Analysis by Jonathan Leitch and Gordon McManus, research directors for the EMEARC refining and oil products team.
New Year’s Day 2020 is firmly marked in the calendar as the refining and shipping industries prepare for change.
The International Maritime Organisation (IMO)’s rules, in force from 1 January 2020, will see the current maximum fuel oil sulphur limit of 3.5 weight per cent (wt%) reduced to 0.5 wt%. This is the largest reduction in the sulphur content of a transportation fuel undertaken at any one time.
With less than a year to go, there are still many uncertainties as to how the change will play out. Are European refiners ready to accommodate big shifts in fuel demand? What will the new specifications mean for refining margins and fuel product prices in the medium and longer term?
Replacing high sulphur fuel oil
We anticipate 85% compliance with the IMO’s regulation in 2020, rising to full compliance in 2025.
Currently, bunkers use around 3.4 million barrels per day (b/d) of high sulphur fuel oil (HSFO). This is set to fall by a substantial 2.1 million b/d by 2020.
What will replace it?
Shipping companies will need to choose between:
- Installing a scrubber to clean the emissions if they are to continue using HSFO as a fuel source;
- Sourcing 0.5% sulphur fuel oil (VLSFO);
- Using LNG;
- Or switching to marine gasoil from 2020.
Each of these choices has its limitations. What are our forecasts for fuel volumes and how will this impact refineries?
It’s good news for most European refiners in 2020. The change in fuel specification will require increased runs that will support refinery margins across the board. Who’s going to benefit the most? Everyone’s a winner, but some won’t win by quite as much.
Widening product differentials mean that refiners will be assessing their crude diet very carefully come 2020.
Gordon McManusView Gordon McManus's full profile
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1. Not enough low sulphur fuel to go around
Initially, we don’t expect there to be enough 0.5% VLSFO to meet demand. The gap will have to be met by the more expensive option, gasoil. The increase in gasoil demand will require higher refinery runs, which should be positive for the refining industry.
VLSFO is a relatively new product, and shippers could be reluctant to take the risk of buying it if they are concerned about its quality, despite its lower price. However, we assume that shippers will generally opt to buy the cheapest compliant fuel. Refiners meanwhile will aim to maximise the value of their residue streams by selling into this emerging market.
By 2024, VLSFO production should increase to 1.8 million b/d, from 1.4 million b/d in 2020, as the supply chain for this new fuel matures.
2. Slow growth for LNG
At the moment, LNG port infrastructure is in its infancy. Currently, there are 100 LNG vessels in the global fleet, with a further 200 either ordered or LNG ready.
As the market develops and there is further global trade in LNG, this will facilitate the development of an LNG bunker supply chain around regasification and liquefaction terminals. Container ships will be a key market for future growth.
But we still expect LNG to remain a small part of the marine fuels market in the medium term. LNG will only displace 100 kb/d of liquid marine fuels in 2020, rising to 340 kb/d in 2025.
3. Fuel price gap provides strong incentive for shippers to fit scrubbers
2020 will be a good year for gasoil. Crack spreads will improve, driven by increased demand from the bunker industry. We forecast an average crack spread of $19/ bbl versus Brent in 2020.
While the crack spreads for HSFO are particularly strong now, all that is set to change as the January 2020 deadline approaches. HSFO will lose its recent strength as demand collapses, with crack spreads dropping to negative $21/ bbl versus Brent in 2020.
The wide gap between gasoil and HSFO prices provides a strong incentive for shippers to run and operate scrubbers.
Around 2500 scrubbers are currently either fitted or on order, and we anticipate that 1700 ships will be fitted with scrubbers by 2020. This should rise to about 2500 by 2021 and 4500 by 2025 – approximately 7% of the global fleet.
Volumes of scrubbed HSFO will increase to around 1.3 million b/d by 2025.
What will the change in fuel demand mean for European refiners?
After a challenging second half in 2018, the IMO’s regulations will lessen the pain for the refining industry.
Gasoil and diesel demand is set to rise by 1.3 million b/d in 2020. Refiners will need to increase runs and add capacity to accommodate the expected surge in demand, which will have a positive impact on margins.
Without the IMO’s regulatory changes, the outlook would be decidedly less attractive.
All refiners stand to benefit from the IMO’s fuel specifications. However, some are bigger winners than others.
The biggest windfall in 2020 is for deep conversion units with a distillate orientation. A refiner that produces high yields of gasoil and middle distillates and low yields of HSFO will be in the best position. Simpler refiners focused on producing gasoline and fuel oil (FCC refiners) will see the smallest margin uplift.
Although there is still a large amount of uncertainty surrounding shipping companies’ choices as the IMO deadline approaches, the regulatory change provides a reason to be cheerful for the European refining industry.
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