Marine fuel regulation change to create African winners and losers
The African upstream may be well placed to benefit from IMO 2020, but it poses significant wider risks to the region
The new International Maritime Organisation (IMO) regulations changing the quality of shipping fuel from January 2020 will have a global effect on oil prices. And the impact of the new regulations on the African oil sector in particular will be profound, given the mix of lower and higher sulphur in oil production in different production centres.
Further downstream, there are generally fewer complex refineries in Africa; there are government subsidies for road transport fuels; there is a higher dependence on imported fuels (which are expected to increase in price); and a higher proportion of power generation fed by high sulphur fuels. The challenges posed by the new regulations should be understood and prepared for by all those affected.
The IMO 2020 regulations will result in high sulphur fuel oil largely replaced by more expensive very low sulphur fuel oil (VLSFO) or cleaner, but even more expensive, marine diesel. The shift will be sudden and unprecedented. This has made it difficult for analysts to predict the likely impact on the various high-sulphur versus low-sulphur product price differentials, product-to-crude price differentials, and HS-LS crude oil price differentials. Consequently, there has been a wide range of price forecasts, some of which are very extreme. This inconsistency of predictions is a reflection of the uncertainty in the market—as we have never before faced such a significant event in the oil markets that will occur so instantaneously as we will see on 1 January.
However, to varying degrees, there is an expectation of the following implications:
- The initial competition for lower sulphur distillate products—marine gasoil/diesel (MGO)—is expected to be significant
- Other distillate products will be used to help create compliant new low-sulphur marine fuels through blending with different fuel oils
- This continues for a period before a greater proportion of VLSFO is produced by refineries
Our analysis suggests that some of the more extreme forecasts of different product prices scenarios are overstated, at least in the longer term. There should be sufficient refining capacity and low sulphur crude oil available to produce the new fuels required by IMO 2020.
But there is still great uncertainty on how long it will take the global refining system to find this new equilibrium, which means an initial period of increased volatility. Oil producers, refiners and consumers will have to review their activities and take action to mitigate the business impact from these impending changes in demand and prices.
The initial competition for lower sulphur distillate products is expected to be significant
Many refiners can produce VLSFO without investment by switching to lower sulphur crudes as their feedstock. Enough straight-run atmospheric residual fuel of less than 0.5pc sulphur will be available just through segregation of crude grades. The price premiums of ‘sweet’ crudes yielding VLSFO will increase as refiners switch their production to VLSFO.
However, there will likely be a period of transition where the shipping industry will need to consume more of the less economic—but more readily available—MGO while the refining and bunkering supply chains gradually increase their ability to supply VLSFO to where it is needed.
For much of Africa, close to 90pc of crude production is already sweet grades with a low sulphur content—a quality shared by the fuel oil that results from its processing—so the demand for exports will remain strong. The challenge will be in maximising the value from those exports.
Africa has roughly 50 crude oil blends containing low sulphur vacuum residue that can be blended directly to meet VLSFO specifications. To put this into context, there are only slightly more than 200 of such marketable crude oils worldwide.
Africa’s challenge will be in maximising the value from sweet crude exports
On average, African oil refineries have about 50pc of both the capacity and complexity of refineries in Europe and United States (see Figure 1). There is a possibility of a windfall for African refiners that can ‘naturally’ produce low sulphur fuel oil, using local crudes as feedstocks to supply product-short markets. Even with relatively less sophisticated refineries it should be feasible for them to meet the new regulations and achieve the higher prices they bring.
Consequently, African hydro-skimming refineries are expected to continue to compete favourably through 2030 due to their access to a significant volume of low sulphur crudes. Such refineries would generally be at risk in other markets, where low sulphur crudes are not available.
The ability to supply fuels to the market is dependent on a variety of factors beyond simple crude choice. For example, there may be limitations of insufficient tankage, pipelines, or access to export terminals. Among the challenges and considerations for African producers, refiners and national oil companies (NOCs) are:
- Export programmes—are African producers of sweet crude ready for the potentially sudden increase in the relative value for their crude and how are they preparing to adjust their supply channels accordingly to maximise value?
- Refining margins—are the refineries’ planning teams prepared for the adjustments they may need to make in their sourcing of different feedstocks and blending components to maximise their refining margins?
- Infrastructure configuration—is the storage configuration of African refineries sufficient for the necessary segregation of LS/HS feedstocks and blend stocks?
The degree of secondary, consequential implications of IMO 2020 across Africa—beyond the upstream and refining sectors—will depend on the severity of the outright and relative price movements of the different oil products as a result of the change. Clearly, other macro-economic changes and geopolitical events will continue to be big drivers of changes in oil prices. However, there are strong arguments why IMO 2020 could have a significant knock-on effect on prices for other transportation fuels, such as diesel and gasoline.
Africa is particularly sensitive to these shifts in oil product prices for a number of reasons, including:
- Many African governments provide subsidies for road transport fuels and public transport, so the impact on their budgeting could be profound
- Consumers spend a relatively large proportion of their income on private and public transportation, captive power generation, and on heating and cooking fuel, so the negative impact on disposable income and GDP could also be significant
- Energy-intensive industries will have a relatively high proportion of their operating costs associated with fuel, so they will be more sensitive to a potential hike in prices
- Power generation in many countries is from oil-fueled generators, so these could become disadvantaged (if running off diesel) or advantaged (if running off HSFO, the price of which is forecast to collapse).
Figure 2 shows some of the potential winners and losers from possible oil price shifts resulting from the IMO 2020 regulatory change.
In summary, the impact of IMO 2020 has created significant price uncertainty and, while the exact consequences remain unclear, the potential to affect the cost and revenue of individual states or businesses, both directly and indirectly, is vast. African entities should already be considering their operational and risk management strategies in light of all potentially likely implications. It is vital that every actor is aware of and understands its own challenge in dealing with the new regulations.
Steve Jones, Founding Director, Energex Partners
Energex Partners has co-authored and published an extensive report with PwC and Downstream Advisors Inc on the potential implications of the impending IMO 2020 rule changes on key players and sectors in Africa. This article is a summary of the report. If the reader wishes to access the full report, then it is available through the following link: https://www.pwc.com/ng/en/publications/imo-2020-regulation.html