IMO 2020 Sulphur Cap – Implications for Oil Markets

14 May 2018

When we first wrote about the International Maritime Organisation’s sulphur cap last year, the 01 January 2020 commencement date still seemed a long way off.

The discount of the forward price of fuel oil for 2019 and 2020 to the respective forward prices for Brent (the fuel crack spread), widened sharply when the cap was announced at the end of 2016. The 2020 crack spread for 3.5% barges fell from around -14 $/b to below -20 $/b. Fuel prices subsequently recovered and the 2020 crack spread increased over the summer of 2017 back to levels last seen before the cap was announced. However, more recently the crack spread has collapsed as the market has become aware of a glaring problem – neither the shipping nor refinery industries are making proper preparations for the sulphur cap. This should not just be a concern for refineries. It could and is having an impact across refined products, particularly middle distillates (diesel, gasoil, jet fuel) and is increasing pricing disparities between different grades of crude, so has and impact on producers too.
A brief recap

When the rules come into force on 01 January 2020, ships operating on the high seas will either have to have scrubbers fitted (which remove sulphur from exhaust gases) if they wish to continue burning high sulphur fuel oil (HSFO), or switch to using lower sulphur fuels – namely gasoil. It had always looked unlikely that shippers would opt to install scrubbers which are expensive to buy and fit, especially on older ships and such has proved to be the case. Another possibility would be switching to LNG, but, while that transition might well be a viable longer term solution, at the moment the limited availability of necessary infrastructure, the costs and practical difficulties of converting ships or replacing them, has put shippers off taking this route. Instead, the shipping industry has taken the default choice which is to burn a lower sulphur fuel when the new rules come into force. However, this just passes the problem of complying with the sulphur cap onto refineries who could deal with it by:
  • Processing more crude to produce more gasoil - the trouble with this approach is that you also get more of everything else, including more HSFO. There would need to some economic way of disposing of the HSFO
  • Use lower sulphur crude - this could help, but would increase the premium of light sweet crudes (such as Brent and WTI) over heavy sour crudes such as (Dubai) and still leaves the question of what happens to the unwanted high sulphur fuel grades
  • Install desulphurisation units to remove sulphur from refined products within the refineries.

Installing desulphurisation units at refineries is perhaps the most effective of the above options as it isolates the real waste product (the sulphur itself) from the fuel. A large upfront investment is required however and the signs are that refineries have not been making those investments. Overall, it appears that the refining and shipping industries are not well prepared for the upcoming changes. The market is becoming increasingly aware of this disconnect which is being priced into crack spreads, high-low sulphur product spreads and between sweet (low sulphur) and sour grades (high sulphur) of crude.
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