Seekingalpha: Shipping’s 2020 Sulfur Cap! A Popular Question is Answered



There’s a significant apprehension regarding the 2020 sulphur cap as several shipowners are worried if it will lead to the decrease of the vessel speed in order to save money. In such a scenario, the natural question that arises is, if there’s a possibility of shipping routes substitution.

Shipping expenses, an overview

Shipping expenses fall into two categories: fixed daily costs and variable costs.

Fixed daily costs occur regardless of the movement or employment of the ship. They can include depreciation, capital cost, crewing, technical maintenance (including drydocking), insurance and general administrative expenses.

Variable costs are the costs related to a voyage (sailing the ship, positioning or even waiting to load or discharge a cargo). They can include bunker costs, port costs (including agent costs), canal transit fees, towage and pilotage.

For voyage-specific sailings, the variable costs of any voyage are deducted from the freight lump sum (paid by the cargo owner) to derive a net freight amount. This is because these costs are variable with the particularities of the voyage performed, i.e., cargo size, distance, number of ports, etc. The net freight amount can then be divided by the number of days that the voyage happened (including the time and voyage expenses of positioning of the ship from the last port where it discharged a cargo to the port where it will take a new cargo), and this which is a daily rate of income called the Time Charter Equivalent Earnings (TCE Earnings), expressed in USD/day.

The Ship speed and fuel savings

The single largest variable cost of a voyage is fuel (bunkers), and this varies in direct relationship to the speed at which the voyage is performed. The slower a ship sails, the longer the voyage. So the calculation of the TCE will be affected in two ways (as the freight lump sum remains the same). The net freight will go up because of the savings made on the fuel, but at the same time, it will be divided by more days, taking the TCE down. Therefore, a ship should only go slower if the cost of fuel saved by slower sailing, offsets the reduction of the TCE caused by the increase in the number of days, the voyage lasted. In short, there is an optimal speed to achieve cost savings.

The Global Sulfur Cap and the emerging costs

The reason we are having this discussion is the 0.50% global sulfur cap which will come into effect in 2020. This revised rate which was announced by the International Maritime Organization (IMO) on 27th October, 2016, is going to affect more than 70,000 ships. Hence, it will have a huge impact on the shipping industry.

Ships can meet the requirement by using low-sulfur compliant fuel oil in place of the high sulfur content heavy fuel oil, traditionally used by ships. Heavy fuel oil is 3,500 times more sulfurous than road diesel. Marine gas oil has a reduced sulfur content and will meet these new guidelines, but is quite expensive.

In December 2017, Platts was kind enough to put forward a useful graphic illustrating just how these costs would impact typical voyages.

(Source: Platts)

On January 16th, according to Ship & Bunker, the Global 20 Ports Average for HFO 380 is $398.50/mt, whereas the Global 20 Ports Average for MGO is $645/mt, which is much higher than the first-half 2017 averages used for these figures.

Now consider that Wood Mackenzie estimates that in a 100% compliance scenario, the price of MGO could skyrocket by 4 times that of 2016 prices, increasing overall fuel costs for the industry by approximately $60 billion/year.

Senior Research Scholar Antoine Halff, of Columbia’s Center on Global Energy Policy, believes “expectations that the IMO sulfur standards will restrict bunker fuel availability and cause product markets to rally are likely overblown.”

IHS Markit forecasts the new low-sulfur fuel will cost between $500 and $650 per metric ton by 2020, indicating very little change from today’s environment.

Platts reports: Estimates of how much the extra costs for shipping would be vary widely, ranging from modest a $5 billion to $70 billion a year, which clearly shows how much uncertainty surrounds the whole issue.”

Why Slow Steaming Matters

Slower vessel speeds consume less fuel and, therefore, produces voyage cost savings. However there’s a trade-off limit to this.

There are only so many vessels on the water with a given number of days available to transport cargo. There is also a given amount of cargo that needs to be transported. This composes the basic supply/demand side of the equation and prices rise and fall according to this.Taking longer to transport a cargo would create a shift in that equation, resulting in higher prices/charter rates.

In May 2015, Genscape created a “TD3” steady state simulation, assuming a constant demand of 6.5 million barrels per day to measure the impact speed has on effective fleet size.

Table 1 shows the last major slow steaming shift, moving from 14 knots, both Laden and Ballast, to a slower speed results in more VLCCs necessary to satisfy a given oil import demand.

(Source: Genscape)

Of course, the opposite is also true, and an increase in speeds on both Ballast and Laden voyages from 11 knots to 14 knots results in a decrease of 33 VLCCs (18 percent) necessary to satisfy the considered requirement.

History Of Slow Steaming

Slow steaming history provides guidance in this matter. Few years ago, a sudden rise in the crude oil prices lead to higher HFO prices. Higher oil prices leading up to 2008 was the first catalyst.

Brent Crude Oil Spot Price data by YCharts

But other factors soon emerged, such as the global economic downturn and a substantial order book for new tonnage, both of which led to falling charter rates.

The biggest single cost factor in merchant shipping is the fuel oil, and the easiest way to reduce this cost is to reduce the ship’s speed. Ship speeds have dropped significantly over the past decade, from about 25-27 knots to approximately 10-12 knots today. That 10-12 knot average was fairly well established by the time oil prices were at elevated levels again, before turning down in the second half of 2014.

But here’s where things get interesting. Two different vessel segments faced very different environments over that time. First, let’s consider the bulker segment. The Baltic Dry Index hit a historic low of 290 on February 10th, 2016.


September 25th, 2013, saw Capesize rates at around $42k/day, which represented a fairly healthy level. By February and March of 2016, those rates were now firmly in the $2,000 range. Although this suggested that it’s the ideal time for slow cost-cutting measure yet the speed remained consistent, as results didn’t show a potential for more savings.  

(Source: VesselsValue)

In late 2015, the crude tankers which highly benefited from a decrease in bunker costs and high spot rate of the environment.

(Source: Mathias Owing Maanum & Henrik Prøsch Selnes)

Although the improving environment seemed like an ideal time to deviate from slow steaming and speed up vessels up but that wasn’t the case, as vessel speed data shows.

(Source: VesselsValue)

Tankers seem to be a bit more responsive, but not by large. In fact, laden speeds changed less than 1 knot since the crude fell from above $110 to below $30 as charter rates skyrocketed. In fact, according to a model presented below, these sort of market conditions could have inspired a 4 knot increase in speed, but that failed to materialize. This shows that shipping industry has found that approximate optimal trade-off point.

Slow Steaming Limits

As Wärtsilä notes, the power required from the main engine correlates disproportionately with the ship’s speed.

(Source: Wärtsilä)

There are other considerations. As fuel costs are reduced, certain fixed costs remain and other expenses may increase.

Initially, as the speed dropped, fuel costs also dropped, but other costs remain fixed or increased over time, indicating this sort of trade-off has its limits – which leads us to optimal speed.

Determining Optimal Speed

The Norwegian School Of Economics. Martine Erika Biermann Wahl and Eirik Kristoffersen’s dissertation entitled “Speed Optimization for Very Large Crude Carriers (VLCCs): Potential Savings and Effects of Slow Steaming,” provides some useful insight on the methods used to find the optimal speed.

In their thesis, the authors utilized the Haugen Model as the basis for a general cost-minimizing speed model. Developed by Petter Haugen in DNB Markets, the Haugen Model is based on a ship’s resistance, a speed/consumption model and the financing cost of the cargo. While being one of the more complex models, it does well to account for several factors to arrive at optimal speed.

Given the conditions presented in their thesis (TCE, bunker costs, cargo financing), the authors were able to demonstrate that finding an optimal speed was possible, and any significant deviation from it would produce higher costs, though slight deviations produced relatively small cost changes.

It is noteworthy in this to say, the authors assessed their results with real-world optimal speed data provided by Frontline’s Operational Manager, Per Gunnar Asheim, around the same period, and that data confirmed their findings.

This specific example depicts a VLCC on route TD3. The Laden voyage includes cargo financing costs and port costs.

(Source: Wahl, Kristoffersen)

The next shows the optimal speed for the ballast voyage where port and financing costs are not included.

(Source: Wahl, Kristoffersen)

First with a drop in bunker costs starting in late 2014, followed by a significant rise in spot rates in mid-to-late 2015, a significant shift in the VLCC market was witnessed over the past few years.  

This is likely because we have arrived at a generally accepted optimal level for a wide range of market conditions. Remember, the further we deviate from the optimal speed the steeper the curve. But around the optimal speed level, the curve is very slight, indicating some leeway.

Furthermore, in the matrix developed for the VLCC market in this report, bunker prices at the $1,000+ level (which is the higher end of estimates for full compliance in 2020) would have to be met with extremely low charter rates in order to inspire further slow steaming.

(Source: Wahl, Kristoffersen)

However, it is noteworthy that ballast speeds according to this formula will be more responsive to market shifts. So, higher bunker prices seem realistic in the future, as older vessels gets scrapped, leading to a decrease in the availability of vessels and an eventual increase in charter rates.

In this scenario, it becomes unlikely that we will see additional slow steaming.

Ton Mile Demand

Any decrease in ton mile demand will have a negative impact on the shipping industry. Here we are comparing one of the more cost-sensitive segments in that regard, the bulkers, along two routes, Australia to China and then Brazil to China. The former represents about a 15.4 days at sea traveling at 11 knots, while the latter comes in at about 56.7 days at 11 knots.

The Shanghai Shipping Exchange currently quotes a rate for iron ore of $5.622/mt and $14/mt for Australia to China and Brazil to China, respectively. A roughly 50% increase ($600/t) in bunker costs would translate into an approximate $1.46 per ton increase for the round trip for the Australian route. A 100% increase ($800/t) would come out to approximately $2.91/ton.

Brazil, since it is further away, would see even larger jumps. They would see a $5.75/ton increase, if bunkers rise to $600/t and approximately an $11.5/ton increase if they are moved to $800/ton. Initially, this sounds pretty scary for Brazilian cargoes, and I would even be tempted to believe it might result in some Brazilian cargoes being dropped in favor of Australian.

As before, we should look at history as a guide. After all, in the last five years, we have seen high bunker prices retreat to extreme lows and then begin a climb again. If bunker price swings have a significant impact on volumes transported along certain trading lanes, it would show up in this data.

However, looking at volumes transported out of Brazil to China in the capesize class from the period of January 1st, 2012 through now, we observe a negligible correlation to bunker price swings. In fact, something interesting is that during the recent low crude oil prices, we actually saw a bit of a stall in ton mile demand growth out of Brazil to China over the same period.We observe a negligible correlation between higher bunker prices and volumes moving out of Australia to China.

This seems to confirm that in the past ton mile, growth along these two routes was not impacted, even as bunker prices went from high to low and are now trending higher.

Finally, let’s also recognize that these comparisons are being done using a capesize vessel. The VLOCs that transport iron ore from Brazil to China benefit from economies of scale, and several deliveries are on the horizon.


Historically, when conditions arise presenting the opportunity for increasing or decreasing speeds, there has been a minimal change. Even radical shifts failed to induce significant changes.

The Haugen model suggests there is some room for further slow steaming, but only with much higher bunker prices, coupled with an extremely poor, even catastrophic, charter market. However, history showed that changes based on this model hasn’t been that successful. On contrary, speeds remained fairly consistent even as market conditions shifted wildly for both charter rates and bunker prices.

Hence, the slow down in vessel speed will be negligible even if it happens in the near future.

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Source: Seeking Alpha


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