Managing the transition to 2020 low-sulphur regulations

The past decade has seen the International Maritime Organization (IMO) adopt ever-tightening regulations restricting sulphur emissions from ships’ fuel.

The last change, in 2015, mandated a sulphur cap of 0.1% for fuel consumed in Sulphur Emissions Control Areas (SECA) in Europe and the United States. On January 1, 2020, the sulphur cap for fuel consumed by ships on the open sea will be cut from 3.5% to 0.5%. Mark Martecchini, President of Stolt Tankers, discusses this change and the challenges it poses for Stolt Tankers and the wider shipping industry.

Mark, we have been through regulatory changes before, including changes to sulphur caps in fuel consumed by Stolt Tankers’ ships. What’s different this time?

Shipping is continually undergoing regulatory changes driven by safety and environmental improvements, which also increase costs. Twenty-five years ago, we saw the introduction of double-hull standards for tankers. From 2007 through to 2015, we managed the introduction of Sulphur Emissions Control Areas (SECAs) and the lower-sulphur fuels mandated by them.

Today we are in the midst of installing ballast water treatment systems at a cost of some US$55 million across the fleet. But the 2020 change lowering the sulphur cap on the open ocean will have a far greater impact. There are 56,000 ships larger than 500 gross tonnes trading today. Most of these will be affected by this change.

Market analysts note that the 2015 change in SECA standards required 300,000 barrels per day (bpd) of fuel production to shift from 1.0% to 0.1% sulphur. The 2020 change will require 13 times that volume – 3.6 to 4.0 million bpd – to drop three times as much sulphur. Less than two years from today, 75% of marine fuel consumed will have to change.

The OECD International Transport Forum estimates that the 2015 SECA sulphur reduction increased fuel costs for one sector – container shipping - by $500 million, or an average cost increase of 2.5%, a relatively small impact. But the OECD estimates the impact for 2020 change as $5 to $30 billion on container shipping alone, or a cost increase of 20-85%, depending on fuel price changes and ship size/speed.

The magnitude of these changes threatens the survival of the entire shipping industry, unless cost increases are passed on.

What will happen to fuel pricing with these changes?

That’s the most studied question in our market today, by ship operators, refiners and fuel suppliers alike. It depends how fuel refiners and suppliers change their refining and blending processes, and what pricing will result from this big shift in demand for an undersupplied product. It also depends on what choices ship operators make in their future fuel selection.

Fuel price forecasting is complex; the total marine fuel market is about 5.2 million bpd, or 11% of total fuel consumed globally in all transport sectors. Transport consumes about half of global oil production – which as we’ve recently seen, is itself subject to price volatitily.

Industry sources have estimated the impact of a ‘base case’ shift, from today’s IFO 380 to MGO (see sidebars for explanations of fuels and low-sulphur options). So far in 2018, we paid on average $375 per tonne for IFO 380 and $600 for MGO, a premium of $225. Most estimates for the premium in 2020 are in the range of $300-400, but some estimates exceed $600.

That is a large cost increase. This regulation and implementation date has been known for some time; why haven’t refiners and fuel suppliers started to increase production of low-sulphur fuel earlier?

Good question. High investment cost is one reason. Refiners under margin pressure prefer to delay investments in non-core businesses, and marine fuels are a secondary market for them. While we can’t speak for others, the sustainability challenge from low-sulphur fuel in 2020 will hit all chemical tanker operators.

The market for diesel for cars and trucks is far larger than the marine market and, with increasing negativity in Europe (and elsewhere) on the environmental viability of diesel compared to hybrid and electric cars, we may see demand for low-sulphur fuel simply shifting from land to sea. For all these reasons, refiners are late in making the necessary supply shift.

What about alternative fuel options?

I’m sure alternative low-sulphur fuels will become available – some already are, and we are testing them – but how widely available, and their comparative pricing, remains to be seen. The magnitude of these changes threatens the survival of the entire shipping industry, unless cost increases are passed on.

In the past, whenever fuel regulations and the supply chain have changed, bringing different formulations and technical challenges, problems from out-of-specification fuel spiked, increasing costs and lost time. We can expect the same to happen in 2020, but worse than before.

Current low-sulphur blends are priced at 5-10% below the price of MGO, compared to IFO 380 which is 38% below MGO. If current price differences are a guide, and in an undersupplied low-sulphur market with a sudden supply shift shock, we expect suppliers to keep prices for these alternative fuels closer to MGO than to IFO 380. In this case, the savings from alternative fuels will not be as significant as some may think.

With so many supply and pricing challenges, is there any chance that the IMO will delay implementation of these regulations to 2025? Can ship operators avoid compliance?

I wish that was an option, but there is no indication of this happening. The IMO has considered many studies and believes there will be sufficient low-sulphur fuel available to proceed with implementation. But sophisticated modelling by some market forecasters does show there is considerable risk of a supply gap of at least one million bpd from the expected four million bpd supply shift.

There will be a market-clearing price, but with such a large supply gap the cost penalty could be economically unsustainable for the industry. This risk is missing from the regulatory agenda.

Responding to industry concerns that individual ship operators might try to avoid compliance, the IMO is also expected to implement regulations that ban the carriage of fuel oil that does not comply with the new rules, unless a scrubber is installed on a ship.

Are you considering technical solutions, on existing or new ships, to reduce the impact of these regulations?

Stolt Tankers is taking a multifaceted approach to low-sulphur fuel. We have taken delivery of 14 deepsea newbuildings in China in the past two years: six of 38,000 dwt from Hudong-Zhonghua, and eight of 33,000 dwt from New Times (in conjunction with our joint venture partners).

We have spent a total of $16 million fitting the last two ships in each series with wet hybrid (open/closed loop) scrubbers. We could expand to a total of 20 ships fitted with scrubbers depending on operating experience and economics.

If and when we build new 6,000 dwt ships for the European coastal trade, we expect to build them with LNG dual-fuel engines. With short voyages, and a ready supply of LNG bunkers at Northern European ports, we believe LNG offers the best option. The rest of the Stolt Tankers fleet will either switch to MGO or alternative fuels, depending on availability, usability and cost efficiency.

What strategies are other ship operators adopting to manage this transition?

We have seen a wide range of strategies being adopted, ranging from LNG for newbuildings, to scrubbers, to switching to alternative fuels. Even within a single industry sector, or within an operator’s fleet, different approaches are used depending on ship size, trading area and investment ability. Weak earnings and less LNG availability on tramping trades means tanker and bulker owners are less inclined to fund technical solutions, with most planning on MGO or alternative fuels.

It looks like relatively little investment in technical solutions, either LNG or scrubbers, considering the size of the worldwide fleet. Why is that?

It appears that technical solutions will not have a large impact on fuel supplies by 2020 at the current installation rate. There are 242 ships using LNG as fuel, aside from LNG carriers consuming cargo boil-off. One market source expects 2-3% of the fleet will use LNG fuel by 2020.

Scrubber installations are more numerous than LNG; sources estimate there were 450-500 ships fitted at the end of 2017. As scrubbers have a lower cost and can be retrofitted, estimates of ship installations by 2020 range from 1,000 to 3,000, but this is far less than earlier forecasts.

A number of market sectors have existing mechanisms to pass on fuel costs to customers. With oil tankers, most ships are either on timecharter, where fuel cost is passed directly to the customer, or ships trade in the spot market, where the Worldscale pricing mechanism adjusts for changes in fuel cost. Container markets have the BAF (bunker adjustment factor). There is less incentive to make large investments up front when operators can pass costs along, especially when operating margins are thin and future outcomes are uncertain.

What is the expected impact on Stolt Tankers?

Like everyone else studying this change, the impact depends on three things: the change in market fuel prices, the impact of technical solutions or alternative fuels, and the extent of costs passed through to customers.

In 2017, Stolt Tankers consumed 529,000 tonnes of IFO 380 and 124,000 tonnes of MGO across all fleets. If alternative fuels are not available or competitively priced, and for a ‘base case’ with MGO priced at $300 over IFO 380 – a conservative estimate, $75 above today’s level – then Stolt Tankers would have a fuel cost increase of $160 million. Our operating profit in 2017 was $111 million; we cannot sustainably absorb this extra fuel cost. The freight revenue increase needed to counter this cost varies by trade, but for deepsea trades it works out to around 16%.

So where does that leave Stolt Tankers, and the chemical tanker industry, for that matter?

While Stolt Tankers was profitable in 2017, other publicly reporting chemical tanker operators were not. 2018 is expected to be an even more challenging environment, with fuel costs up and freights flat. While we can’t speak for others, the sustainability challenge from low-sulphur fuel in 2020 will hit all chemical tanker operators.

Fuel efficiency will become an even more important differentiator, but that is nothing new for us; we already focus on reducing fuel costs. And the Stolt Tankers fleet already benefits from having a larger average ship size compared to others; larger ships generally have a fuel cost advantage per tonne of cargo carried.

While the outcome will be driven by market forces, we will be asking our customers to bear extra costs when the shift happens in 2020, to maintain a viable chemical tanker industry available to carry their cargoes safely around the globe.

The magnitude of cost increases is likely to impact some trade flows, especially for commodity products where freight represents a higher percentage of total supply chain cost, and in arbitrage situations. We look forward to working with our customers towards an equitable and sustainable solution to this change – a change which will protect the environment but must now be funded.