants also noted that the value of crude in 2020 would be an influential factor in determining the competitiveness of HSFO.

"The more Brent swings towards $80-$90/b, the lower the cracks have to be for HSFO to find demand," Bhandari said.

"It is difficult to estimate the long-term effects and shifts on the fuel market arising from IMO 2020. The extent to which any of the segments will see gains depends on relative price movements. For example, a large price discount on high sulfur fuel oil would make it relatively attractive to retrofit vessels with scrubbers," Commerzbank analysts said recently in a note.

Moreover, OPEC in its annual long-term oil forecast at end-September said that IMO's regulations will negatively impact the bulk of OPEC members who mainly produce heavy or high sulfur crudes.

Prices for heavy and sour crudes are expected to weaken "potentially severely" from 2020, while light crudes are expected to benefit and command a premium over heavy grades, OPEC said in the report.

Reflecting this, the swap spread between the lighter Brent crude and heavier Middle Eastern Dubai crude stood at $3.45/b on Monday, Platts data showed.

"As these trends cannot yet be foreseen, some refineries and shipping companies remain in wait-and-see mode," the Commerzbank analysts said.

--Avantika Ramesh, avantika.ramesh@spglobal.com

--Edited by Wendy Wells, wendy.wells@spglobal.com