IMO 2020: What are the short-term implications for the oil market?
The new regulation will mean ships can no longer simply burn untreated high sulphur fuel oil and will have knock-on effects for global crude demand.
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The International Maritime Organisation (IMO) (a branch of the UN) has stated that as of the 1 January all ships must reduce their sulphur emissions from 3.5% thresholds to 0.5%. The IMO 2020 regulation has already been passed and any attempt to change the regulation would potentially take another 22 months (i.e. the regulation will go through on the stated date). The aim of this regulation is to reduce the emission of sulphur dioxide (which results in acid rain and environmental damage). To give a sense of how pressing this is, on an annual basis, one large container ship emits more sulphur dioxide than 50 million diesel cars over a year (there are over 65,000 ships in operation globally).
Why the IMO is important
The bunker fuel market currently accounts for around 5.5 million barrels per day (mb/day) of global crude oil consumption, with 4mb/day accounted for by ferries, cruise/container ships, LNG/LPG carriers, dry bulk transport and oil tankers; amounting to around 70,000 ships. These ships consume over 50% of the total global fuel oil demand. IMO 2020 will mean ships can no longer simply burn untreated high sulphur fuel oil (HSFO), resulting in three options for shippers: installing exhaust gas cleaner systems (scrubbers), switching to low sulphur fuel oil or switching to LNG (liquid natural gas) propulsion systems.
Impact from changes
Low sulphur fuel oil and diesel prices will increase as a result of higher demand from ships. Crude oil demand will be artificially high in 2020, before reverting back to normalised growth rates in 2021/22. Refiners’ supply of distillate is inelastic given crude availability is skewed to light crude; they are already operating at near maximum utilisation rates and suffering from a lack of adaptive capital expenditure (capex) in recent years. Producers supplying the wrong crude (i.e. extra light and sour crude) will be negatively impacted in terms of their realisations. This distillate demand lift, in the context of global crude demand balances, means 2020 will prove to be an unusual and potentially very strong demand year. Additional capex will be required to increase desulphurisation/cracking capacity.
Higher diesel (and distillate prices) will negatively impact shipping costs and be inflationary globally. Given the global nature of the regulation, costs are likely to be largely passed on to the consumer. Fuel costs also make up approximately 70-80% of total transport costs. Therefore, higher fuel costs will greatly impact total shipping costs, and have knock-on effects for globally traded goods. Perishable goods (like agricultural produce) will be negatively impacted more than other commodities, as shippers can moderate the speed to economise on fuel use in the latter case.
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