New fuel rules for ships entering low sulphur zones around northwest Europe and North America next year could trigger a price spike in European gasoil, whilst refiners will struggle to offload unwanted fuel oil.
From January 2015, ships entering “Emission Control Areas” (ECAs) in the Baltic, North Sea and English Channel and around the North American coast, will have to switch from low sulphur fuel oil (LSFO) with 1 percent sulphur content to 0.1 percent gasoil, in a crackdown on marine pollution.
Industry experts believe shipowners will opt for gasoil rather than using exhaust filter systems known as scrubbers or alternative fuels such as liquefied natural gas (LNG), because of high investment costs, long payback times, and the lack of suitable port infrastructure.
Gasoil currently trades at around a $300 premium to LSFO on a flat price basis.
“Most ships will move to marine gasoil in 2015,” said David Wech, an analyst at JBC Energy. He sees demand for gasoil growing by 135,000 barrels per day (bpd) in northwest Europe and 105,000 bpd in the United States. Demand for fuel oil will fall by 120,000 bpd and 90,000 bpd respectively.
This could prompt a short-term price spike in gasoil, similar to that in August 2012 when North America’s ECA first came into effect, mandating a switch to 1 percent LSFO. Although this was flagged well in advance there was a run on European LSFO from June, peaking in mid-September.
“When spec changes have taken place in the past there have been spikes, but there is more spare capacity in the system now,” said Jonathan Leitch, head of oil product short-term analysis at consultancy Wood Mackenzie.
“So there’s a potential for price spikes to be shorter-lived. We might see a run up in November/December ahead of the switch, and in the first couple of months.”
Crucially, North America is switching to 0.1 percent at the same time as northwest Europe, which could lead to a temporary reduction in middle distillates export volumes - exports that Europe relies on to help make up its shortfalls.
“It’s moving them more back into equilibrium as it’s encouraging more domestic middle distillates consumption,” said Iain Mowatt, an oil analyst at Wood Mackenzie.
WoodMac calculates that some 220,000 bpd will switch from LSFO to gasoil in northwest Europe, which Leitch argued could be found from new refining capacity in the Middle East.
But traders are not convinced cheap gasoil will be so easy to find as ship owners will have to compete with existing gasoil buyers in North Africa and West Africa. This will push up prices before the market adjusts to the new demand.
One trader pointed out that European refiners have upgraded units to produce more diesel and less gasoil. This could prompt some blending of high value diesel into the mix if gasoil prices rise enough to make it worthwhile.
“If you look at gasoil I don’t think there is enough supply, but there is plenty of diesel. So we might see diesel ending up in the 0.1 percent,” another trader agreed.
As late as 2013 some expected a broad take up of scrubbers or LNG, but this is now considered unrealistic for 2015 with adoption put at less than one percent of the global fleet.
Scrubbers were not an unmitigated success in sea trials and still need to prove themselves. The installation expense is also deterring shipowners, with only a few exceptions such as Carnival Cruise Lines, which is spending more than $180 million to install scrubber technology on 32 ships.
“For most ships it isn’t cost-effective to put in scrubbers,” said WoodMac’s Mowatt. “Even those ships that will spend 100 percent of their time in the ECA are a bit reluctant to fit scrubbers as they are still at the demonstration phase, and in some ships it isn’t easy to retrofit them.”
A handful of shipowners are opting for LNG, with Brittany Ferries commissioning a 270 million euro LNG cruise-ferry from shipbuilder STX France for service in spring 2017.
But LNG only suits ships with regular ports of call because of the infrastructure required. The EU is trying to ensure this will be ready post-2020, when further sulphur restrictions are implemented globally. Even so, Brittany Ferries said its new ship would have a dual fuel engine, so it can still use gasoil when necessary.
One sticking point is how easy it will be for authorities to enforce the new rules. North America is expected to do a more consistent job than EU member states, although Mowatt thought the Netherlands would try hard.
Antoine Kedzierski, policy officer at Transport & Environment, a campaign group for greener transport policies, said that the lack of a proper enforcement mechanism was a big issue in Europe. “Quality shipowners that invest to comply with the (EU) Directive will potentially suffer a competitive disadvantage compared with the laggards who may just bet on the low chance of being controlled,” he said.
UNWANTED FUEL OIL
For European refineries still producing large amounts of low value fuel oil, margins are likely to deteriorate further as they struggle to offload the unwanted product.
LSFO’s premium to high sulphur fuel oil (HSFO), known as the hilo, will compress as demand for LSFO falls. “The spread will fall markedly in late December/early January with LSFO possibly pricing very close to HSFO in a few instances,” JBC Energy’s Wech said.
It’s also far from certain that Asia - once seen as an outlet for European LSFO - will absorb the surplus barrels.
“It’s bearish on the market as overall there’s going to be excess fuel oil,” said one North Asian trader. “Another downside factor is the Japanese government’s push for nuclear power plants to restart.” He pointed out that fuel oil was already the last choice for Asian power stations, with natural gas and coal preferred for electricity generation.
But what refiners lose on the fuel oil may be partly offset by what they gain on the gasoil. This could give some European plants, which are under extreme pressure from U.S. exports, a short-term reprieve.
“The switch may offer a boost to European refiners in 2015 and 2016 but that will be short-lived as Russia ramps up 10 ppm (diesel) production,” a trader said.