What do Japan’s recent positioning in favour of open-loop scrubbers and the global trade slowdown have in common? They will both serve to slow fuel use change in the shipping sector.
The International Maritime Organisation’s new rule reducing the limit for sulphur in fuel oil used on board ships from 3.5% to 0.5% comes into effect on January 1, 2020. This will cause a radical change in fuel use by ships, but primarily a shift from one oil product – High Sulphur Fuel Oil (HFSO) – to other oil products – Low Sulphur Fuel Oil (LSFO) and Marine Diesel Oil (MDO).
This presents the refining sector with multiple challenges, not least the production of sufficient quantities of 0.5% fuel oil, essentially a new product, in the context of insufficient desulphurisation capacity, and the problem of what to do with a large surplus of HSFO no longer required by the shipping industry. The lack of desulphurisation capacity means HSFO production cannot be avoided in the attempt to supply the needed volumes of lower sulphur fuels.
Refining throughput should rise, giving a boost to oil demand. This boost will be real but also somewhat artificial as very low-priced HSFO temporarily pushes out other feedstocks in sectors such as refinery own use, power generation and cement production.
However, the IMO’s sulphur regulation is only one part of the story.
The organisation in April last year also resolved "to reduce the total annual GHG emissions [from shipping] by at least 50% by 2050 compared to 2008, while, at the same time, pursuing efforts towards phasing them out entirely." Given the expected expansion in sea freight over this time frame, CO2 emissions from shipping, which accounted for 2.6% of global CO2 emissions in 2015, will inevitably become the target of stricter carbon regulations.
Slow to change
This prospect had been expected to accelerate change to lower carbon, non-oil fuels, with the sulphur cap working as a powerful catalyst, but change is coming only slowly.
The number and growth rate of LNG-fuelled ships, excluding LNG carriers and inland waterway vessels, is less than spectacular at 121 in operation in 2018, 51 on order and 68 LNG-ready. By 2022, the figure for all three categories rises from 240 in 2017 to 353.
Battery use seems to be rising faster. There are now more than 300 commercial vessels registered with battery packs, with over 240 expected to be in operation by the end of 2019. These are rarely all-electric, but replace one oil-fuelled generation set with batteries, delivering significant operational gains, leading to fuel savings and lower greenhouse gas emissions.
However, the global merchant fleet is in excess of 50,000 vessels.
The real problem is overcapacity in the shipping sector and the relative youth of the global fleet, which means that there is currently little incentive to build new ships. New ship orders remain at decade-low levels. The majority of both bulk carriers and container ships are under 10 years old, while the largest concentration of oil tankers is in the 0-14 year bracket, with a concentration in the 5-14 year range.
Ships are scrapped for three reasons: physical, technical or regulatory obsolescence. In the first instance, recycling provides better cash flows than repair, given the likely returns and remaining lifetime of the vessel. In the second, a ship may be sound, but cannot compete with newer, more efficient shipping. In the third, regulations raise the physical standards required for service and the cost of upgrading pushes the vessel into premature physical obsolescence.
Overcapacity favours retrofit options for the younger majority and scrappage for the older minority. Last year saw the highest rate of oil tanker scrappage in more than seven years, driven by low earnings. A significant upturn in new ship orders won’t occur until the excess capacity is eradicated, but such is the long cycle of ship building that new ships are still coming out of the yards, postponing the point where new orders revive.
LNG or dual-fuelled engines are an expensive retrofit and make better economic sense if installed in newbuilds. A big jump in numbers is therefore contingent on – but not guaranteed by – an upturn in new ship orders.
The most cost effective way to meet the IMO’s sulphur cap is to stick with oil and retrofit scrubbers, which come in two broad forms, closed-loop or the more controversial and cheaper open-loop systems, although hybrids than can operate in both modes are also available. The essential difference is that in a closed-loop system, the exhaust gas from the engine is scrubbed and the waste is collected in a tank, allowing later treatment.
In an open-loop system, the washing water and waste are discharged directly into the sea, leading unsurprisingly to the claim that they simply replace atmospheric pollution with marine pollution, in particular ocean acidification. China, Singapore and Fujairah have banned the use of open-looped systems in their coastal waters, largely it would appear on the precautionary principle, but Japan has come out in favour, following a recent study which showed open-loop scrubbers do not cause significant damage to the marine environment.
The shipping industry is now divided over the issue, with those that have already retrofitted open-loop scrubbers keen to defend their investment. The scrubber war will be fought out in the IMO, but the fact that there is a war at all is likely to slow regulatory curbs on their use.
The current slowing of global trade, brought about by the US-China trade war and other barriers and risks to international trade, will extend the period of overcapacity in the shipping industry. Cuts in OPEC’s oil production will add to the hurt in the oil transportation sector.
This will have two effects. First, it will increase the scrappage rate which is inversely correlated to freight returns and, second, it will delay the upturn in new orders needed to stimulate the adoption of new engine technologies in maritime transport.
This will be accentuated if the proponents of open-loop scrubbers delay curbs on their use as it reduces the cost of retrofitting versus either scrappage or newbuild.
It is not a great outlook in terms of meeting the IMO’s stated carbon emissions reductions targets, which need new lower carbon technologies to be deployed, whether it means LNG, battery/oil hybrids, biofuels, more efficient ship designs or more futuristic solar and wind-assisted vessels.
Deep decarbonisation in shipping requires technological evolution that can only come with more rapid fleet renewal.
In oil demand terms, it confirms that scrubbers will be the primary response to the IMO’s sulphur cap, which in turn means a rebalancing on two sides of barrel. Refiners will up production of compliant low sulphur fuels, while demand for HSFO will fall, stabilise and then rise again as scrubber technology is more widely deployed, extending oil’s long phase of dominance as the fuel of choice in maritime transportation.