Maritime Regulations, NOPEC, and What’s Ahead for Crude Oil Markets

At a Glance

  • New marine fuel standards and anti-cartel legislation will require “careful navigation” of oil markets, says one analyst

Two little-known news events could have a sizable influence on crude-oil prices this year.

By 2020, new global pollution-control regulations to reduce sulfur use in marine fuels take effect, which may significantly boost container ships and other vessels’ use of lower-sulfur light, sweet crude versus the heavy, sour crude types the industry relies on currently.  Additionally, market watchers are keeping an eye on a recent passage of a bill in a U.S. House committee to make oil-producing and exporting cartels illegal.

Together, these two factors could cause swings crude-oil prices, especially in spreads between other types of petroleum, particularly toward year’s end when the International Maritime Organization’s regulations, known as IMO 2020, draw near.

A Significant Change for Oil Markets

IMO 2020 mandates that by Jan. 1, 2020, global bunker fuel must have a sulfur content of 0.5 percent by mass or less, down from the current 3.5 percent maximum to control emissions. Shipping companies have three options if they are going to comply with the regulations: use a low-sulfur fuel, install scrubbers to clean gas emissions, or switch to liquid natural gas.

Brian Kessens, managing director and portfolio manager at Tortoise, says bunker fuel represents 3 percent of the 100 million barrels of daily total global oil demand, so these changes are significant. Although the IMO agreed in October 2016 to implement the 0.5 percent sulfur limit by 2020, Wood Mackenzie says there isn’t enough of the Very Low Sulfur Fuel Oil (VLSFO) to replace the Heavy Sulfur Fuel Oil (HSFO) and Low Sulfur Fuel Oil (LSFO) that will be displaced from the marine market in 2020.

Spencer Welch, director, oil markets and downstream energy at IHS Markit concurs, saying the refining and shipping industries appear unprepared for it and the regulations could roil the markets.

“The IMO 2020 scramble is unlikely to be calm for oil markets, and careful navigation will be required by anyone exposed to oil markets and freight rates,” Welch says.

Most shippers will likely switch to low-sulfur fuel versus pursuing the other options, Kessens says. The cheapest option is to install scrubbers to remove sulfur from air emissions, but that sulfur will be discharged into the water. Wood Mackenzie says orders for on-board scrubbers are increasing, but will only represent about 10 percent of marine fuel in 2020.

Although shippers can convert their engines to using LNG, that’s not expected to be a popular choice, Kessens says, since its relatively costly to make that conversion. Wood Mackenzie forecast a 70 percent rise in LNG use between 2019 and 2020, but adds that only displaces just under 100,000 b/d of liquid marine fuels in 2020.

More Light, Sweet Crude?

That means demand for low-sulfur light, sweet crude oil will likely rise, and the price spreads between light crude and any of the heavier sour crude types will widen out, Kessens says. He adds the margin refiners charge for low-sulfur distillates, primarily diesel and jet fuel, will also increase. As a side effect of the IMO regulations, refiners may end up producing more gasoline because they will maximize their low-sulfur fuel-oil quantities.

That could ultimately weigh on gasoline prices, but Kessens says, from a refiner’s perspective, this won’t be a problem. “They’re going to be more than making up for (lower gasoline prices) by the profits they’re going to make for (low sulfur marine fuel),” he says.

While several market watchers say the industry isn’t prepared, Goldman Sachs analysts say these concerns may be overblown. They point to growing orders for scrubbers, and that the combination of refineries adding secondary units and the growth in U.S. shale oil has already tightened the high-sulfur fuel oil market.

Wood Mackenzie anticipates about 85 percent of the industry will be in regulatory compliance in 2020, with full compliance coming by 2025.

Still, the analysts say there will be price impacts on forward margins, crack spreads and fuel prices no matter what. Goldman Sachs says prices could be most volatile from autumn into spring 2020.

Kessens concurs, noting autumn is when refiners start switching from making summer fuel blends to winter blends. “As they reconfigure for those winter blends, they’re going to refigure their refineries to make more of the low-sulfur fuel,” he says.

NOPEC Bill and Market Ramifications

In February, the U.S. House Judiciary Committee voted on HR 948, to amend the Sherman Antitrust Act to make oil-producing and exporting cartels illegal, with the bill informally known as “NOPEC.” It would allow the U.S. Attorney General to sue the Organization of Petroleum Exporting Countries, says Michael Cohen, analyst at Barclays.

While Kressens and Cohen doubt the legislation would move forward, there still could be some market impacts. And this isn’t the first time there’s been attempt to pass a bill like NOPEC.

“Even if the bill never becomes law, it would bring the Trump administration significant leverage should prices start to rise. Thus, it would provide potential legislative options that could be seen as punitive in light of the recent Kashoggi killing, Russia/Ukraine tensions,” Cohen says, referring to the murder of Saudi Arabian journalist Jamal Kashoggi.

While oil prices are relatively low, there might not be much interest in moving the legislation forward, Cohen says. If it were to become law, it opens a host of questions, such as whether Saudi Arabia could withhold spare capacity, and whether non-OPEC members would sign agreements to keep a perceived floor under prices.

Kressens says for now, OPEC may not necessarily target a specific oil price, which would be an action by a cartel, but would rather continue to speak about stabilizing the oil market. But the bill even as is, could push OPEC to take other actions.

“OPEC is clearly cognizant that this bill passed. But because they’re stabilizing the oil market and there’s this question of NOPEC, I think they don’t have an incentive to be as transparent as they otherwise might have been,” Kressens says.

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.

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