Oil markets don’t need more uncertainty right now. There’s plenty of concern already about crude oil supply disruptions to make the market skittish. But looming regulations mandating the use of marine low-sulfur diesel fuel in global shipping are a coming problem all the same.
The International Maritime Organization’s (IMO) decision to slash sulfur emission limits for bunker fuel from 3.5% to 0.5%, effective at the beginning of 2020, doesn’t grab headlines like Iran sanctions or the economic meltdown in Venezuela, but the regulations could have the most significant impact of all on oil prices in coming years.
How impactful? Veteran analyst Philip K. Verleger believes the regulations could spur a global “economic crash of horrible proportions,” and drive crude prices to $200 a barrel or higher. That’s because a lack of low-sulfur diesel – critical to the world’s agricultural, trucking, railroad and shipping industries – could lift the oil products markets to “astounding levels.”
The IMO implementation date also holds significant political consequences for the U.S. presidential election which would be in full swing in 2020.
What exactly is at stake? And is the concern about potential $300 a barrel oil justified? Yes and no. It is true that refiners and shippers have been slow to make adjustments to comply with the new low-sulfur regulations and, despite industry pressure, the IMO has stubbornly refused to ease the environmental regulation or extend its implementation date.
Fundamentally, the rule threatens to leave refiners with roughly 2 million barrels a day of unmarketable fuel oil, while shippers would be short the same amount of compliant low-sulfur fuel. The worldwide marine fuel market of over 4 million barrels a day accounts for more than 4% of overall global oil demand – 75% of which is now comprised of high-sulfur fuel oil – the 3.5% sulfur fuel the IMO is seeking to address. The rest is marine gasoil and low-sulfur fuel diesel, both of which comply with the new IMO regulations.
Refiners say it doesn’t make “economic sense for them to produce more of the 0.5% low sulfur fuel oil, as this small corner of the market is not essential to them, while marine gasoil is also not the answer. Refiners can earn better profit margins making other oil products. All this means the world could run woefully short of low-sulfur diesel in two years.
While liquefied natural gas (LNG) has been hailed as the answer to the shipper industry’s long-term need for cleaner-burning fuels, in practice it remains a bit player. In most parts of the world, LNG is indexed to oil prices, making it expensive to procure, not to mention the significant investments shippers would have to make to reconfigure their fleet.
The IMO regulations will undoubtedly be supportive of higher oil prices. Indeed, past implementation of environmental rules on fuels has proved this, most recently in the U.S. and Europe in 2007 and 2008 when low-sulfur rules on diesel took effect.
But panic over the potential for oil prices to soar into the hundreds of dollars and talk of global economic collapse look overblown. Bottom line, the industry has always demonstrated an ability to adapt to changing regulations, no matter how onerous.
In this case, the burden does not entirely fall on refiners. Ship owners can invest in onboard desulfurization or “scrubber” technology to keep running high-sulfur fuel oil that will meet the new IMO standards. They could also signal a move to low-sulfur diesel oil that could prompt greater production by refiners of 0.5% low-sulfur fuel. Another option now gaining momentum among refiners is blending existing low-sulfur supplies with high-sulfur volumes to generate a stock of compliant fuel.
Despite the doomsday scenarios, industry will utilize a host of alternatives to make things work. Refiners will tweak their product slates or increase blending, while ship owners will drive up demand – and prices – for low-sulfur diesel, or make long-term investments to retrofit vessels to run on LNG or liquefied petroleum gas (LPG), which is also seeking a bigger place in the marine fuel market, particularly in Asia.
Marine or “bunker” fuel is part of the refined product slate known as “distillates,” where diesel is king. Diesel demand in 2017 made up about 50% of the year-on-year growth in global oil products in 2017. Diesel’s importance to the oil markets is why some analysts fear significant knock-on effects on crude oil prices from potential dislocations in the relatively small marine fuel market.
But the situation has a “Chicken Little” and “Y2K” feel to it considering the industry’s history of adapting to fuel regulations relatively smoothly, even when reluctant.
In the United States, it will also be interesting to see how President Donald Trump deals with the International Maritime Organization. If the regulations are in fact contributing to rising energy prices during his 2020 re-election campaign, it’s not hard to see Trump removing the United States from the underlying treaty that created the IMO back in the 1950s, given his track record for pulling out of “bad deals.”
America’s withdraw from the IMO would spare U.S. refiners and ship owners some pain, but consumers could still feel the impact of the IMO regulations since oil prices are based on global markets.