New Marine Fuel Regulations and Potential Consumer Impact
Posted October 30, 2018
There has been a recent flurry of news about whether the Trump administration will succeed in easing the rollout of new international rules to power commercial ships with environmentally cleaner fuels.
The main fear is the change of rules could drive up demand and prices for low-sulfur fuels like diesel fuel – and ultimately the costs to consumers and businesses for their motor fuels, transportation, and everything that depends on them.
In addition to being of economic importance to Americans, this issue also concerns tensions over international trade relations and U.S. participation in global climate initiatives, where the question is whether America can or should be putting on the brakes.
Maintaining the January 2020 implementation date is necessary to promote a fair and level playing global field for all affected industries. The take here at API is essentially that, based on past precedents and the U.S. Energy Information Administration (EIA) and International Energy Agency (IEA) data, the market should work to solve this issue. EIA’s outlook suggests there should be a minimal impact on U.S. fuel prices.
At its heart, regulatory predictability is the issue, as these international rule changes have been in the works for a decade, advanced a structural decline in high-sulfur marine fuels, and already motivated investments by shipowners and refiners to comply and meet the world’s growing needs for even cleaner fuels. Backsliding near the finish line could send the wrong signals.
Beginning in January 2020, the International Maritime Organization (IMO)’s 2020 global sulfur cap for marine fuels would largely eliminate high-sulfur marine fuels by reducing the global maximum sulfur content of marine fuel (bunker fuel oil), the main fuel for the shipping industry, to 0.5 percent from the maximum 3.5 percent today. In an article in the Oil & Gas Journal, some consultants suggested the tighter fuel specification could trigger a sudden shift in demand to distillate fuel oil from residual fuel oil.
Lowering sulfur in marine fuel should be a good change for the environment and a progression of long-standing trends. Initially proposed in 2008 as a long-term regulatory target and reaffirmed in 2016, this tightening sulfur specification has been years in the making. Before it takes effect, ships that have been using high-sulfur fuel have a few options to comply with the change: 1) switch to low-sulfur fuels like distillate and distillate blends; 2) use high-sulfur fuel oil and invest upwards of $7 million to install a scrubber on the ship that cleans its exhaust; 3) switch to an alternative fuel such as liquefied natural gas (LNG); or 4) as a last resort, hope for lenient prosecutorial discretion from the port state to continue to use high-sulfur fuel oil without a scrubber, if for example low-sulfur fuel is unavailable at a port.
Since installing scrubbers and switching to LNG require costly investments, the main questions come down to the ability of the market to flexibly and affordably switch fuels as well as the extent to which shipowners comply with the regulatory change. Let’s look at the market first.
According to IEA, the global market for residual fuel oil and distillate fuel oil is around 35 million barrels per day (mb/d) out of a total current oil market of 100 mb/d, so we are talking about a relatively large market. Residual fuel has experienced a structural decline for decades, due to tightening sulfur fuel specification and fuel switching to distillate as well as natural gas substitution in the power sector.
Notably, we see three-year periods where fuel oil demand decreased by as much as 3.4 mb/d and distillate increased by as much as 2.4 mb/d. Roughly speaking, these are the kinds of magnitudes we’re talking about switching in 2020. The entire global residual fuel oil market for marine use was 3.4 mb/d per the IEA, and industry has had ample time to plan for the changes.
The next question is how willing shippers will be to switch fuels. According to Platts, strict compliance is expected in the United States and Europe, but less so among other regions. At the FUJCON bunker conference, Platts reported that 35 percent of shipping survey respondents indicated they would not comply. If this seems extraordinary, consider that the top 6 ports account for more than half of ship refueling, so compliance in Singapore, Hong Kong, and the United Arab Emirates may have much to say about the immediate efficacy of the regulation globally. But the U.S. and the Netherlands also are among the top ports, so we should expect switching to occur here at home and abroad.
Let’s look now at the EIA's outlook. It shows U.S. residual fuel oil demand is small (0.3 mb/d) but still poised to grow after 2020. Moreover, EIA’s price projections for distillate and residual fuel oil both rise over time in tandem with assumptions about crude oil prices. In other words, the EIA sees IMO 2020 as a minor issue for the United States.
The other issue to explore is whether actions taken alone by the U.S. would have any impact on the global market. The U.S. has an Emission Control Area (ECA) in place that already requires an even lower sulfur maximum of 0.1 percent for marine use within 200 miles of the shore, so domestic shipping routes would not be affected by any changes. Should a vessel use higher sulfur bunker fuel on the open ocean, it remains subject to violations when inspected at its ports of origin and destination. Any relaxation of the rule changes by the U.S. therefore would have very limited effects since a vessel likely would be transiting to or from another port with similar treatment.
The 0.50 percent by weight global sulfur limit is a significant challenge for refiners, bunker suppliers and shippers. Clear, uniform, and enforceable regulations and standards are essential to facilitate global compliance. As the proverbial bottom of the barrel, residual fuel oil has served a niche and should continue to have a small role in the future. Although conflicting consultant reports have drawn attention to this issue, it is good to see the IEA and EIA data are aligned in suggesting the market has in the past been resilient to changes such as IMO 2020 and that markets should continue to work well in the future.
About The Author
Dr. R. Dean Foreman is API’s chief economist and an expert in the economics and markets for oil, natural gas and power with more than two decades of industry experience including ExxonMobil, Talisman Energy, Sasol, and Saudi Aramco in forecasting & market analysis, corporate strategic planning, and finance/risk management. He is known for knowledge of energy markets, applying advanced analytics to assess risk in these markets, and clearly and effectively communicating with management, policy makers and the media.