Changes ahead

Jaime Ruiz-Cabrero, Clint Follette, and Rafael Moreno look at IMO MARPOL Annex VI 2020 and predict there is volatility ahead for the refining sector

The International Maritime Organization’s MARPOL ANNEX VI regulation limiting sulphur emissions from marine fuels to 0.5 per cent in all marine areas will take effect in 2020. It is a commendable initiative that will reduce polluting emissions in shipping and help address global environmental concerns.

As of today, however, the affected players and sectors are simply not ready to comply. This does not mean that the regulation will meet with widespread noncompliance, but rather that the price to comply will be high during the period immediately after the regulation comes to effect.

The result will be increased volatility in an already volatile refining sector. Some players will benefit during the disruption period, while others will see significant erosion in their bottom line.

What are the options?
The options for compliance are widely known. Ship owners can build scrubbers, refineries can invest in facilities to desulfurize fuel or upgrade residue to gasoil, and ships can move to liquefied natural gas (LNG) as a preferred fuel—a step that would also require hefty investment in port infrastructure.

Unfortunately, each option requires different actors to make the upfront investment, in sectors that already face challenges today. The result may resemble a game of chicken, in which each player stays on track, hoping that the other will change course first. For this reason, we anticipate that upfront investments will remain limited until the regulation officially comes into effect, thus driving high price volatility in 2020 as involved parties belatedly scramble to achieve compliance by using either bunker gasoil or low-sulphur fuel oil (LSFO) – regulation-compliant fuel oil that produces sulfur emissions of 0.5 per cent or less.

About 90 per cent of the marine fuel sold today is 3.5 per cent sulphur. In total, about half of global high-sulphur fuel oil (HSFO) production is consumed as marine bunker. Because the IMO regulation will require ships to use marine fuel with no more than 0.5 per cent sulphur, we believe that in the short term we will see a glut of nearly two million barrels per day of HSFO.

Potential outcomes
In the short-term we believe that the increase in volatility will have a profitable upside for complex, high-conversion refineries with low fuel oil yields. Gasoil and LSFO pricing will necessarily rise relative to HSFO prices, widening the light-heavy differentials and providing hefty margins to conversion units that produce gasoil. The situation is analogous to the one that arose in 2006 following the US Environmental Protection Agency’s introduction of lowsulphur fuels for road traffic.

On the other hand, simple refineries with high HSFO yields—as well as refineries with fluid catalytic crackers (FCCs) that produce high gasoline yields—will suffer. The Boston Consulting Group’s refining model simulations show that in order to comply with required distillate streams and to minimise HSFO production, units that co-produce gasoline and gasoil, such as delayed cokers, will have to increase their utilisation, pushing gasoline production above its demand level and depressing market prices.

The long-term outlook is different, owing to a combination of pricing signals and investment cycles that change the mix. Faced with a wide spread between LSFO and HSFO and between distillates and HSFO, shipping companies will demand more ships with scrubbers. At the equilibrium point, use of HSFO in ships fitted with scrubbers should continue to be a mainstream alternative. Companies could slowly introduce LNG-based vessels, given a sustained price-differential advantage, but no such advantage may exist in countries that already rely on LNG imports to supply their natural gas demand for power generation for industrial or home use. In any case, such vessels will be limited to ships with regular routes that call on ports with LNG-enabled facilities.

What to do?
There is still time to act. Refining companies should carefully analyse investment options for producing regulationcompliant fuel and eliminating noncompliant HSFO. The period of volatility that will arrive in 2020 will provide good margins to compensate for part of the investment. Refineries should also carefully look at their portfolios and act today, before they are left holding assets that will struggle to survive in a post-2020 environment.

Refining companies with compliant fuel should focus their marketing and trading capabilities accordingly. LSFOcompliant bunker will command a premium price against today’s price realisation. Companies need to find in advance the right markets to place their product, however; otherwise, they will have to rely on intermediaries that will capture a sizable part of the upside.

Creative responses could pay big dividends. Refining companies might even consider developing partnerships with shipping companies, mitigating their investment limitations by using off-take agreements. Wärtsilä, a manufacturer of marine equipment, is already offering ship owners the option to repay their investment in scrubbers through a premium paid on top of HSFO costs, thereby reducing the capital requirement in a cash-strapped industry, while enabling them to benefit from the HSFO price advantage that will follow.

Volatility ahead—and opportunity for those that are better prepared
In short, the refining sector is about to undergo significant changes and volatility due to the IMO’s revised MARPOL Annex VI regulation, which will take effect in 2020. While complex refineries with little HSFO and gasoline production will benefit, others will face challenging times. It is not too late to act, but companies need to move quickly and decisively.

Boston Consulting Group
Jaime Ruiz-Cabrero is a partner and managing director in the Singapore office of The Boston Consulting Group (BCG). He leads the energy practice in Asia Pacific and the refining sector globally. Clint Follette is a partner and managing director in the firm’s Dallas office and leads its petrochemicals sector globally. Rafael Moreno is a principal in BCG’s Madrid office and an expert in refining operations. BCG is a global management consulting firm and the world’s leading advisor on business strategy. It partners with clients from the private, public, and notfor- profit sectors in all regions to identify their highest-value opportunities, address their most critical challenges, and transform their enterprises. Founded in 1963, BCG is a private company with 85 offices in 48 countries.

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