Scott Reynolds from BLOC-X, a trading software provider for the OTC oil block futures market, assesses the impact of the first 24 days of the global sulphur cap.
The International Maritime Organization (IMO) has recently hailed the “relatively smooth” introduction of the global sulphur cap, which mandates the use of lower 0.5% sulphur marine fuel oils from the beginning of this year. For the IMO, this new regulation is a first big step in the clean up of one of the last great polluting industries, but behind the scenes, there is a sad familiarity to the winners and losers in this environmental story.
Boom time for tanker owners
Ahead of the IMO deadline for compliance, the tanker market has experienced one of the biggest commodity booms in modern history. The inherent seasonality within shipping means we can expect elevated rate volatility in the northern hemisphere winter. But this time things are different, as tanker market returns have moved far beyond these seasonal norms. A newbuild VLCC capable of carrying two million barrels of hydrocarbons has up until recently been offering returns in excess of $150,000 per day. To put this into perspective, a newly built $100M VLCC delivered last October could have made enough of a return in the first three months of trading to pay back a staggering 15% of the original capital investment. As a result, asset values across the complex have almost doubled.
A perfect storm
The geopolitical landscape has played a notable role in this tanker market bonanza. US sanctions on Iran have increased ton-mile demand for tankers as refiners have had to pull from further afield to find equivalent crude grades. Furthermore, sanctions on individual firms accused of illegally transporting Iranian crude, such as COSCO last year, have dramatically trimmed vessel supply. Compliance with IMO 2020 regulations this year have added more fuel to the fire. The global refining system has struggled to adjust and availability of the new fuels have been tight, pushing price differentials between low and high sulphur fuels to levels few expected. Shipowners who invested in exhaust gas cleaning systems, or scrubbers, that enable them to continue burning higher sulphur fuel oil, are huge winners. Investment payback for this compliant technology was expected to be in excess of two years, but many could see full returns after as little as five months.
Tanker owners have seen asset values and cash flow soar, with related equities hugely outperforming other sectors over the past six months. Oil traders have benefitted from a shift in product arbitrage and blending opportunities. Related technical industries such as scrubber manufacturers and niche lubricant suppliers have seen sales more than double, whilst marine lawyers are gearing up for a flurry of claims potentially arising from off-spec low sulphur blends. For most of the existing market participants it’s boom time, and there are still greater profits to be made.
Whereas the air we breathe will be cleaner, the impact on the marine environment is less clear. Open loop scrubbers have been the go-to technology for vessel operators, enabling continued burning of high sulphur fuels whilst pushing emissions directly into the ocean. It is the cheapest solution for vessel operators, but such are the environmental concerns that many major ports have banned their use. Questions also surround the compliant fuels themselves, as recent samples have shown some low sulphur blends to have greater black carbon emissions than high sulphur fuels. Then there is the question of overall marine fuel oil consumption. Disruption to global oil arbitrage routes will likely increase fleet miles, whilst scrubber fitted vessels burning cheaper low sulphur fuel may be less likely to slow steam in weaker markets. Booming tanker markets have also dramatically improved the economics of older, less efficient tonnage that would otherwise have been heading for a permanent berth on Alang beach.
Finally, as the costs are passed down the supply chain it is ultimately you and I, the end consumer, that will underwrite the profits of a dirty industry cleaning up its act. Many observers will note the irony of a ‘successful’ implementation of maritime regulations which, despite being constructed with the best of intentions, carries a significant economic burden whilst offering highly questionable environmental benefits.