WHAT: Revised sulphur rules for marine bunker fuel will be introduced globally from 2020.
WHY: The IMO approved a reduction in marine sulphur content from 3.5% down to 0.5%.
WHAT NEXT: Major changes in refinery configurations, product trade flows and crude price differentials are anticipated.
Challenging 0.5% sulphur rules for marine bunker fuel to be introduced globally from 2020 will spur major changes in refinery configurations, product trade flows and crude price differentials.
The extent of the disruption will depend on the level of adoption and choice of alternative fuels, and it is unclear where the unwanted sulphur will end up.
In 2016, the International Maritime Organisation (IMO) approved a reduction in the current marine sulphur content of 3.5% (outside emissions control areas (ECAs), where the limit is already 0.1%), down to 0.5%. The modified regulations form mart of the International Convention for the Prevention of Pollution from Ships (MARPOL) and will be introduced globally from 2020.
Such widespread sulphur limits are a major red flag for the global refining sector. For a start, simple refineries that turn a significant share of their crude run into high sulphur (3.5%) fuel oil (HSFO) could be under threat (mostly outside Europe), while more complex refineries may benefit if low sulphur bunker prices rise.
It is anticipated that refiners will increase production of alternative fuels, including low-sulphur fuel oil (LSFO), which is a straight run product that can also be produced by de-sulphurising HSFO – although this is expensive and very little capacity exists globally (just 100,000 bpd).
The other main alternative fuel is marine gasoil (MGO), which can also be increased by raising refinery runs, but has far greater potential for production through more cracking, desulphurisation and other secondary refining. LNG is also being introduced as a (clean) bunker fuel and views vary widely on its likely market share, although it is unlikely to be enough to make much difference to petroleum product demand in the short term.
Alternative methods to comply with the MARPOL regulations include installing scrubbers that allow shippers to continue burning HSFO, while legally releasing emissions into the water instead of air. Scrubbers are expected to account for less than 15% of global MARPOL compliance, although this may go up if low sulphur bunker premiums rise sufficiently.
There is also a risk that some shippers will not comply at all, as the IMO does not have a proper enforcement mechanism in place. However, bigger and more established shipping companies are more likely to comply and may well push for tighter enforcement, as well as development of technologies that identify non-compliant vessels.
Most shippers will probably go for MGO, although this will depend on price differentials. If MGO does dominate, there may be some temporary regional refinery throughput increases to meet demand, according to industry sources. But even if the MGO/LSFO cut is maximised, higher runs mean other products will be produced too – which would lead to oversupply in some areas (as well as having surplus HSFO).
The main alternative is secondary processing, which (including hydrocrackers and hydrotreaters) is expected to rise faster than demand over the next few years and should provide some wiggle room. But it may not be by enough, with a study by Ensys in 2016 estimating that 60-75% additional sulphur plant capacity above currently planned projects would need to be built by 2020 to meet low sulphur demand. And newer generation catalysts or processes, plus more advanced hydrocracker technology, such as slurry hydrocrackers, could also be needed.
However, the refining sector as a whole is also likely to work out ways to utilise the secondary capacity more effectively – the financial incentives to do so will increase as HSFO prices fall relative to MGO and other grades.
Rather than just more refining, compliant fuels are likely to involve blending of various products, including distillates, residue, vacuum gas oil, cutter stock, unconverted hydrotreated oil and even some kerosene/naphtha.
The lower the sulphur level the higher the cost of extraction, but refiners – in Europe and North America at least – have already had experience of 0.1% sulphur limits under the ECA restrictions since 2015, when they were reduced from 1%. Direct demand for this ECA 0.1% grade is likely to face considerable competition from blenders aiming for the 0.5% limit.
According to the UK Petroleum Industry Association (UKPIA), a change to 0.5% sulphur marine fuels “would have a massive impact on refinery configuration and operations,” and would require both more fuel oil upgrading to gasoil grades, and more desulphurisation of residual fuel oil (through blending with low sulphur gasoils). It said the other two options would be sweeter crude slates or “residue destruction”.
Higher prices or deeper discounts?
The additional cost could end up pushing bunker prices up, with some estimates suggesting it will add up to US$10-20 per barrel on average, across all products in all regions worldwide – not just across marine fuels.
Alternatively, part of this cost could be borne by sour crude producers in the form of higher discounts to sweet benchmark grades, such as Brent. This is a threat to OPEC revenue, as its exports are sour-dominated, as well as to countries like Canada and Russia.
Western Canadian Select crude, with sulphur levels of up to 3.5%, would be hardest hit, along with sour grades like Iraqi Basrah light, which is almost 3%, while Russia Urals at 1.35% would also be under pressure. Heavy sweet grades, which have a high distillate and fuel oil cut, would likely gain ground.
There are a number of other factors that could influence developments. For example, the diesel emissions scandal in Europe could see road transport demand falling well below anticipated levels by 2020, and this could free up middle distillates for the MGO market.
Ultra-low sulphur diesel that had been destined for the EU’s road transport market (either from refineries within Europe, or export orientated operations targeting the continent), would make an ideal contribution to the low sulphur marine bunker pool.
However, the Middle East, with its new complex refineries, is expected to become the most important exporting region for the new grades, while Russia, which is currently a key HSFO exporter to Europe and Asia, could end up switching to bunker imports.
If HSFO is discounted sufficiently, demand from alternative markets could rise – possibly displacing coal in power generation and industrial uses.
In addition, more coking could reduce HSFO to useful products and residual fuel that can be burnt in a similar way. This could lead to sustained higher runs and an underlying increase in crude demand owing to the new sulphur regulations, as high sulphur residues expand into the coal market. This was certainly not the intent of the new MARPOL rules.
Furthermore, an increased use of HSFO and other high sulphur residues in industry or power could mean higher sulphur emissions on land, possibly in heavily populated areas (although not in the EU where a 1% sulphur cap on fuel oil used for power generation is likely to be lowered further by 2020).
These are fundamental concerns that raise serious questions about the wider environmental effectiveness of the new marine regulations.