Philip Verleger, an economist, recently released a paper that looked at a maritime fuel ruling that will take place starting in 2020. This ruling is via a U.N. organization called the International Maritime Organization (IMO) that regulates global shipping. The ruling will cut the sulfur content in maritime fuel from 3.5% to 0.5%. It was first announced in 2008 that this would be going into effect. The target date of 2020 was set in 2016.
To meet this requirements, the shipping industry must do one of the following three options:
1. Put scrubbers on their ships, which helps reduce the sulfur content. (I don't know what a scrubber is, but that's what I've read.)
2. Switch to LNG.
3. Buy lower sulfur content fuel.
His over-all expectation is that this ruling will be very disruptive to the world economy as his assumption is that most ships will need to go with option 3.
US News and World Report reports on the paper. Here are items from the article:
1. Oil prices could hit $200.
2. Gas prices could hit $6 a gallon.
3. Morgan Stanley isn't as aggressive, but does see it as a reason for oil hitting $90.
4. Goldman Sachs also addresses the issue though glancing through their report, I don't believe it targets an oil price.
5. An example for why we're seeing this shift to lower sulfur content is that a cruise ship in one day generates as much particulate matter as 1 million cars. I'm not sure what the time frame is on the cars. Is the 1 million cars also based on 1 day? I'm guessing so.
6. There has been procrastination on the part of shipowners, which means that the switchover come Jan 1, 2020 will be more disruptive.
Verleger's Findings
Verleger's actual reports can be read here (summarized) and here (detailed).
From the summarized version we learn a little bit about this high sulfur content that ships use:
The shipping business has traditionally consumed a form of “residual fuel oil” blended to specifications set by the shippers. They call this product “residual fuel oil” for a reason. It is what is left over after refiners have processed crude to produce higher-value products such as diesel fuel, gasoline, jet fuel, and petrochemicals. process engineers do whatever they can to minimize the production of residual fuel oil because it is a money loser. refiner investments focus on producing the more lucrative products. refiners produce residual fuels because they must do this to obtain the more-profitable products. In short, refiners tend not to invest specifically in manufacturing fuels for the maritime industry.
Is it really a money loser? Why would they sell this residual fuel oil at a loss?
Once this fuel is no longer needed, it will result in the following for "residual fuel oil":
The IEA also estimates that two million barrels per day of residual fuel oil that would have been used by ships will suddenly be surplus. Up to three-quarters of it will have no market unless blended with light, low-sulfur diesel fuel. an Exxon official explained that some of the residual fuel oil could be converted to compliant fuel by mixing 89 percent low-sulfur gasoil with 1 percent residual fuel oil. Such blending, though, would still leave substantial volumes of residual fuel oil without buyers.
I read this as follows: anywhere from 1.5 million to 2.0 million barrels per day of oil will no longer have any use.
Who might benefit?
For example, eagle Ford shale, a crude that will be exported in increasing volumes from Corpus Christi in Texas, contains less than 0.15 percent sulfur. When refined, such crudes could produce a residual fuel oil that meets the new IMO standard.
So this could actually benefit US shale as their oil has lower sulfur content. A loser could be Mexico which via Antoine Halff, economist (link below), produces high sulfur oil.
Goldman Sachs Thoughts
The Goldman Sachs article doesn't appear to address how this ruling will impact oil prices, but it has some interesting notes on the LNG and scrubber options.
Switching to LNG is expensive due to the capital requirements so LNG is more likely to be used on newbuilds. It is estimated that LNG will make up 5% of maritime fuel by 2030, which really doesn't help in the short-term.
If I'm reading the report correctly, there are 90,000 ships out there. Goldman Sachs states that by 2025, 5000 ships will install scrubbers. That's not that great of a percentage, but I suppose it would allows ships to switch back to high sulfur content fuel.
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