Secretary General, GPCA WITH no delays expected for the implementation of the new International Maritime Organization (IMO) bunker fuel regulation, from Jan.1, 2020, shipowners will be required to meet the 0.5% global sulfur cap on fuel content, vs. the present limit of 3.5%. The new regulation is expected to dramatically alter the global supply chain landscape, leading to serious implications for the entire oil value chain, particularly on the refining and petrochemical side. Compliance with the new fuel specification will involve significant costs for the refining and shipping industries, while petrochemical producers could face higher freight rates and changes in feedstock pricing. In order to comply with the regulations, shipowners would need to adopt one or a combination of solutions. One of the compliance routes is to switch to low sulfur fuel with 0.5% sulfur content or below. This would involve minor capital expenditure to ensure the segregation of fuels. However, it would be the costlier option, as compliant fuels are expected to price at a premium to High Sulfur Fuel Oil (HSFO). It would also inevitably result in higher demand for low-sulfur fuels and a surplus of high-sulfur residue. According to some estimates, more than 2 million b/d of high sulfur fuel oil (HSFO) will be displaced from the bunker sector as bunkering (in addition to power generation) is a key demand sector for fuel oil. The FO displaced from the GCC region may potentially flow to Saudi Arabia, where demand for FO in power generation is increasing in order to replace direct crude burning in power generation, particularly in peak months. may potentially flow to Saudi Arabia, where demand for FO in power generation is increasing in order to replace direct crude burning in power generation, particularly in peak months. If this scenario plays out, winners will be the highly complex refineries and refiners with deep conversion/distillate-oriented configurations. Refiners, particularly in the US and China, will also benefit from the changes by capturing the value of their ultra-low sulfur fuel oil (ULSFO) component streams and growing their share of the global bunker market. A second option would be to install on-board exhaust gas cleaning systems, known as scrubbers, to remove emissions from the ship exhaust. This would allow for the continued use of HSFO with 3.5% sulfur content or above, but it could lead to increased fuel consumption and CO2 emissions. For ships planning to retrofit scrubbers, a GPCA report estimates that capex of $0.5 million to $1 million will be incurred depending on the size of the vessels. The third option involves using alternative fuels such as LNG, which would require vessel modifications and higher upfront capex. This would also reduce demand for both gasoil and fuel oil and lower fuel costs for ship owners. While this would significantly reduce CO2 emissions from ships, bunkering logistics are not yet sufficiently available and LNG infrastructure needs to be expanded. A combination of all three compliance routes will result in higher costs for the shipping industry and significant capex requirements. This would be reflected in freight costs post-2020. By some estimates, shipping costs could rise by up to $60 billion annually from 2020 onward, with bunker costs taking up 70-80% of total voyage expenses in a full compliance scenario. A separate analysis estimates that at 100% adoption, switching to marine gas oil (MGO) would see freight rates go up by around USD 1 a barrel. Subsequently, higher freight rates will influence relative differentials on both the feedstock and product sides of the supply chain, but the effect will vary depending on the dynamics present in each value chain and market. Impact on petrochemical supply chain costs The regional chemical industry in the GCC (and globally) will feel the impact on two major fronts: firstly, in the form of higher freight rates related to the transportation costs of its products; and secondly, in its feedstock pricing. All six GCC states are signatories to the IMO. As one of the most heavily export-oriented industries in the region, with 83% of chemical output being shipped to over 100 countries worldwide, the regional chemical industry has one of the longest and most costly supply chains. Transportation costs are estimated to account for 5% of total chemical sales, warehousing for 3.5%, and additional cost related to supply chain planning and administration accounts for 1.5%, thus, overall supply chain costs take up 10% of total chemical sales. To measure the impact from higher freight rates on chemical supply chain costs, let's take the following scenario: When low-sulfur fuel became compulsory in 2015 at the Emission Control Areas (ECA) comprising northern Europe and the US, Maersk Line introduced low sulfur surcharges ranging between USD 15/teu and USD 80/teu, depending on the route. If we take the same scenario for the new IMO regulations, export freight rates for GCC producers could increase by as much as 10% reaching USD 1,688 on average. As a result, GPCA estimates that transportation cost will increase its share in total chemicals sales to 6%, up from 5% previously, while total chemical supply chain costs will increase to 11% from 10% currently. Given the scale of the change, the entire oil value chain is likely to see high volatility during 2020. The market price for crude oil and naphtha feedstocks are likely to rise as the refining system increases crude runs to supply the additional demand for distillate bunker fuels and "pushes" some volume of high-sulfur fuel oil to the power sector. As we move towards 2020, refineries' efforts to minimize non-IMO compliant products by using lighter and low sulfur crudes will accelerate. This will result in collateral benefits for petrochemical producers – given that lighter crude tends to yield greater proportion of naphtha, there could be an increase in naphtha oversupply. Structural oversupply in naphtha will be ultimately beneficial to naphtha-based petrochemicals production. Longer-term, demand-side opportunity for methanol producers can also be expected as methanol can be considered an alternative fuel for vessels under the new IMO 2020 regulation. The gasoline crack spread, and associated naphtha to crude crack spread, is projected to increase, while FCC propylene production is likely to decline. The aromatics and olefins chains are closely connected to the refining chain, and the IMO bunker quality changes are significant enough to substantively move refined product price relationships. Parts of the industry have already begun to move into implementation stage, meaning that we will see a transient period up to 2025. The period from 2020 to 2025 is likely to witness some turbulence with potential volatility in terms of margins for refiners. Approximately five years will be needed for the market to absorb the impact of the new IMO specification, and for things to normalize. Given the need for compliance on 1 January 2020, impact could well be felt from mid-2019 onwards 2019 would be a disruptive transition period, with implications going far beyond the shipping industry, and leading to significant volatility in fuel prices, potential fuel scarcity and higher freight rates. Some of the largest crude oil tankers could see a 25% increase in shipping costs resulting in higher prices for consumers. By the end of 2019, companies and households across the world would begin to feel the impact from higher freight costs which would push up prices for services and goods. Greater volatility is expected to unfold into the following year. Post 2020, the IMO has announced a strategy for the reduction of Green House Gas (GHG) emissions at sea. The strategy involves a focus on low carbon fuels between 2023- 2030, with long-term provision for the development of zero carbon fuel for 2030 and onwards. It further aims to reduce the total annual GHG emissions by at least 50% by 2050 compared to 2008, while pursuing efforts towards phasing them out, consistent with the Paris Agreement temperature goals. Moving forward, this will carry new implications for the shipping and energy industries. It will require greater focus on research and innovation into low-carbon technologies and fuels and more efficient engine designs. More stringent regulatory requirements are likely to spur a shift to alternative fuels like biofuel/gas, hydrogen, methanol and ammonia. Using new fuel types to meet the IMO 2050 target could also stimulate demand for fuel cells technology, as ships equipped with fuel cells are initially expected to make up 10% of the fleet in 2025, rising to 50% in 2050. The chemical industry could capitalize on this trend by contributing to innovations in fuel cell systems and batteries.
