Low sulphur, high price
European refiners anticipate increased margins and improved utilisation due to the IMO 2020 cap
The International Maritime Organisation's (IMO) 0.5pc sulphur cap on bunker fuels, imposed from 2020 globally, will require a step change for European refineries. Utilisation and margins are expected to receive a boost from increased demand for marine gasoil and diesel, accelerating the trend away from conventional fuel oil.
The cap "is going to represent a significant change for refiners in Europe, because the switch for fuel oil from 3.5pc to 0.5pc is not straightforward," says Damien Valdenaire, science executive, refining operations, Concawe, the environment research arm refining industry association FuelsEurope. "Refineries in Europe don't have the ability to remove the sulphur… we'll have to produce a fuel that is a different product."
Gordon McManus, research director, EMEARC oils and refining at Wood Mackenzie, says the cap will increase demand for an alternative, the high-value product of marine gasoil. "It is expected to increase refineries' margins overall. There isn't enough flexibility to increase production of low sulphur fuel oil (LSFO) sufficiently to meet demand. Demand for marine gasoil will increase, which will make it go up in price. Refineries are going to work hard to meet the increased demand for this type of product."
Tim Fitzgibbon, oil and gas expert at McKinsey, adds: "Many refiners are confident of being able to make low sulphur bunker fuel. To make it compliant [they will make it] from a combination of already-produced LSFO and by shifting to sweeter, lighter crude. There is, however, some uncertainty about the amount of LSFO that refiners can segregate. People may find that it is operationally more challenging to segregate those barrels."
In the short term, the most likely outcome is that refiners will shift to a "fairly even mix" of LSFO and marine gasoil (or perhaps marine diesel), with only residual demand covered by high sulphur fuel oil (HSFO), he says. The increased demand for low sulphur bunker fuel alternatives "will have a positive impact on refineries' margins and utilisation," he adds.
McManus estimates that European combined HSFO and LSFO demand is 750,000bl/d while gasoil demand stands at around 300,000bl/d. "As Emission Control Area (ECA) regions in Europe require ships to run on 0.1pc sulphur fuel, most of them use gasoil," he says. In 2020 he expects fuel oil demand in Europe to fall to 600,000bl/d and gasoil demand to rise to 400,000bl/d.
It is important to note that refineries are not the obligated party. "They don't have to produce 0.5pc bunker fuel. It's a strategic decision whether to produce it in limited quantities, or at all," says Valdenaire. Refineries will make a short-term optimisation calculation "unless a contract or partnership has been developed between a refiner and its clients. Refiners are going to wait to see positive demand on the market and a price incentive to produce these types of fuel in marginal quantities."
The IMO has factored in the possibility that compliant fuels may not be available and has created a reporting system. "IMO doesn't want ships to have to change route or wait to get the bunker fuel," he says. "With time, the system will find an equilibrium. But matching supply and demand will not be immediate." In the meantime, the Fuel Oil Non-Availability Report (Fonar) "will be there to ensure the system continues to work," he says.
Under the system a shipowner will be able to bunker HSFO even if it doesn't have scrubbers installed to remove the sulphur, as long as it can prove compliant fuel was not available at the ports along its route, he says. However, the International Bunker Industry Association (IBIA) has warned that "the idea that a Fonar is a kind of get-out-of-jail-free card is misconceived" and that the inability of a ship to find complaint fuel would have to be "thoroughly documented".
Gasoil crack spread to widen
The expected shift towards low sulphur bunker fuels is likely to be reflected in crack spreads. "Light sweet crude will rise in value and crude differentials will widen," says McManus. "We're already seeing a trend for more and more exports of light sweet crude from the US to Europe and production is increasing rapidly."
The crack spread versus Brent has averaged -$9/bl for HSFO during 2019. "We expect it to fall to -$21/bl in 2020," he says, adding the crack spread for gasoil is set to rise from +$13/barrel in 2019 to +$20/barrel in 2020. "There isn't really a market for 0.5pc low sulphur fuel oil at the moment, but we expect the crack spread to be positive, at +$8/bl in 2020," he adds.
“The 10mn tonnes of HSFO leaving Europe in 2019 will still leave Europe in 2020, but will have to find new markets” Damien Valdenaire, Concawe
Globally, the market impact is not expected to last very long. Fitzgibbon says: "We expect a couple of years of higher margins, then investments in scrubbers will allow more use of HSFO."
Europe looks set towards a progressive shrinkage of the fuel oil market, with new refining projects mostly focused on destroying fuel oil and increasing the competitive sustainability of refineries, according to McManus. "We've not seen any large investments in Europe aimed at providing more 0.5pc low sulphur fuel oil to the market. From a financial point of view, there isn't a huge incentive to put in place a project to change HSFO into LSFO."
New outlets for high sulphur fuel oil
European refiners will have to find new outlets for the remaining HSFO produced, says Valdenaire. Currently, 10mn tonnes of HSFO are being exported to Asia for bunkering. "The minimum expectation in our modelling study is that the 10mn tonnes of HSFO leaving Europe in 2019 will still leave Europe in 2020, but will have to find new markets" he says. "That's the key uncertainty."
"Some advisory companies are saying that demand for power will appear, competing with coal. However, the evidence is missing-the industry has not yet made public any decisions or deals," he says. "High-sulphur fuel oil can compete with coal. In terms of emissions, if you are burning coal you can equally burn high sulphur heavy fuel oil."
Fuel oil is currently more expensive than coal. However, as prices reflect supply/demand dynamics, a decline in fuel oil demand from shipping would make it more competitive, supporting a switch to fuel oil for power generation, he reasons.
Whether Europe will be better suited to attract low sulphur crude remains "one of the biggest questions" for refiners, Valdenaire adds. The crude slate "is getting lighter" with more US shale oil coming to Europe.
The IMO cap is not expected to drastically change supply dynamics, with Russian Ural crude, as well as West Africa and Middle East crudes, set to remain the "key supplies to Europe," he says.