You pays your money, you takes your choice

August 7, 2018

The true cost of compliance with the 2020 sulfur cap? Anything from very high to utterly exorbitant to judge from the available evidence.

In true shipping industry style, there is little consensus about the impact of the new rules, but opinions range from a £400 hi/lo sulphur fuel spread, a boost to the shipping market generally, a new oil shock, a glut of heavy fuel oil, a shortage of low sulphur product, risk to marine engines from use of gasoil and the potential destruction of balance sheets caused by the cost of switching to compliant fuel if owners are unable to pass on the cost.

President and chief executive of Japan’s Mitsui OSK Lines Junichiro Ikeda memorably told the Financial Times “We’re all going to go bust,” and that “society as a whole” should help to fund the move to low-sulphur fuel. By switching to gasoil or low sulphur fuel, pollution emissions fall but costs could double in the short term as a supply squeeze hits.

Analysis by Goldman Sachs, Wood Mackenzie and others have predicted that the rule change will create an additional $40-60bn in costs for the industry, money it will have to pass on to its customers, affecting the cost of everything from bulk commodities to TVs, furniture and clothes.

For BIMCO’s Peter Sand, the ability to pass on the extra costs is the critical issue. “The shipping industry does not have a financial war chest to cover an escalating cost like that,” he said.

To others there is an upside here. Among the optimists is JP Morgan, which believes that the regulations will create a distortion in the usual market cycles, dry bulk in particular. Without taking into account the 2020 sulphur regulations, the bank thinks the dry bulk cycle could peak in the latter half of 2019. However, the inevitable slow steaming and increased levels of scrapping that result will extend the upcycle into 2020/2021.

Slow steaming is probably the best means at the owners’ disposal to combat the fuel price rises. In the process they might be able to shave millions of dollars off fuel bills and effectively limit the number of available vessels, creating an upward trend to freight costs.

The founder of an exchange-traded shipping hedge fund that launched this year told Bloomberg news: “It’s going to impact all of shipping: containers, tankers and in particular dry bulk. You will have shipowners instructing their ships to slow down, and if everybody does, global supply will come down significantly.”

The problem is that unlike, say airfreight or even road transport, shipping supply is as elastic as demand. Even if ships slow down to save fuel, when freight rates improve the temptation will be for some or all to speed up again to secure the cargo, bringing a swift end to the better earnings.

Despite a flurry of recent orders, a majority of the fleet will not be equipped with sulphur scrubbers, at least not by the deadline. At a couple of million dollars apiece, sulphur scrubbers offer the ability to demonstrate compliance and still burn high sulphur fuel oil, which will be banned as bunkers except where a scrubber is fitted.

Scrubbers have been the 2020 Cinderella until just recently but big owners and charterers alike are waking up to the fact that fitting a one means increased capex now and some more opex going forward, but essentially, the ability to burn cheaper fuel and sail as fast or slow as required.

Owners have ordered or installed scrubbers for nearly 1,000 vessels (out of a global fleet of around 60,000) according to the Exhaust Gas Cleaning System Association (EGCSA) as they opt for a solution that will take them past 2020 but not close enough to 2050 to worry unduly.

Critics remain. At a seminar held during Posidonia, Dynagas boss George Procopiou suggested that since the pollution is created by the engines, engine makers should have the responsibility of designing less polluting engines. “You don’t ask the truck or taxi driver to improve his car, you ask the manufacturers to meet certain criteria.”

Angelicoussis Shipping Group CEO John Angelicoussis pointed out that while LNG would be a cleaner fuel, “we must not forget that scrubbers are a temporary technology, it’s a method of meeting the regulations and at the same time making some money. I am adopting scrubbers, because I’m in the business of trying to make money.”

The doomsday scenario is that shipping cannot get the blended low sulphur fuel oil or gasoil it needs to comply with the regulations because refiners cannot adjust fast enough to supply it.

Bunker fuel has traditionally been where refiners have dumped the sulphur already banned from lighter distillates, so the new rules present them with a waste-disposal problem. Production won’t dry up altogether but refiners will need to blend more crude with gasoil or middle distillate to get the sulphur levels down. Shipping could require an additional 2m barrels a day of low sulphur fuel and there is no guarantee that the world’s refiners can shift that fast.

Even if they do, there are warnings from class societies and others that reliance on blended fuel means taking a potential risk on its quality and possible contamination with residual heavy fuel oil in vessel tanks. There is a similar lack of experience with the long term effect on engines built to burn HFO but which are switched to gasoil.

Perhaps the most pessimistic analysis, according to Bloomberg, is that a steep rise in demand for gasoil as well as jet fuel and gasoline boosts the cost of crude itself, a scenario that could play out in unpredictable ways. The last time the world saw this sort of disruption in the oil products market was arguably in 2008, when prices topped out at $150 a barrel.

Oil being the world’s most traded commodity, there will be plenty of opportunities for speculators to ride the waves up and down, but without taking on some kind of physical or financial protection, shipowners are likely to themselves caught in the crossfire.

Perhaps more important is whether the positive environmental impact that lies behind the regulations can be realised as quickly as the IMO would like; especially if a large enough proportion of the industry calculates that the cost of playing by the rules outweighs the risk of being caught for non-compliance.