With the New Year already knocking at the door, long-suffering energy investors are looking to put another disappointing year behind them--and the International Maritime Organization’s sulfur regulations targeting the shipping industry have oil bulls dreaming of a much better 2020.
They’re banking on Goldman Sachs estimates that complete compliance with IMO 2020 will increase refining costs by $200 billion in the first year, which is likely to indirectly impact the price of other fuel products such as gasoline.
But the bears are calling this one for themselves, too, saying the new rules aren’t going to have any significant impact at all.
There is little else in the bulls' favor outside of the IMO change, so a lot is riding on this for oil price hedging as we enter the new year.
The new global environmental standard for shipping fuel calls for sea-faring vessels to switch from 3.5% high-sulfur fuel oil to marine fuel with no more than 0.5%S m/m sulfur content beginning January 1, 2020.
The United States, together with several flag states, have tried to lobby for a phase in the rule’s implementation to no avail, meaning the set deadline stands.
The maritime industry has been targeted due to its outsized role in global air pollution.
According to Goldman Sachs, ships account for just 5% to 7% of global transport oil demand but spew out 50% of sulfur emissions because they tend to use the dirtiest (and cheapest) fuels. The IMO says the move will prevent over half a million premature deaths from air pollution globally over the next five years.
The new rules are also expected to drive the cost of cleaner alternatives such as maritime diesel oil higher and generally boost oil prices.
However, the actual margin of the oil price boost depends on whom you ask, with a cross-section of experts predicting drastic price increases while others are less sanguine and expect minimal changes.
Source: Wall Street Journal
The Bull Case for a Boost
On the bulls end of the IMO 2020 ring, investors contend that refineries as currently configured are simply unable to handle the volume of refining required to comply with the IMO regulations.
Only a handful of shipowners--about 10% of global tonnage--have installed scrubbers in their vessels with Tor Svelland, a London-based shipping expert, warning that as many as 62,000 ships with no scrubbers could be grounded.
The scramble for cleaner fuels is already having an impact on fuel prices, with marine gas in north-west Europe already selling for a premium of $317 per metric tonne over their high-sulphur counterparts compared to premium of $140 a tonne at the turn of the year. Mr. Svelland reckons the price gap between cleaner and dirtier fuel could reach $1,000 a tonne in just one year.
Goldman Sachs estimates that complete compliance with IMO 2020 will increase refining costs by $200 billion in the first year, which is likely to indirectly impact the price of other fuel products such as gasoline.
Source: Financial Times
Apart from refiners, other clear winners will be oil producers that pump “sweet” lower-sulfur crude such as those in the North Sea, Texas and Nigeria. Power producers that use dirty fuel oil as well as road builders who can turn petroleum dregs into cheap asphalt could also benefit as high-sulfur fuels go out of favor. Companies like Air Products & Chemicals that produce hydrogen for refiners could also have a field day.
On the flip-side, those that pump “sour” higher-sulfur varieties such as many producers in the Middle East, Canada and Russia will be disadvantaged.
The Bearish Stance: Minimal impact
On the opposite end of the ring, the bears counter by pointing out a couple of factors that could rain on the bulls' parade and limit the oil price boost by the IMO transition.
First off is the ongoing downside price pressure on crude oil.
IMO 2020 is almost certain to be a significant boon for low-sulfur fuels, particularly middle distillates; however, it’s unlikely to boost crude oil demand to a large enough degree to boost overall oil prices significantly. Good case in point is the Saudi Arabia Abqaiq drone attacks which only provided temporary respite to a depressed oil market despite precipitating the largest supply disruption in history--a clear indication of high supply flexibility. A well-supplied market is likely to offset a good chunk of the positive effects of IMO 2020.
Second is weakening demand for refined products like diesel. U.S. distillate sales during the second and third quarters of the current year have trailed 2018 sales by ~120,000 barrels per day. Weaker demand may again offset the effects of IMO 2020.
Finally, U.S. producers have ample capacity to quickly ramp up production whenever incentivized by higher oil prices. Growing crude oil pipeline capacity in the Permian and Eagle Ford means that light, low-sulfur oil from West Texas, Central Texas and Southeastern New Mexico can be more efficiently moved to ports for export.
In the final analysis, there doesn’t seem to be much clarity regarding the extent to which IMO 2020 will boost oil prices.
As Robert Campbell, analyst at Energy Aspects, tells FT: “This could be the period of peak uncertainty on these prices as we move into the transition. Right now the market is trying to grasp how much of this stuff is there.”
By Alex Kimani for Oilprice.com
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