Changing marine fuel legislation – a curse or blessing for refineries?

by György Halász

The sulphur content of marine fuel will be decreased from 3.5% to 0.5% in 2020. The regulatory change – easily defendable on the ground of environmental aspects – directly affects ship owners, ship builders, marine transportation fuel traders, wholesalers and refiners as well. In what follows, the history of marine fuel legislation and the expected effects of the regulatory change will be discussed.

The International Maritime Organization (IMO) was established in a convention adopted by the UN in 1948, originally called as the Inter-Governmental Maritime Consultative Organisation (IMCO). The IMO Convention entered into force in 1958 and the organization changed its name in 1982. IMO has been targeting the development of marine shipping in all aspects including maritime safety, navigation efficiency and prevention and control of marine pollution. This latter being in the focus nowadays.

Marine pollution has been regulated by IMO’s convention (Marine Pollution – Marpol) since 1983 – the date of entering into force of the convention, protocol and the first two annexes. Marpol Annex VI defines the limits on sulphur oxide (and nitrogen oxide) emissions from ship exhausts and the schedule for decreasing the limits as well as the definition of the designated emission control areas (ECAs).

Graph 1: Areas with lower sulphur emission limits in shipping exhaust gases

The ECAs cover the most frequented coasts of the developed World – a range of 200 miles from the coasts next to nearly the full Northern-American coasts, as well as on the North Sea and Baltic Sea (see graph 1). ECAs have had already a sulphur limit of 0.1% in the fuels since 2015. On all other seas, the emission standards are looseró

Graph 2 Change of limits of sulphur content in marine fuels

Shipping on the ECAs thus meant the obligation to meet harsher regulations – but the involved parties: ship owners, fuel supplying ports and refineries were informed well about all modifications on time and were able to prepare for the changes. The recent decision of making global regulation as well more severe was less presumptive. Originally, the 0.5% sulphur content limit was planned worldwide for 2020 but based on an impact study to be prepared by IMO the proposed deadline can be postponed to 2025. Indeed, most of the parties involved attached a significantly higher probability to the 2025 introduction date. However IMO – without the preparation of the promised impact study – voted for the 2020 target date in October 2016.

To show the importance of this particular regulatory change it is worth to take a look at what is at stake:

• 120 000 ships/vessels,
• 200 million ton fuel oil consumption in marine transportation,
• 650 refineries producing fuels for maritime use (as well).

Until today, high sulphur fuel oil (HSFO – up to 3.5% sulphur content)[1] was overwhelmingly used in shipping. To comply with the new regulation the following strategies can be chosen:

1. Use of low-sulphur alternative fuels Marine diesel is the most expensive though most feasible choice. It is a somewhat cheaper option to use blended fuels, potentially including HSFO as well. But here better skills in fuel blending will come handy.
2. Use of scrubbers Scrubbers are able to filter out certain parts of the exhaust gas, e.g. sulphur oxides (SO_x). Application of scrubbers would lead to significantly lower OPEX than the abovementioned 1st alternative, however it requires high initial investments. Moreover, as this CAPEX is dependent on the size of the ship, the number of funnels and the type of the scrubber[2], it is hard to predict the payback period. Different studies arrive at different conclusions, estimated payback periods range from 1-2 up to 10 years. Hence, even though scrubbers can be built in retrofit, wide usage is only expected in new ships.
3. Gas engine ships Decoupling of oil and gas prices can lead to the lowest OPEX outcome, however to the highest initial CAPEX need on the other hand. Furthermore, LNG engines are typically not possible to be built in retrofit and need a higher cubic content than traditional engines (actually decreasing the carrying capacity). For this reason, this alternative is also envisaged for newly built ships mainly. Increasing availability of LNG and better infrastructure could give support to this alternative.
4. Non-compliance Assuming an effective control by authorities and the implementation of potentially higher fine amounts, this alternative cannot be a long-term one. Although in 2020 and the following years a certain part of the ships might go for this option, in case they cannot afford and/or don’t want to pay the higher fuel prices or execute the alternative costly investments. Earlier examples show that efficiency of controls varied by the countries: e.g. when the stricter regulation in ECAs was introduced Platts estimated a 6% non-compliance in May 2015 and fines moved in a wide range depending on the country that had to impose them (fines between EUR 2000-60000 were communicated).

Taking into account the initial investment need of alternative 2 and 3, alternative fuel usage is expected to be the most popular solution in the early period after the introduction. Especially, as still many players give a non-zero possibility to the deferral of the 2020 target date. Besides the “wait and see”, existing capacities to build scrubbers or LNG engine are also insufficient to make it possible to comply to large degree by choosing these alternatives by 2020. Hence, the demand for HSFO should fall, while for low sulphur fuels, especially gasoils increase. In the longer term, however, use of the cheaper (i.e. NPV positive thanks to lower OPEX) alternatives (scrubbers and LNG engine) is set to rise.

Consequences are diverse:

• Demand for crudes with low(er) sulphur content (so called sweet crudes)[3] are expected to increase against crudes with higher sulphur content, resulting in wider sweet-sour spreads. Hence, flexibility in the optimal use of different crude types will play the key role in refineries.
• Investments in residue conversion[4] has already been widespread among refineries. Refineries using these facilities will be advantaged after the regulation change, especially those with coastal location. On the contrary, refineries with a large share of high sulphur, mainly black products[5] in their yield structure will be at a competitive disadvantage.
• Leading think tanks (IHS, WoodMac, JBC) regard diesel production capacities as insufficient in 2020. In the short term, it should be reflected in the prices, but if the tightness on the market remains it may lead to supply corrections (capacity enlargements).
• Blending techniques become crucial in refineries potentially leading to technical innovations, or at least better use of the technical knowledge and expertise.
• HSFO falling out of maritime demand might be used at least partly in power generation: becoming a cost-efficient solution (as a result of the collapsing price) it might substitute temporarily less polluting elements of the energy mix (natural gas, renewables) or delay the growth of their shares. ETS can hinder this possibility in Europe, but it is unclear whether this issue will be regulated in other continents.
• Fuel oil yield of refineries can be altered without reside conversion as well (although only to a lower level), which would lead first of all to an oversupply of bitumen, the other black product with a significant market.

All in all, refineries will face significant challenges but also opportunities. E.g. MOL Group’s two larger refineries are in a good position due to the fact that even though crude intake is based largely on sour crude, residue conversion capacities are already significant and there are plans to enlarge them further. Rijeka refinery can make a use of the change based on its coastal location in case the planned delayed coker will be built. The total effect on MOL Group is expected to be positive in 2020 and the years thereafter even without the Croatian investment since the Croatian refineries, disadvantaged by the regulatory changes, have a low share in the total refining production of the Group.

IMO did not leave too much time for the adaption of the changes. Refinery profitability will depend thus on the flexibility in adjusting to the expected change in the product demand.

[1] In 2014 HSFO was by far the most important maritime (bunker) fuel accounting for more than 90% of the total volume of maritime shipment.

[2] To make it simple, there are two main types of scrubbers. The so called dry scrubbers that require usually lower CAPEX can filter only sulphur (and sulphur based molecules), whereas more expensive wet scrubbers can filter out multiple exhaust gases or even particles. On the other hand, dry scrubbers produce sulphur as a residual product, which might have some positive value added opposed to the very dirty fluid produced as residue in wet scrubbing.

[3] Taking crude types used or monitored by MOL Group as examples: Brent or Azeri light are sweet, while Urals or Iraqi Basra are sour.

[4] Investments leading to higher yield of traditional fuels, mainly diesel. In refineries at large ports of Western and Southern Europe – e.g. Antwerp, Rotterdam, or Bilbao – residue upgrading investments were similarly done to Russia’s often cited Tuapse refinery at the Black Sea. Furthermore MOL Group’s Danube and Bratislava refineries possess similar units.

[5] Black products include beside fuel oils amongst others bitumen and coke, though the share of fuel oils is usually the most significant.

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