Shipowners are installing scrubbers as mini oil refineries to desulfurize higher sulfur bunker fuel. This is a bet they can beat oil refiners at their own game. However, these scrubbers do not have the complexity or scale of large refineries, writes Robert Boslego in an article published in the Seeking Alpha.
- Therefore, they will lose the battle against oil refiners and be less cost competitive.
- Heat/Gas futures price spreads may collapse as a result, as complex refiners win the game.
A losing proposition?
Beginning on January 1, 2020, ships must either use a low sulfur fuel, LNG or install “scrubbers” to remove sulfur from high sulfur bunker fuels. Those opting for scrubbers would essentially be building and operating mini oil refineries onboard to comply with the lower sulfur fuel standard.
In effect, buying scrubbers is a bet that the shipowners can beat complex oil refiners at their own game. This is going to be a losing proposition.
The rationale for installing scrubbers is that the price differential between marine grade, IMO-compliant distillate fuels and high sulfur resid will “pay for itself,” as residu fuel prices drop to almost nothing for lack of demand.
A Big Change That Won’t Go Smoothly?
The market narrative is that the IMO 2020 regulation is the biggest change in the oil industry in a generation or more. Well-known oil economists have added fuel to the fire.
Phillip K. Verleger has predicted oil prices could rise to $200/b as a result of the regulation, causing an “economic collapse.” Daniel Yergin has predicted an “IMO 2020 scramble.” He said that IMO 2020 represents a “big change” which “won’t go smoothly.”
Economies of Scale
In oil refining, there are economies of scale. The sophisticated, complex refiners, such as Valero (VLO), Marathon Petroleum Corporation (NYSE:MPC) and Phillips 66 (PSX), have the capability to “pre-scrub” the residual fuel, if you will, into low sulfur bunker fuel and sell that product without cutting into distillates. And they have the ability to do it at scale v. 70,000 ships scrubbing their own.
How can the refiners recover?
One Asian refiner explained that they can take high sulfur residuals through a residue desulfurization process, instead of passing the product through a residue fluid catalytic cracker (RFCC) to make gasoline. This would “reduce gasoline output while increasing LSFO output so the gasoline market could recover.”
If refiners buy residuals to scrub, the relative price of the fuel will rise due to demand. That has already begun to happen. Residual prices in Europe have already topped Brent crude prices for the first time in over 5 years.
How the pricing will speed up?
Based on economics, the price of low sulfur (pre-scrubbed) residuals will be the price of the high sulfur product plus the cost of scrubbing and a profit margin. That price will be less than the cost of the high sulfur product plus the cost of scrubbing on ships because large refiners are more efficient than ship-borne scrubbing. Thus the ships that are outfitted with scrubbers will be less cost competitive than those which buy the low sulfur product processed by large refiners.
The low sulfur residuals will also be priced less than marine grade gasoil. That’s because gasoil is a distillate with a higher value.
The futures market has bid up the spread between distillates and gasoline to unsustainable levels. For example, Heat/Gas futures spreads on NYMEX average $10.12/b for 2020 contracts. By contrast, that spread averaged -$ $2.21/b for the period of 2009 through 2018.
JBC Energy Estimates
Consulting firm JBC of Vienna estimates that global demand for marine gasoil to be only 250,000 barrels per day higher than 2019 levels. They believe that refiners will more likely supply very low sulfur fuel oil than marine gasoil because this provides “greater operational flexibility.”
“We expect VLSFO (very low sulfur fuel oil), at least in 2020, to price at a premium to Brent of over $10 per barrel, which is a level where it can and will compete against gasoline. In our logic, then, IMO 2020 is bullish for gasoline,” they wrote. “For diesel we see less upside from IMO than gasoline.”
Platts Analytics Estimate
Platts Analytics forecasts a spike in marine gasoil demand in Q4 2019 and the first half of 2020. “But will gradually be replaced by VLSFO as it slowly gains widespread supply/acceptance/use.”
Höegh Autoliners Say
“We have ordered zero scrubbers and will order no more,” said Ivar Hansson Myklebust, CEO, of Höegh Autoliners, a leading global provider of transportation and logistics services within the Roll-on Roll-off (RORO) segment.
Implementing a scrubber can actually end up increasing the CO2 footprint of a vessel. The scrubber adds weight to the vessel and requires tens of thousands of tons of water to wash through the systems each day. This requires energy and energy comes from burning more fuel, in this case High Sulphur Fuel.
Another reason he gives for not using scrubbers is they are being banned at ports. The Port of Fujairah, the only multi-purpose port on the Eastern seaboard of the United Arab Emirates, has also banned the discharge of wastewater with sulfur.
Odfjell Say
“Our conclusion for the moment is that it does not make sense for Odfjell (to install scrubbers),” CEO Kristian Moerch said.
“Everything comes back to if you believe this spread of $300 (of high sulphur fuel oil vs low sulphur fuel oil) will stay or not,” Moerch said.
Phillips 66v Say
Phillips 66 CEO Greg Garland said, “We still have IMO yet to kick in in the second half, which I think is going to be very constructive, although maybe not as constructive as people thought in the first half of 2018.”
Conclusions
The winners from IMO 2020 will be the complex refiners, such as VLO, MAP and PSX, and shipping lines that do not install scrubbers. The losers will be shipowners who install scrubbers.
Predictions of distillate market pricing chaos and demand that cannot be met will fail to materialize. Thus, the heating oil/gasoline futures spreads will collapse once the market recognizes that marine grade distillate demand will not materialize as feared or will ease as low sulfur fuel oil is accepted by the shipping lines.
“The tribe has spoken.”
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Source: SeekingAlpha
