BAKU, Azerbaijan, Jan.23
By Leman Zeynalova – Trend:
Implementation of the International Maritime Organization (IMO) regulations, which came into effect on January 1, 2020, is reshaping marine fuels demand, as ship owners switch to low sulphur fuels to move into compliance with the cap, Trend reports with reference to the outlook for IMO 2020 and marine fuels, released by Fitch Solutions Macro Research (a unit of Fitch Group).
"The cap - which became effective on January 1 - limits the allowable sulphur content in marine fuels (outside of Emissions Control Areas) to 0.5 percent mass-by-mass, compared to 3.5 percent previously. For the majority of vessels, which lack scrubber capacity, this has meant a switch to very low sulphur fuel oil (VLSFO) or marine gas oil (MGO), as they have moved towards compliance with the cap over Q419. As a result, prices for these fuels have risen and their differentials have strengthened relative to high sulphur fuel oil (HSFO) and crude.
"The rises in VLSFO and MGO prices have been substantial, especially for the former, and the large increase in VLSFO demand has caused logistical issues in some regions. That said, there are no signs of a major market dislocation and since the start of January the prices for both - as well as their differentials to crude - have been receding. In contrast, HSFO spreads to Brent have shown some signs of improvement in recent weeks, which may in part reflect the return of vessels to market, after extended periods spent in dry dock for scrubber installation.
"In Asia, shipowners have shown a strong preference for VLSFO. Data from the Maritime and Port Authority of Singapore (a major bunkering hub in Asia) show that in January 2019, VLSFO accounted for less than one percent of total sales; by December of their share had risen to around 65 percent. HSFO accounted for around 31.0% of December sales, with MGO representing little more than 2 percent. The strength in demand has introduced considerable tightness into the market, which existing inventories and new supplies were unable to fully relieve.
"As a result, VLSFO was pushed into a sustained premium over MGO, contrary to market expectations. A number of issues have been reported around the availability of adequate VLSFO supplies, delays to barge deliveries and backlogs and bunker congestion. These issues, which are largely logistical in nature, are likely to ease as bunkering infrastructure is more fully adapted to meet the needs of the market. As such, we do not expect the Asia premium to hold over the long term. China has also had a significant role to play in the premium. Chinese refiners have not been producing VLSFO in recent months, due to domestic tax issues, which rendered that production uneconomic. As a result, Chinese buyers were forced onto the regional market, which led to the diversion of supplies from Singapore. However, in January the State Council approved a tax waiver, which should unlock upwards of 200,000b/d of VLSFO output in China. It is unclear how much of this will flow to the wider region initially, but at the very least it should alleviate some of the buying pressure.
"There is scope for additional MGO uptake, should its premium continue to narrow. VLSFO inventories will become depleted and prices could see further gains should new supplies prove lacking. That said, logistical debottlenecking and new refinery production (not least from China) should provide some offset to the price. It also remains to be seen how price elastic VLSFO demand will be relative to MGO: the premium of the former over the latter seems to have done little to dampen its attractiveness in the Asia market. MGO holds some environmental benefits, such as lower particulate matter, but the regulation is not currently in place that would render this a deciding factor for ship owners. As such, we have adjusted our marine fuel demand forecasts to account for a significantly large sharer for VLSFO at the expense of MGO in 2020.
"Given our more bearish outlook on MGO demand, it now appears unlikely that IMO will provide the boost to gasoil/diesel margins that we had previously expected (see 'IMO 2020: Reassessing The Risks', September 18 2019). Margins have already been coming under pressure from high inventories and warm winter weather in the northern hemisphere. Last year was a challenging year overall, as slowing economic activity and a contraction in global trade growth sapped global demand. Although the macroeconomic backdrop looks set for gradual improvement this year, we still expect some spill over from the weakness seen in 2019. Overall, given ample supply and a chequered outlook on demand, the anticipated margin spike looks unlikely to accrue.
"Our outlook on HSFO demand remains broadly unchanged, with a sharp drop in 2020 followed by a gradual recovery in subsequent years. The forecast largely hinges on scrubber penetration (and, to a lesser degree, trends in compliance with the cap). The speed and scale of scrubber uptake this year will depend heavily on the price between high and low sulphur fuel oil. The direction of this spread over the first quarter will give us better insight into the share of HSFO in total demand over the coming year. The boost to crude demand also appears softer than we had initially anticipated, which will cap any gains in the oil price. This will be a welcome relief to refiners, which face a growing glut in the global products market. The global downstream sector faces a new wave of greenfield refineries. Following estimated net additions of 1.9mn b/d of refining capacity in 2019, we forecast net additions of 2.6mn b/d and 2.4mn b/d in 2020 and 2021, respectively (see'', January 10). Even allowing for lower utilisation of legacy capacity, this signals higher crude throughput and downward pressure on refining margins, absent a major upsurge in demand, which - given the macroeconomic outlook - seems unlikely to occur.
"Complex refiners remain well placed to profit from the broader shift in global fuels demand towards higher quality, less pollutive fuels. And, on the reverse, low complexity refineries with high residuals yields will see significant margin pressure, given the lower share of higher value add fuels to offset the steepening discounts on HSFO. That said, the outlook for complex refiners is not entirely rosy. We have previously flagged that the skew of production growth towards light sweet crudes, combined with near-term constraints on heavy sour production (stemming from the OPEC+ production cut deal and sanctions in place on Venezuela and Iran) would distort crude price differentials (see 'Refiners Feels First Ripples From IMO 2020', November 26 2019). This view appears to be playing out and we expect the premium of light sweet crudes over heavy sours to remain narrow over 2020, eroding the relative margin advantage of complex facilities," reads the outlook.
---
Follow the author on Twitter: @Lyaman_Zeyn
