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Goldman: Don’t Expect A Major Oil Price Spike From IMO Regulations

GS

We are now a little over 15 months away from a major set of international regulations over maritime fuels, which have raised concerns about the havoc and price spikes that may occur over a lack of fuel supply. But a new report says that meeting the new standards will be “challenging, but solvable.”

The International Maritime Organization (IMO) has binding regulations on the global shipping fleet that take effect on January 1, 2020. The rules require a reduction in the sulfur concentration in the fuel used in ships to 0.5 percent, down from 3.5 percent. The result will be a dramatic reduction in pollution.

However, because the global shipping fleet will shift away from high-sulfur fuels all at once, the regulations pose challenges for shippers, refiners as wells for the markets for crude oil and refined fuels. 

Because of the uncertainty, as well as questions around the enforcement mechanism, many shippers have refrained from taking action to date. But they are running out of time.

The fear is that there won’t be enough low-sulfur fuel available, which could open up massive price differentials between different types of fuel, and ultimately, causing crude oil prices to rise sharply and abruptly.

But a new report from Goldman Sachs says that the issue is “solvable.” The shipping industry has several options at its disposal: Scrubbers, low-sulfur fuels and LNG. First, shippers can install scrubbers that will essentially cleanse high-sulfur fuel oil (HSFO) of some of the sulfur. There are downsides to this option, including the high cost of installing the technology. But Goldman says new providers will enter the fold and that the “economics of installing scrubbers makes sense.”

Related: Is This The World’s Most Beautiful Electric Car?

Moreover, the economics are even better for larger ships, who, not coincidentally, are larger consumers of fuel. As such, many analysts underestimate the amount of fuel that will be scrubbed, Goldman says. Between 2020 and 2025, the investment bank estimates that about 1 to 1.4 million barrels per day of HSFO will be scrubbed. That reduces the rush on low-sulfur fuels.

Still, switching to low-sulfur fuels will be the default option for many shippers since the upfront cost is minor by comparison. The downside is that fuel prices are higher relative to current options (installing a scrubber is expensive, but at least the shipper can still burn relatively cheaper HSFO). Demand for low-sulfur fuels will rise, pushing up their prices even more, which in turn will incentivize refiners to switch their fuel blends to favor low-sulfur options. Fuels able to comply with the IMO regulations consist of low-sulfur fuel oil or marine gasoil (a distillate similar to diesel).

The third option is running ships on LNG instead of dirty fuel oil. LNG has almost no sulfur, burns fewer air pollutants than distillates, and the fuel cost is relatively low. However, the capital investment of converting a ship to LNG is huge. Plus the ship would need to be traveling along routes where it can refuel, which is only possible at certain ports. Thus, the opportunity for LNG created by the new IMO regulations is rather limited. Goldman Sachs estimates new LNG-equipped ships to displace around 250,000 bpd of fuel oil by 2025.

These three options for shippers will go a long way towards getting the shipping fleet off of dirty fuels. But a few other dynamics will help as well. There might be some leakage of high-sulfur fuels, diverted to onshore power plants while low-sulfur fuels move to shipping. This fuel switching will ease the crunch (although some of the environmental benefit of the regulations will be offset if high-sulfur fuels are simply burned in onshore facilities).

Another reason why the fuel supply crunch might not be as bad as many think, Goldman argues, is that the shipping industry won’t achieve full compliance with the IMO regulations right out of the gate. The investment bank estimates the initial compliance rate will be about 80 percent for the first year, rising gradually to 95 percent by 2024.

Putting it all together, scrubbing and non-compliance preserves 1.05 and 0.65 mb/d of HSFO demand, respectively, but that will be down by at least half from the total 3.3 mb/d of HSFO demand in 2017.

Related: Why Oil And Natural Gas Prices Are Diverging

On the supply side, refiners could begin stepping up their efforts to produce low-sulfur fuels, which could add 1.35 mb/d of capacity by the time the regulations take effect.

The upshot is that refiners will need to come up with another 0.8 mb/d of low-sulfur fuels. Goldman Sachs says that gap will be bridged by wider price differentials between distillates and HSFO, a spread of about $40 per barrel. That may seem large, but it is only a little bit above the forward prices in 2020 and also at the lower end of many analysts’ forecasts, Goldman argues.

In short, the whole effort is “challenging, but solvable,” the investment bank says.

There is plenty of uncertainty, including GDP and a possible recession, the ability of refiners to pivot towards distillates, the compliance rate with the IMO regulations, among others. Any number of these factors could complicate the implementation and the compliance with the sulfur regulations that are set to take effect in a little over a year. “For now, however, we think the answer to the IMO 2020 question is closer than most think,” Goldman concluded.

By Nick Cunningham of Oilprice.com

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