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IMO 2020: sulfur sea change to disrupt the bulk shipping industry

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Are you a seaborne exporter or importer of coal? Does the date 1 January 2020 mean anything to you? Wood Mackenzie is here to convince you that it should.

The clock is ticking on global bulker companies before binding international marine fuel sulfur limits come into force. Currently, bulk carrier ships use compliant residual-based high sulfur fuel oils (HSFO). HSFO sulfur content is capped at 3.5% under existing International Maritime Organization (IMO) regulations. This insight is limited to the bulk coal shipping industry and impacts to coal freight rates.

Fast-forward to 1 January 2020 and a sulfur sea change will disrupt the bulk coal shipping industry. Marine ship fuels will be limited to a sulfur content of 0.5% (or equivalent) when operating on open oceans. The days of abundant and cheaper marine fuel are ending. Refineries are slow and possibly reluctant to make major investments for the swing.

As the hard deadline approaches, shipping companies face critical compliance decisions. Wood Mackenzie examines three compliance options. These options will affect CFR pricing. Will they select high cost lower sulfur fuels? Will they install costly sulfur dioxide scrubbers on older ships? Will they invest in LNG powered ships? What is the potential impact on voyage rates? As a vital part of the coal supply chain, proactive exporters and importers can identify how this significant sulfur shift will shape the shipping industry and their bottom lines.

Coal companies relying on ocean transport should brace for increased voyage rates. Bulker fuel costs will rise leading up to 2020 and beyond until a balance is achieved between shipping company demand and refinery marine bunker fuel output. Based on our IMO 2020 analysis, assuming fuel switching for compliance, coal exporters and importers can expect a 20% to 40% step change increase in coal route voyage rates on a US$/tonne basis in 2020, depending on the compliant fuel type used. Compliant fuels rate impacts for scrubber installations and LNG fuel switching were not analysed.

How did we get to IMO 2020?

The International Marine Organization (IMO), an agency of the UN, counts 174 member states, representing over 99% of the world's shipping tonnage. As part of its mandate for "safe, secure and efficient shipping on clean oceans", the IMO adopted global sulfur dioxide emissions regulations in 1997. Under the International Convention for the Prevention of Pollution from Ships, better known by its acronym MARPOL, the IMO added Annex VI to the convention to set limits on sulfur oxide emissions from ship exhausts.

This annex came into force in 2005 and was followed by revisions in 2010 that defined progressively stricter sulfur limits in open ocean use marine fuels. In 2018, the IMO ratified 1 January 2020 as the definitive date for its latest sulfur limit. On this date, maximum sulfur in marine fuels decreases from 3.5% to 0.5% (by weight).

As part of Annex VI, the IMO instituted even stricter regional operating zones called emission control areas (ECAs), requiring 0.1% sulfur fuels. They cover the Baltic Sea, North Sea, and English Channel, as well as the US and Canadian coastlines out to a limit of 200 nautical miles. In addition, an ECA came into force in the US Caribbean Sea covering Puerto Rico and the US Virgin Islands in January 2014. China has established its own non-IMO ECA type restrictions where 0.5% sulfur fuels are required in coastal regions. There are growing calls by the public to expand ECAs into other coastal areas. Currently, there are no official motions by the IMO to expand ECAs.

Crash course in marine fuels

Within the global bulker fleet, heavy fuel oil (HSFO) has been the fuel of choice for decades due to its low price and wide availability. HSFO, also known as intermediate fuel oil (IFO) in marine fuel classifications, is a mix of highly viscous residual and less viscous distillates from the refining system. HSFO predominantly consists of the residual fraction, typically over 80%. One of the major downsides of these fuels is their high sulfur content that ranges from 2.0% to 3.5%.

On the other end of the marine fuel spectrum are distillate fuels, primarily marine gasoil (MGO). MGO has a sulfur content of 0.1%. This fuel is used extensively for operations in ECAs. An emerging fuel specification known as very low sulfur fuel oil (VLSFO) contains 0.5% sulfur content. VLSFO will not be a traditional distillate fuel, but a residual-distillate blended product. In terms of viscosity, VLSFO (11 to 180 centistokes) sits between HSFO and MGO (1 to 11 centistokes). VLSFO will contain residual components whereas MGO is 100% distillates, naturally low in sulfur. VLSFO and MGO will be the fuels of choice for IMO 2020 compliance.

Compliance options for coal bulkers

Option 1: Install an emissions scrubber system and continue to run HSFO

Wood Mackenzie predicts scrubbers as a medium-term solution for marine fuel compliance. To continue running traditional HSFO/IFO fuels requires the cost of a scrubber and downtime for installation. Before a shipping company selects this solution, there are a few points to consider. How cost effective is the technology? Does a scrubber 'future proof' a ships' emissions? No company wants to risk installing unproven and expensive technology with emissions regulation and uncertainty regarding fuel availability.

Scrubbers involve a large capital outlay (US$2 - 7 million) and valuable downtime for installation (up to two months in dry dock). The window to install scrubbers is closing for shipping companies if their goal is to meet IMO2020 compliance. On older less valuable ships, companies are reluctant to spend CAPEX dollars on scrubbers. The shipping industry is recovering from the lows of 2016. They also have limited credit to fund fleet-wide capital projects.

Time charter rates, where the shipper pays for fuel, make it difficult to recover capital from upgrade projects. Shipping companies choosing scrubbers will seek to pass on costs to coal exporters and importers. This will come from either third party leases or increased voyage charter rates.

Regulatory uncertainties in ECAs do not 'future-proof' scrubber investments. The most common scrubber design (open loop style) relies on disposal of sulfuric acid-tainted seawater, including heavy metals and residual fossil fuels, back into the ocean. As such, a scrubber-equipped ship will not necessarily guarantee ECA or open water compliance in the future.

Another consideration for scrubber installations is the future availability and price of HSFO. Refineries will move to increase production of lower sulfur fuels. Will a scrubber be justified long-term? In 2020, there will be an initial surplus of residual fuel stock as refineries shift production to produce more distillate fuels. In the long term, refineries will look to upgrade excess residual feedstocks to produce lighter products. Decreasing volumes of HSFO will be available for ships operating a scrubber. As such, fuel considerations add another decision variable, further complicating the scrubber equation.

Lastly, scrubbers generally add additional weight to ships, reducing all-important cargo capacities.

Wood Mackenzie estimates scrubber penetration rates at less than 1% of the bulker fleet in 2020. The existing bulker fleet lacks incentive to retrofit their ships prior. However, generally all future ship builds will be constructed 'scrubber ready'. In 2025, Wood Mackenzie assumes that one in five 2013 - 2018 vintage bulkers will have a scrubber installed. Wood Mackenzie estimates 2000 scrubbed bulkers or under 20% of the global bulker fleet in 2025.

Option 2: switch from high sulfur to low sulfur fuels

Wood Mackenzie foresees fuel switching as a short to medium-term solution for marine fuel compliance. The IMO has issued a recent decision to ban carriage of HSFO on ships without scrubbers, commencing in March 2020. Shippers are left to chose from compliant fuel options including VLSFO and MGO. These products are not new and are generally available globally. Since 2015, operation in strict 0.1% sulfur ECA zones have made these fuels mandatory. The question is how much is going to be available, where is it available, and at what cost?

Will there be enough VLSFO and MGO to replace non-compliant HSFO? Two scenarios are analysed: full and Wood Mackenzie's view of partial (80%) 2020 compliance. A full compliance scenario assumes all ships comply with Annex VI requirements in January 2020. Wood Mackenzie feels a full compliance scenario is unlikely due to disparity in regional fuel availabilities and inconsistent enforcement by members. What are the daily requirements for the total global marine fleet by fuel type in each scenario, comparing fuel demands in the step change years of 2019 and 2010?

What are the projected price differences between the HSFO and compliant VLSFO and MGO in 2020? Wood Mackenzie's 1H18 2020 bunker price forecast for the Rotterdam bunkering hub in northwest Europe was used in our voyage rate analysis. The Rotterdam bunkering hub pricing is a good proxy for global bunker prices however, it should be noted there are minor price deviations from hub to hub depending on regional supply and demand.

Despite the forthcoming deadline, refineries have shown reluctance to invest the hundreds of millions to billions of dollars to increase production of low sulfur marine fuels. The key difficulties are the uncertainty around compliance and that refining and marine investments are in direct competition, prompting a 'wait and see' approach from both sectors. Wood Mackenzie asserts the installation of commercial scrubbers has the advantage of being less expensive and faster to put in place than a major refining upgrade, which is highly capital intensive and can take many years to implement. For further detail on refinery impacts, please review the insight IMO 2020 Updated analysis of the marine fuel sulfur changes.

One potential risk in switching fuels is the impact on engine performance and ship speed. Switching fuels needs to be planned. Current bulker engine design favours higher viscosity HSFO fuels. It will be important for shipping companies to understand the performance impacts of switching to lower viscosity fuels such as MGO and VLSFO.

Option 3: switch to alternative fuels like LNG

Wood Mackenzie forecasts LNG as a long-term solution for marine fuel compliance. Direct fuel switching between oil based fuels to LNG is not an option for existing oil-based engines. Shipping companies can procure new LNG-fuelled ships with engine package options ranging from 100% LNG fired steam turbines to dual diesel and LNG-fuelled units. However, shippers should consider the special fuel storage considerations necessary to keep natural gas in a liquefied state.

The appeal of LNG is its low sulfur and clean burning properties. LNG promises emissions compliance on open seas and within ECAs. On the downside, global LNG infrastructure is in its infancy; global investment has been slow; and current fuel transfer technology is inefficient.

Given these complications, is the leap to LNG-powered vessels worth the risk? The proverbial LNG ship has sailed for investment decisions based on meeting IMO 2020. Lead times on new LNG-powered ships or retrofits would place deliveries beyond 1 January 2020. Instead, companies will look to incorporate LNG ships in their fleets as older ships move to demolition.

From 2020 - 2025, Wood Mackenzie sees limited, but growing, LNG ship penetration into the bulker fleets. In 2020, Wood Mackenzie expects 8.8 million DWT of LNG dry bulk capacity, rising to 20 million DWT in 2025. For comparison, the current coal bulk fleet (capesize, panamax and handymax) has a capacity of 667 million DWT.

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