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A clean slate for Gulf refiners

The region's refiners have less than three years to play their ace card as the IMO implements new sulphur limits on bunker fuel from 2020

The biggest surprise following the International Maritime Organisation's (IMO) ruling last October was that anyone was surprised; reducing the sulphur cap for bunker fuel from 3.5% to 0.5% has been on the regulatory table for nearly a decade. Sulphur caps of 4.5% from 1997 and then 3.5% from 2012 also gave refiners and their slow-but-steady attitude a heads up.

Still, many are now hurriedly reviewing their crude slates and balance sheets to try—and it is an ongoing, not guaranteed, effort—to keep pace with the biggest shift in the shipping industry since coal-powered vessels crossed the world's oceans nearly a century ago. Only the complex refineries producing a broad crude blend and an ability to adjust their output with relative ease can breathe a little easier.

Therein lies the Gulf refiners' ace card—one they must play cleverly for their own commercial stability and to support the region's growth as a global shipping and energy hub. The UAE's Port of Fujairah, for example, is home to the world's second-largest bunkering hub. The port lies just south of the Strait of Hormuz, through which around 18.5 million barrels a day of crude oil and petroleum liquids were transported last year—the highest volume passing through a single chokepoint worldwide, according to the US Energy Information Administration (EIA).

Fortuitous timing has enabled Gulf refiners to grab the reins of Europe's withering refinery sector and leverage funds generated by high oil prices pre-2014, thus establishing itself as the new well-muscled kid on the eastern refining block. The UAE's recently expanded 0.9m b/d Ruwais refinery and Kuwait's 0.62m b/d al-Zour, scheduled to come online by 2020, are amongst the world's largest.

The clock is ticking

But Gulf refiners' prowess today is of little use post-2020 if they don't quickly adjust their offering from high-sulphur fuel oil—used for approximately 70% of bunker fuel last year—to marine gas oil (MGO) and liquefied natural gas, for example. The IMO's lack of legal clout to enforce the 2020 ruling also means a sufficient supply of compliant fuels will help soothe the shipping industry's inevitable teething issues for compliance, especially in the early 2020s.

Refiners' complaints that mixed messages on the availability of compliant fuel supplies are making it tricky to pin down costs are valid. Netherlands-based CE Delft says there could be sufficient capacity, but US-based Ensys warns that up to 60-75% of additional sulphur plant capacity will need to be built by 2020 to meet demand, compared with planned projects. Such varying forecasts do little to plug refiners' black hole of guesswork.

The Gulf's regional and international investors can provide big-ticket financings for expansions and upgrades, but only cautiously. Borrowers may have to swallow a rise in the cost of securing debt pre-2020, for the traditional project financings that typically stretch into the decades aren't as useful in this scenario. Refiners' hesitation to invest could prove equally costly as competition for post-2020 market share gains traction; China already has plenty of MGO fuels.

Investors also want clearer signals on how the shipping industry plans to navigate its turbulent seas, powered by an oversupply of ships and financial woes. The clock on the 2020 ruling is ticking faster than shippers can adapt.

And it gets worse. Wood Mackenzie estimates that a full compliance scenario would mean an increase of up to $60bn per year in global bunker fuel costs. This would mark the tipping point for some shipping operators already struggling to stay afloat. Size and influence do not ensure commercial security; Hanjin Shipping, South Korea's biggest shipper and number seven in the world, declared bankruptcy in February this year.

Installing scrubbers, which 'clean' high-sulphur fuel to compliance levels, can cost up to $5m per ship. But they give the shipping industry more time to gauge market dynamics; the value of that cost-time dynamic will be determined on an individual basis. Non-governmental organisation Transport and Environment estimates that scrubbers could cut emissions of sulphur dioxide by 99%, but questions remain over the environmental impact of the by-product scrubbers produce during the cleaning process. So, a heavy reliance on scrubbers comes with a warning: their use could one day be cast under a disapproving spotlight in the ever-evolving environmental rule book.

The IMO's ruling will set alarm bells ringing well into the 2020s, but Gulf refiners have the capacity to turn down the volume far sooner.

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