The looming tectonic shift in fuel rules poses an enormous financial risk to the very largest ocean shipping companies – but these players are also in the best financial position to counter that threat.
The IMO 2020 rule mandates that all vessels not equipped with exhaust-gas scrubbers must burn more expensive fuel with a sulfur content of 0.5% or less starting Jan. 1. This could lead to at least temporary and possibly lengthy fuel price volatility, which could severely impact shipping companies' bottom lines.
The larger the fleet, the higher the potential fallout – and thus, the greater the need to act preemptively. The larger the shipping company, the greater the financial firepower to take those preemptive steps.
In July, Frontline (NYSE: FRO) and Golden Ocean (NASDAQ: GOGL) announced plans to create a joint venture with trading house Trafigura through which Trafigura will contribute its global network of marine fuel facilities, ensuring supply to Frontline and Golden Ocean.
The JV with Trafigura reduces IMO 2020 risk by effectively bringing fuel supply in-house. Now, tanker major Euronav (NYSE: EURN) is doing the same thing, but in a very different way.
Instead of a JV with a fuel provider, it's buying its own fuel wholesale, storing it aboard its own ultra large crude carrier (ULCC), positioning the ULCC in Malaysian waters near Singapore, and bunkering its own fleet from that location.
Compliant fuel storage
During a lengthy, in-depth conference call with analysts on Sept. 5, Euronav executives disclosed that the company has been spending the past six months stocking up on compliant fuel in preparation for IMO 2020.
It has purchased 420,000 tons of compliant fuel, with 70% of the volume comprised of 0.5% sulfur fuel (low-sulfur fuel oil or LSFO), and 30% comprised of 0.1% sulfur residual fuel oil and distillate, for a total price of $201 million. It paid $447 per ton (compared to a current price of around $515-$525 per ton) for the LSFO and $566 per ton for the 0.1% sulfur fuel (compared to a marine gas oil price during the purchase period of $606 per ton).
Euronav owns the last two operational ULCCs on the high seas, which are larger than standard very large crude carriers (VLCCs) that have capacities of around 300,000 deadweight tons (DWT). Euronav's ULCCs, the 2003-built ULCC Oceania and 2002-built ULCC Europe, each have capacities of 441,561 DWT.
Euronav's compliant fuel purchases have been loaded and stored aboard the ULCC Oceania in Malta. Purchases were made in Europe, as prices there are about $35 per ton lower than in Asia.
As the IMO 2020 deadline approaches, the ULCC Oceania will be repositioned to a mooring area in the vicinity of the Singapore bunkering hub. Based on Euronav's tanker routes, the ULCC Oceania should be in position to provide fuel to around 70% of the company's fleet.
On the conference call, Deutsche Bank analyst Amit Mehrotra pointed out that if you do the math, 420,000 tons does not seem enough to cover Euronav's needs.
Euronav chief executive officer Hugo De Stoop responded, "The part of the fleet we're trying to protect [from IMO 2020 volatility] is the VLCCs, and most of them pass through the Singapore area. We have 42 VLCCs, and of those, five are on time charters [which require the charterer, not the vessel interest, to buy fuel]. We're not looking to cover the entire year and some of the ships will need to bunker [buy fuel] on the other side of the world – you don't always have a choice on where you fill up your ship."
Euronav CEO Hugo de Stoop. Photo courtesy of Marine Money/John Galayda
Euronav tankers that cannot access the in-house bunkering solution in Asia "can either buy in the market or we can do a swap with someone who can take fuel from us near Singapore in return for us getting fuel from them in the Caribbean, for example."
Euronav's ULCC Europe is currently on charter to a third party, but it could also be used to service the company's in-house fuel strategy when it comes off-hire early next year.
What Euronav does not plan to do, confirmed De Stoop, is to develop a bunkering business that caters to third parties, as the Frontline-Golden Ocean-Trafigura JV plans to do. "Buying wholesale versus retail seems very attractive from a pricing point of view, but that doesn't mean we will be bunker providers – absolutely not," he said.
Noncompliant fuel storage
Euronav is not only focused on compliant low-sulfur fuel. Even though it currently has no firm commitments for installation of exhaust-gas scrubbers, it sees a potential opportunity in storing noncompliant high-sulfur fuel oil (HSFO).
As previously reported by FreightWaves, one of the commonly asked questions in ocean shipping is: Who will buy all of the excess HSFO – which is to a large extent a byproduct of the refining process – if it's not consumed by vessels?
HSFO can be used for utility fuel in some developing nations with very low environmental standards, for asphalt production and for marine fuel by ships that have scrubbers. But these uses are widely expected to leave a large quantity of excess HSFO in the market post-IMO 2020, which would heavily depress pricing.
"HSFO price could fall in value – and fall a long way. Should the price fall to a very low level, this could provide Euronav with an opportunity," said De Stoop.
According to Rustin Edwards, Euronav's head of fuel oil procurement, who came aboard in early February, there is a "very strong" contango developing in the 2020 and 2021 forward curves for HSFO. Contango refers to a dynamic in which the futures price is above the spot price, implying that traders believe the price will rise. A wide enough contango compels traders to buy physical commodities to store them in hopes of selling them in the future for a profit.
Traders first go for land-based storage, the cheapest option, and when that's full, they go for floating storage aboard tankers. This reduces the number of tankers available for normal trading and increases freight rates.
ULCC Europe could be used for storage by Euronav starting in 2020. Photo courtesy of Euronav
Edwards explained that current land-based HSFO storage is dwindling. "Tank farms are swapping out tanks from high-sulfur storage to low-sulfur storage to meet the new bunkering demands, reducing the amount of HSFO storage at major pricing hubs. Tanks farms have also allocated more tankage for blending, because the 0.5% sulfur market requires more blending than the high-sulfur market.
"So, the infrastructure on shore has been reduced considerably, and we believe that a deepening contango will develop, and develop quickly, as we get into the end of the fourth quarter and the beginning of the first quarter, which will open up floating storage opportunities for larger vessels until such time that there is enough scrubber capacity to alleviate the overhang," said Edwards.
According to De Stoop, "We could potentially purchase any stranded HSFO at a low price and having captured that advantage, we could then store this fuel and utilize it," either by retrofitting scrubbers on its own ships or otherwise.
"We could use one or potentially two of our ULCCs to gather the HSFO if the price collapses and if the forward curve proves it's the right move," he explained.
Second-mover scrubber advantage?
Over the past several years, Euronav has garnered a reputation as being anti-scrubber, largely because the company's former CEO, Paddy Rodgers, openly and aggressively berated the scrubber option at virtually every public appearance he made (Rodgers left Euronav in the second quarter of this year, after announcing his departure in early February).
De Stoop maintained, "We never really said we were against scrubbers, although some people thought we did. What we say is that we are ‘scrubber watchers.' We're waiting for the market to develop."
He said that Euronav has yet to commit to scrubber retrofits because it's missing two key pieces of information: the spread between HSFO and LSFO, and the forward curves of both LSFO and HSFO. Those should become available in early 2020, at which time scrubber installations would become inherently much less speculative.
"We don't want to do a speculative investment," he said. "If it turns out that the spread is narrow and the curves show it will be narrow for a long time, it's probably not necessary to do any scrubber retrofits."
If the spread is high and the curves show it will have duration, he argued that Euronav would be in a better position to do installations than those who bought scrubbers earlier.
"We believe that far from being left behind by the dash to fit scrubbers, there could be a considerable second-mover advantage because of experience gained in the first installation cycle, which could result in reduced cost, reduced time between ordering and installation, and reduced uncertainty over the retrofit itself," he said on the conference call.
Euronav's IMO 2020 strategy and its conservative approach could ultimately prove prescient, but De Stoop was correct when he acknowledged that his company has a reputation among some market participants as being "left behind" and "against scrubbers."
The reality is that a significant number of VLCCs will have scrubbers installed as of Jan. 1, and assuming there is a significant LSFO-HSFO spread, these ships will be able to underbid scrubber-less Euronav for cargoes, because scrubber-fitted ships will be able to burn much cheaper HSFO. In the near term, Euronav's preemptive amassing of LSFO won't help them win those contracts. More FreightWaves/American Shipper articles by Greg Miller
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