Act now to manage fuel price risk associated with the 2020 Sulphur cap
On October 27th, the International Maritime Organization (IMO) decided to roll out a global 0.5% Sulphur cap in 2020. As one of several players that co-signed a letter urging IMO to take a proactive stand on climate change in shipping, we believe this is the collaborative mindset the industry needs to reduce emissions and move towards a greener and more sustainable long-term growth. Although the rollout may seem far away, the potential financial implications for shipping players may take place much before 2020.
Don’t underestimate the potential impact
According to the International Energy Agency (IEA, MTOMR 2015), 2.2 mb/day in maritime fuel demand would switch overnight to 0.5% gasoil (or 0.5% fuel oil). The International Bunker Industry Association (IBIA) pegs the number to 4 mb/day. This however assumes that all shipping fuel goes from fuel oil to gasoil, and probably underestimates the impact from scrubber investments and switching to LNG fuel.
A potential scenario
Leaning on IEA’s numbers, a Sulphur cap roll-out in 2020 could cause middle distillate demand to spike to around 9%, and have ship operators compete with truck drivers and SUV owners to buy the fuel, potentially driving prices for gasoil and diesel to skyrocket. Conversely, as fuel oil can only be used for asphalt, its price can potentially drop moving towards the global rollout. Refineries might invest in upgrading units, and ship owner will consider their choices. Furthermore, if everybody knows that demand for fuel oil can drop like a stone, and that there will be a middle distillate shortage coming up, prices could start to move sooner rather than later. Much sooner than 2020.
If we envisage that the scenario unfolds, the difference between gasoil and crude oil and fuel oil and crude oil will display great movements before 2020 (to provide economic incentives for required investments). Most likely causing prices for fuel oil to fall substantially. Mitigate the risk:
- For existing freight contracts (COAs) extending beyond 2020, check if and how bunker price adjustment factors (BAFs) would impact the contract parties. For COAs without BAFs, any underlying hedge in fuel oil could become obsolete and create a large loss if fuel oil prices plummet and the price of gasoil increases.
- For new long-term contracts consider how the BAF is structured, and hedging any oil exposure partly in gasoil and/or hedge in crude oil, and then swap into gasoil (or fuel oil).
- Operators should consider what would be a sound fuel hedging strategy in today’s highly uncertain price environment, as the product prices could display unexpected volatility prior to 2020.
In the long term, the decision has the potential to enable international collaboration amongst industry players towards greener and more sustainable growth. However, the effects of the decision may come into play sooner than you expect.