Why the feared IMO 2020 spillover effect on diesel markets didn’t happen
A year ago, as 2020 dawned, the trucking industry was eyeing a marine fuel regulation that it feared could spill over into diesel markets, boosting the price of that fuel.
It didn’t happen.
IMO 2020, after years of preparation and anxiety, made its full debut on Jan. 1. The International Maritime Organization’s core requirement was that marine fuels needed to meet a new sulfur specification globally of 0.5%. The previous limit, found in high-sulfur fuel oil, was 3.5%.
Where this was going to possibly impact diesel markets is that one of the ways to comply with that rule was to produce a new product called very low sulfur fuel oil (VLSFO). The problem for diesel markets — at least according to the projections — was that a product called vacuum gasoil (VGO), which could be used to produce diesel, was going to be needed to produce VLSFO. VGO, like diesel, is a distillate product. And the concern was that the distillate molecules found in VGO that would head off to make VLSFO would be diverted away from making diesel.
“Even sophisticated refiners worried they might not make enough complaint fuel to meet shipping demand without risking supplies of the lighter products needed to blend very low sulfur fuel oil,” Sandy Fielden, the director of oil and products research at Morningstar, wrote in a recent report about what happened to IMO 2020 in its namesake year.
But then the pandemic hit and all bets were off.
As for diesel, it mostly boiled down to those distillate molecules. With diesel demand falling at the start of the pandemic (though nowhere near the decline in gasoline demand) and demand for jet fuel, another distillate, cratering by enormous levels, there were plenty of molecules to go around, including enough to make compliant marine fuel.
“At the end of last year, impending International Maritime Organization regulations mandating the use of VLSFO … were expected to divert distillate supplies to meet the new specifications,” Fielden wrote back in October in a review of the distillate market. “The IMO 2020 fuel shortage never transpired in early 2020 after refiners produced enough VLSFO to meet shipping demand.”
Fielden’s year-end report also discussed the economics of scrubbers on ships, an alternative that would have allowed a ship to meet tighter sulfur specifications while burning high-sulfur fuel oil (HSFO). That’s relevant to diesel because a ship still able to burn HSFO because of a scrubber is by definition a ship that doesn’t need to burn VLSFO.
But to make the cost of the scrubber work — which Fielden assumed as $2.7 million — the spread between VLSFO and HSFO would need to be wide enough that the lower costs for buying cheaper fuel would pay off the scrubber cost in a reasonable time. And according to Fielden, the collapse of various markets meant that did not happen in 2020.
The analyst noted that in February, before the pandemic, the spread between fuel oil that was compliant with IMO 2020 and traditional HSFO got as wide as $210/metric ton, or $33/barrel. With that sort of spread, Fielden said, the payback period for investing in a scrubber fell to less than a year.
But with the collapse of the demand for refined products, “IMO 2020 concerns vanished when the sulfur spread narrowed in April and stayed low for the rest of the year,” Fielden wrote.
Refiners went ahead with making less HSFO as part of their overall cutback in operations. But the collapse in demand for lighter-sulfur transportation fuels like gasoline and diesel meant that the spread between low-sulfur and high-sulfur products narrowed. According to Fielden’s data, the low-sulfur fuel oil to high-sulfur fuel oil spread averaged $22.90/b in February, was down to a little more than $9/b in July and was $14/b in the first half of this month. “That translated to a longer 1.64-year payback period for installing scrubbers on a VLCC tanker, discouraging shippers from making the investment,” he said.
There were other market developments that kept the price of products higher in sulfur from collapsing, a decline that would otherwise have incentivized scrubber conversion. A new tighter specification for sulfur in gasoline, which also raised market concerns, proved to be such a nonevent because of weak gasoline demand that sulfur credits trading at one point for more than $3,000 fell to $167 per credit by the end of the year. Cutbacks by OPEC in its production of high-sulfur crudes outpaced cuts in lower sulfur U.S. crudes, resulting in high-sulfur crudes increasing in price relative to low-sulfur grades.
These developments “would all have attracted long odds this time last year,” Fielden wrote. “Instead, refiners faced urgent challenges from low margins and reduced capacity this year that render 2019’s expected hiccups harmless by comparison.”