IMO 2020: Imminent fuel surcharge increase amplifies ocean shipping uncertainty
Low sulfur fuel oil (LSFO) has been a major topic of discussion in the ocean shipping industry this year. But concrete specifics and granular detail on the amount of expected fuel surcharge increases have been elusive – frustrating shippers who must budget for future transportation expenses. With the implementation date right around the corner, shippers are hungry for information on how carriers will comply with IMO2020. How will fuel prices be affected? What are the consequences for non-compliance? Are refineries ready to support the dramatic demand for LSFO? How will the extra cost be passed along?
To recap, the International Maritime Organization’s (IMO) Marine Environment Protection Committee (MECP) adopted a strategy to reduce total greenhouse gas emissions from international shipping by at least 50 percent, compared to 2008. On January 1, 2020, the IMO will prohibit ships from using fuel with a sulfur content higher than 0.5 percent, compared to 3.5 percent now, unless it has equipment to clean up its sulfur emissions. Ocean carriers have three options to comply with the new IMO protocol: install scrubbers, convert from petroleum-based fuels to others such as liquefied natural gas (LNG), or buy low sulfur fuel oil (0.5 percent sulfur content).
How are carriers preparing to comply?
Ocean carriers have started to make a conscious choice regarding how to take on the new regulation. Japan’s MOL, will mainly use low-sulfur fuel oil, but also plans to install sulfur oxide scrubbers on 50 of their vessels. The company is also planning to use cleaner LNG and methanol fuels for bunkering (S&P Global Platts). Maersk and Hapag-Lloyd plan to use both 0.5 percent sulfur marine fuels and scrubbers with HSFO to comply. Regardless of the option they choose, it is going to be a costly endeavor.
S&P Global Platts Analytics estimates the total global impact of IMO2020 on various sectors in the energy space, as well as other industries, will be in excess of $1 trillion over five years (2019). With the increased expenses in the forefront of everyone’s minds, carriers are doing the math on cost recovery for the installation of scrubbers vs. paying a premium for the increased demand of LSFO until supply regulates.
It is estimated that initially, the price of HSFO will decline sharply after 2020, while the price of LSFO will remain high. There is uncertainty over how great the premium of LSFO over HSFO will be, but it is expected that the premium of HSFO will be robust enough to recuperate the price of scrubbers within the first two years (S&P Platts, 2019).
“We don’t know what the price of compliant fuel is going to be, and the market doesn’t know,” Hamish Norton, the president of Star Bulk Carriers, said in April. “The only way to hedge is to put in a scrubber that allows you to use residual fuel oil, which will always exist.”
The problems with scrubbers
So why doesn’t every carrier just depend on the scrubber system for compliance and call it a day?
Washwater has been such a concern that China has banned the use of open-loop scrubbers in its emissions control areas covering inland waters and most of its coastline (Meng, Reuters, 2019). In addition, Singapore is set to implement a ban, along with regions in Belgium, California, Massachusetts, Germany’s Rhine River, and the Irish Port of Waterford (S&P Global, 2019). Where the ship is fitted with an open-loop system, the ship will need to switch over to a closed-loop system for access to these regions.
Scrubber installation can cause an upfront capital expense ranging between $2 million to $10 million per vessel. Not to mention the engineering plan along with installation of a scrubber can put a vessel out of commission up to a year. But again, the payback time could be short if HSFO fuel declines with LSFO/MGO fuel remaining high, as is to be expected.
“Ship operators tell me they don’t really care about scrubbers. They just want to get their money back on the scrubber system in five or six years…once settles down, they’ll just switch to low sulfur,” says Graham Porter, one of the founders of Seaspan Corporation. “They’re just trying to avoid the likely price spike for low sulfur fuel…pricing is going to go through the roof” (Wilson, American Shipper, 2019).
Violation of IMO2020
Many people have asked about how violations will be handled and whether we really think all vessels will comply with the new sulfur regulation. While the IMO has no enforcement power, monitoring and enforcement of the new limit falls to Governments and national authorities of Member States that are Parties to MARPOL Annex VI. Flag States and port States have the rights and responsibilities to enforce compliance (IMO.org, 2019).
There are predictions which indicate at most, only 10 percent of vessels are expected to be non-compliant in the initial months following 2020. Stringent checks will be in place with stiff penalties, particularly in the major ports.
Earlier this year, the IMO MEPC 74 issued its Guidelines for Consistent implementation under MARPOL Annex VI as well as Guidelines for Port State control under MAROL Annex VI, to assist with the implementation and enforcement of the new sulfur cap. There are still a number of countries which have not ratified Annex VI of MARPOL and therefore ships in those regions likely will not enforce the regulation (Attard, Times of Malta, 2019).
Because the IMO 2020 rule falls under MARPOL regulations, a violation could allow for a vessel’s MARPOL certificate to be withdrawn or suspended by a flag state. According to the Stevenson (2011), a person who knowingly violates MARPOL commits a serious crime – a class D felony punishable by imprisonment by up to six years and varying fines of up to $250,000 for an individual and up to $500,000 for an organization, for each violation (p. 13). On top of hefty fines and imprisonment in some regions, the owner and master of a non-compliant ship risk detrimental damage to their reputation among charterers and customers.
Will the supply meet demand?
U.S. and Port industry sources indicate they are somewhat confident that the industry will have a new fuel type, however, the demand will be massive and analysts aren’t so sure. IHS Markit warns that the refining and shipping industries aren’t ready for the new mandate. According to Knowler (2019), “The analysts predict a ‘scramble period’ of up to a few years when a new equilibrium of supply and demand will be determined by refiners and ship-owners.”
Furthermore, oil companies have promised to create a compliant fuel from a variety of sources and methodologies, which may or may not be compatible with each other. Some refiners have reportedly been unwilling to provide details or samples, perhaps with the hope of locking in customers.
Currently, less than half of one percent of fuel oil deliveries face fuel compatibility issues, but these problems will increase considerably with new LSFO fuel blends (Knowler, 2019). New fuels need to have consistent viscosity and stability, otherwise ship engines and other equipment onboard could be damaged (Lin, 2019).
Many major oil suppliers have been slow in giving samples to the IBIA to test compatibility; the marketing implication is, theoretically, if a carrier bought fuel from a major supplier in Antwerp, they would have to buy from the same supplier in Singapore to guarantee compatibility. “Vessel owners and operators are scared of incompatibility,” says Rick Joswick, head of oil pricing analytics at consultancy S&P Global Platts. “They could look completely different and not be able to be mixed—there could be dangerous compatibility issues,” he adds.
A TradeWinds Knowledge survey has found that 18 percent of the world’s largest bunkering ports will generally be able to supply the main types of marine fuels January 1, 2020. The ports surveyed are Busan, Shanghai, Zhoushan, Hong Kong, Singapore, Colombo, Mumbai, Fujairah, Durban, Istanbul, Piraeus, Rotterdam, Gibraltar, New York, Houston, Los Angeles, Panama and Santos (Lin, 2019).
So, who’s paying the difference?
Transitioning to a low sulfur fuel will increase carriers’ costs, which are expected to be passed on to shippers in the form of higher floating bunker fuel surcharges. Surcharge pricing for burning the new LSFO is complex. Factors include: TEU capacity of vessel, length of voyage, and price of petroleum. Each carrier is taking a different approach to applying the surcharge to cover their increased costs, but ultimately all ocean cargo and all trade lanes will be affected.
Actual fuel surcharge increase amounts are still uncertain, with initial levels announced by carriers varying widely and subject to change. For example, a preliminary review by CVI’s pricing department shows a wide range fuel increases, anywhere from $5 to $317/TEU, depending on the specific trade lane and ocean carrier.
Maersk has created a new Environmental Fuel Fee (EFF) and APL, the Low Sulfur Surcharge (LSS), which will apply to all spot business and contracts with validity up to 3 months. These tariffs are trade-specific and reflect the fuel-related costs and will be reviewed in case of significant fuel price fluctuations (more than 45-50 USD/ton depending on carrier).
Hapag-Lloyd is passing on costs via its Marine Fuel Recovery (MFR) mechanism, which combines consumption with market prices for fuel oils. It takes into account various parameters, i.e. vessel consumption per day, fuel type & prices, sea and port days, and carried TEU.
All in all, shippers should prepare for a boatload of uncertainty coming alongside IMO2020 regulations in January. As carriers begin burning remaining HSFO at the end of November, and other vessels remain on standby to retrofit vessels with scrubbers, we anticipate higher costs and possibility of tighter capacity than was seen during an unusually slow peak season of Q3 of this past year.
Prices will certainly increase with ocean shipping costs, but demand for the portion of the refined barrel is also about to experience vast growth. This can mean higher prices for other low-sulfur fuel consumers outside of the commercial maritime industry, particularly trucking and rail – possibly even jet fuel.
Time is running out for carriers to comply and refiners to supply necessary quantities of fuel; it looks like we may have to continue to wait until after January 1 for the definite answers.
Jessica Lonsdale, MBA, is a graduate of Old Dominion University and Regent University. She is an active member of the Virginia Maritime Association and works for a freight forwarding, customs brokerage, and global logistics company, CV International Inc., in Norfolk. She can be reached at .
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