Refiners over a barrel?
Challenges and costs increase as ageing oil fields reach the ‘babushka’ stage
When the International Maritime Organisation (IMO) set in motion the changes to its international convention for the prevention of pollution from ships, or Marpol, to move the sulphur standard for marine bunkers from 3.5pc to 0.5pc, it probably believed that the timeframe would smooth the path for the change that is taking place on 1 January 2020.
But, in reality, that neither oil refining companies nor ship owners have invested heavily enough should not be a surprise, given the costs entailed and the uncertainty of any investment paying back.
Meeting the change in sulphur specification is not simple and prices are responding to the distortion that is being created in global supply/demand balances. The price changes are in part going to dictate which fuels are used by ship owners—and reflect the pressures in the supply chain to continue to supply other grades of fuel, such as gasoline and diesel, from largely the same fuel components.
Solving the problem is a matter of fundamental constraints on the global supply and demand balance and feedstock availability. Production and demand are dislocated from one another. There is not enough low sulphur crude oil available to allow refiners simply to switch to a new feedstock. Substitution is not straightforward; investment in equipment to remove sulphur from crude oil residues is very expensive. Refiners are not convinced that it will be worth the investment in the long run. And prices have a habit of shifting to take away the benefits. We are already seeing that occur.
Bunker fuel today is primarily high sulphur fuel oil (HSFO), which has been a welcome disposal route for otherwise uneconomic high sulphur crude oil residues. Options to replace it are scrubbing, very low sulphur fuel oil (VLSFO), or marine gasoil (MGO). To a large extent, VLSFO and MGO in combination will replace HSFO (see Figure 1). This is expected to tighten global gasoil supply, which then throws up challenges of availability.
For now, the refining industry is concentrating on developing its own grades of VLSFO, by whatever means are available. Each refiner is developing its own fuel grades. It is safe to expect that trading houses, for one, will step into the blending game and provide their own VLSFO solutions, further upsetting the applecart for the refiners. But none of this activity is expected to make enough VLSFO to replace the HSFO that is required by ships without scrubbers. MGO is expected to fill the gap.
To meet new VLSFO specifications, refiners will either need to blend components or to change their crude slate. But whichever route they go, they will want a margin to make these more expensive options worth their while—the price of VLSFO is likely to be higher than HSFO by some large distance. We calculate that it will be somewhere near the price of 0.5pc sulphur vacuum gasoil (VGO). However, premia may erode with time as competition bites.
Another logistical challenge is that very few crude oils available in the global market provide sufficiently low sulphur residue and gasoil components. Widespread competition for the best low sulphur feedstocks will drive their prices higher.
To meet new VLSFO specifications, refiners will either need to blend components or to change their crude slate
Among the feedstock components that will be most sought after are:
- Low sulphur light sweet crude oils such as WTI, Nigerian, Libyan (when available) or Caspian blends.
- Low sulphur atmospheric residues currently bought by refineries with excess vacuum and cracking capacity.
Today, these feedstocks are cracked to produce gasoline components. And therefore, post-January 2020, the bunker market will have to compete for this feedstock with cracking refineries—resulting in a much higher price for bunker fuel.
At the same time, upgrading refineries that are sourcing low sulphur feedstocks will see their cracking margins reduced, given the greater competition for feedstock. Thus, the price to the bunker market will become in part a function of the appetite to generate light products such as gasoline from upgrading.
In essence, to produce the required VLSFO and MGO, we envisage a high level of competition for components at the bottom of the low sulphur barrel. This will lead to short-term price distortion and a temporary inversion of refinery economics as the heavy components attract increased demand.
Over time, changes in trade flows and alternative products will settle into a pattern. But, for the long run, ship owners will become multi-product buyers and will have to absorb higher costs—or pass them on to the consumer.
Mark Waddington, Associate Director, Channoil Consulting