Iran and Venezuela have dominated the oil market discourse for a while and will continue to do so in the coming months. Fears of supply shortages amid a tighter market have stoked an oil price rally that saw Brent Crude hitting $80 a barrel last week.
But an upcoming regulation that analysts have called “the biggest change in oil market history” and the “the most disruptive change in the refining industry” is lurking just around the corner, and experts say that it will drive oil prices higher as it will fundamentally shift the demand pattern for fuels.
The regulation concerns significantly limiting the sulfur content in the fuel that ships use, in a bid to curb emissions from the shipping industry.
The International Maritime Organization (IMO) has set January 1, 2020, as the starting date from which only low-sulfur fuel oil will be allowed to be used for ships. The global sulfur limit on fuel oil will be set at 0.50 percent m/m (mass/mass) in 2020, a significant cut from the 3.5 percent m/m global limit currently in place.
The regulation will send demand for middle distillates such as diesel and marine gasoil soaring, and refiners will have to shift some of the products they will be processing from crude oil, analysts concur.
Middle Eastern crude oil producers could be one the biggest losers from the new regulation, because they pump high-sulfur crude, Amrita Sen, chief oil analyst at Energy Aspects, told CNBC this week, discussing the outlook for oil prices. Related: Oil Prices Fall Despite Iran, Venezuela, Libyan Supply Outages
“That is very important because Middle Eastern producers lose out heavily from that because their crude tends to be very high sulfur,” Sen said, noting that the shipping fuels regulation is the “biggest change in the history of the market.”
The stricter regulation on the fuels used by the shipping industry will result in booming demand for middle distillates that would boost crude oil demand by additional 1.5 million bpd, potentially sending oil prices to as high as $90 a barrel in 2020, Morgan Stanley said last week.
In fuel oil prices, the forward curve has not yet fully priced in the regulation, according to research from S&P Global Platts Analytics last month.
“This is going to be the most disruptive change to hit the refining industry in its history,” Chris Midgley, global head of Platts Analytics, said. “Unlike other specification changes seen by the industry, this isn’t a little bit of tweaking.”
According to Rick Joswick, managing director for downstream oil analytics at Platts, the forward curve for middle distillates currently shows little change between 2019 and 2020—underestimating the impact of the new rules.
“The market has not appreciated yet the degree and scope of these changes,” Joswick said.
The timing of the new regulation will coincide with the effect on supply from the underinvestment during the oil price crash and the strength in demand, suggesting that the “era of ‘lower for longer’ oil prices is dead”, Energy Aspects’ Sen and Yasser Elguindi wrote in a commentary in the Financial Times this week. Related: OPEC Sends Oil Prices Crashing
Over the past month, the five-year forward oil prices that generally trade in a much narrower band than front-month futures have rallied more than the prompt prices.
“While there has been breathless attention paid to prompt Brent prices climbing to $80 a barrel for the first time since 2014, what has received less attention is that the entire Brent forward curve is now trading above $60, including contracts for delivery as far out as December 2024. This development is an important psychological milestone for the oil market. The market is, in effect, saying that ‘lower for longer’ is dead,” Sen and Elguindi wrote.
Looming shortages of supply and strong demand will combine with the marine fuel regulation in 2020 to put additional pressure on the physical oil market. Demand for diesel and ultra-low sulfur fuel is expected to jump by 2 million bpd-3 million bpd, Energy Aspects analysts noted.
“Nothing ever moves in a straight line, but the broader oil market is perhaps not prepared for what will happen to oil prices over the next couple of years,” they concluded.
By Tsvetana Paraskova for Oilprice.com
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