By John Mayes and John Auers
While the final decision has yet to be announced, the probability of a shift to low sulfur bunker fuel in 2020 appears to be rapidly rising. This transition will likely have a significant impact on global refiners, including those which do not even produce residual fuel or bunkers. Where there are challenges, however, there are also opportunities and these new regulations will certainly create those for refiners and bulk terminal operators, but only if they are adequately prepared. Just because low sulfur bunker demands can be met doesn’t mean there won’t be significant disruptions in product markets, with corresponding implications on prices for both distillates and residuals. This will lead to a challenging environment for some refiners, but also provide opportunities for others to improve their bottom lines. In today’s blog, we delve into these issues and provide some of our thoughts on the aftermath of IMO’s upcoming decision.
As discussed in last week’s blog by David St. Amand, in 2012, the International Maritime Organization (IMO) developed their Annex VI regulations which mandated a maximum sulfur level in bunker fuel of 0.5% to begin in January 2020. The regulations also required the IMO to conduct a study prior to this implementation date to evaluate the expected volume of low sulfur bunker fuel which would be available in 2020. If the study concluded there would be insufficient bunker supplies, the IMO was authorized to delay the implementation date until 2025.
The study has now been completed (by CE Delft), and as David revealed in last week’s blog, the report took the view that there will be no shortage of 0.5% bunker fuel. This seems to indicate that a 2020 implementation date is likely.
Interestingly, the global refining industry has never really doubted the ability to produce 0.5% sulfur bunker fuel. In 2020, the bulk of the global bunker fuel demand will simply be met by blending very low sulfur distillate stocks into a smaller amount of fuel oil to produce a 0.5% sulfur blend. In fact, this is the process by which 0.1% sulfur bunker is currently being produced to meet the requirements of the North American Emission Control Area (ECA) which went into effect in July 2015. As stated in last week’s blog, the two dominant sources of bunker blendstocks in 2020 will be the lower sulfur resids and distillates.
Refining Impacts
The primary challenge for global refiners is not the ability to produce low sulfur bunker fuel, but rather where to place the surplus high sulfur residual fuels being displaced by the distillates. How much distillate will be added into the bunker pool remains uncertain and is dependent on how much bunker fuel can be produced by lower sulfur resids. Many crudes (like Bakken, Eagle Ford, Saharan Blend, etc.) produce low sulfur resids suitable for producing 0.5% bunker fuel, but many of these volumes are comingled with higher sulfur crudes when processed in refineries. To retain the sulfur benefits, these grades would need to be processed in blocked mode in separate crude units. How many refineries would operate in such a fashion is not clear.
After producing the available, segregated low sulfur resids, the remaining bunker requirements would come from the distillate pool. The IMO has previously estimated that as much as two million barrels per day of global distillates would be required. This would back out approximately 1.8 million barrels of higher sulfur fuel oils. The existing global, non bunker fuel oil demand is only around 3.5-4.0 million BPD and has been shrinking for decades. The sudden supply of an incremental 1.8 million BPD would be very disruptive to the market.
The refining solution to this impending fuel oil imbalance would be for a significant increase in global coking unit construction. This would decrease surplus fuel oil stocks while increasing distillate yields to replace volumes diverted to the bunker pool. TM&C has been monitoring refining construction projects for over a decade as a component of its Crude and Refined Products Outlook. Regrettably, such an increase is not seen in the announcements of new projects, and with only three years and three months remaining until January 2020, it is unlikely that new projects will be announced which can be completed before the implementation date.
Pricing Implications
Several shifts in product prices are likely as a result of the move to low sulfur bunker fuel. In 2020, TM&C expects global distillate demand (before diversions to the bunker pool) to be around 37 million BPD. A sudden increase of up to two million BPD (equivalent to nearly four years of global demand growth) will initiate a surge in distillate prices. Because the new 0.5% sulfur bunker fuel will be predominantly distillate based, it will also rise in price.
The high sulfur price will fall, but the move should be even sharper than the distillate shift. The increase in supply by 1.8 million BPD in a market of only 3.5-4.0 million BPD could be dramatic. The severity of the decline will be dependent on the ability of the system to quickly develop alternate markets.
These pricing shifts will not impact global refiners consistently. Coking refineries will benefit from the surge in distillate prices, but will not be impacted by the decline in fuel prices. Asphalt refineries should see the same advantage as coking refineries, but have the risk that some fuel oil refiners may attempt to enter the asphalt market to reduce their exposure to the decline in fuel oil prices.
The refineries most at risk after 2020 are refineries which process higher sulfur crudes and produce fuel oil. While they too will benefit from the higher distillate prices, the effects of the lower fuel oil prices will be greater. The relative magnitude of the shifts will determine their ability to survive in the new pricing regime.
Market Opportunities
What may be adversity to some can be opportunities to others. The new market conditions likely in 2020 can present some interesting challenges. A prominent question is how low could high sulfur fuel oil prices go? This is dependent on the alternate uses for the product. A potential disposition for the unneeded fuel oil would be to blend it back into crude oil. More distinctly, the potential exists to blend new crudes using the fuel and other, lighter crudes to produce synthetic heavy grades.
An example of a crude-blending solution would be a 60% Mars/40% fuel oil which would yield a gravity similar to Maya (around 20.5 API). Similarly, a 45% LLS/55% fuel oil blend would also produce an equivalent gravity. Refiners are more concerned with the intermediate product yields, however, which would have to be evaluated accordingly. These grades could then be sold to coking refineries which currently purchase Maya, WCS or similar heavy grades. Obviously, this would substantively increase the supply of heavy crude grades and, as a result, widen the light/heavy crude differential. This would further advantage coking refineries relative to fuel oil refineries, but could become a solution to the fuel oil imbalance.
While potential solutions may emerge, the timing of their introduction may be critical. The world can only store a limited amount of fuel oil and new markets must be ready in January 2020. A crude-blending operation is likely the largest opportunity to absorb surplus fuel oil stocks, but operations should begin before 2020. Multiple blends should be evaluated and even marketed to ensure refiners are prepared to purchase the new grades. Like all budding opportunities, the early bird gets the worm.
Considering all of the effects of the upcoming low sulfur bunker specifications, it is clear that a major problem is potentially brewing for global refiners, with the impacts very region- and refinery-specific. Certainly, additional study is required to better quantify the likely surplus of high sulfur fuel oil in 2020 (or whenever the 0.5% bunker specification goes into effect) and the pricing implications for low and high sulfur fuel oil, distillates and heavy crude differentials. We made a concerted effort to include the effects of the LS bunker mandate, as well as the many other regulatory and policy impacts in our 2016 Midyear Crude and Refined Products Outlook, which we released in July. We will be issuing an updated version of this report in January 2017, which will include a refreshed analysis of our market view. These reports, which we issue on a biannual basis, discuss (in detail) our projections of global and regional petroleum supply and demand and provide a detailed 20-year forecast of both crude and product prices in all of the major refining and demand centers around the world. Please feel free to contact either of us or visit our website to get more information on this publication or any of the other services TM&C offers to industry players and participants.