European fuel oil margins are set to come under further pressure in 2015 as long-heralded regulatory changes shift marine demand to gasoil while no new outlets appear from export markets.
From 1 January, marine sulphur limits in dedicated emission control areas (ECAs) in Europe and north America will be cut from 1pc to 0.1pc, requiring shipowners to buy marine gasoil (MGO) while in those areas where they were previously taking low-sulphur fuel oil (LSFO). MGO averaged about $250/t more than low-sulphur 380cst fuel oil at Rotterdam in 2014, and MGO premiums to fuel oil are expected to widen in the coming year as a result of more demand from shipowners.
The IEA forecasts a 240,000 b/d shift in fuel oil demand to MGO in 2015 because of the regulatory change. European bunker fuel demand will shift to about 70pc fuel oil and 30pc MGO in 2015, according to the IEA's forecasts, from a ratio of 80:20 in 2014.
The moribund LSFO market is set to shrink further with the disappearance of demand from the bunker market, its main outlet. No trades have been reported for LSFO barges since 11 November, and some bunker suppliers halted LSFO sales as early as the start of December. The one remaining outlet for 1pc sulphur fuel oil will be power plants and other utilities, mostly in the Mediterranean. But this demand represents only a small percentage of the buyers formerly in this market. Much of the remaining LSFO can be expected to be blended into the high-sulphur fuel oil (HSFO) bunker pool, putting significant downward pressure on prices.
A side-effect of the new emissions regulations has been oil producers developing new marine fuels that meet the 0.1pc sulphur limit but can be sold at slightly lower prices than standard DMA-grade MGO. Some, including Spanish oil group Cepsa, plan to sell a denser and more viscous grade of MGO, while ExxonMobil, Finland-bsed Neste Oil, Russia's Lukoil and Gazpromneft and others will sell a blended product with elements of both fuel oil and middle distillates as well as other products. Questions remain over the reliability of supply of these products, as well as whether any engine problems may arise if they mix with standard MGO or other products in a vessel's fuel tank. European policymakers are also continuing to push for the development of infrastructure for LNG bunkering, but this is unlikely to be available as a mainstream solution next year.
The main alternative to switching to MGO for shipowners is fitting scrubbers to vessels — emissions-cleaning equipment that sprays water into the exhaust to remove sulphur and other emissions. This allows vessels to burn HSFO even when in an ECA, and some companies have predicted scrubbers may add as much as 18,000 b/d of HSFO demand next year from vessels previously burning LSFO in the ECAs. But the technology costs several million dollars, and in most cases vessels will need to be at dock while they are fitted.
Of course, the impact of the new emissions regulations would be reduced if shipowners opt to ignore them. Some market participants estimate only 75pc of shipowners currently comply with the 1pc sulphur limit in the ECAs, and predict compliance may drop as low as 50pc for the 0.1pc sulphur limit. The temptation not to comply is especially strong in Europe, where fines are rarely more than a few thousand dollars and a large vessel could save as much as $20,000/d through non-compliance.
Danish shipping company Maersk estimates that no more than one in 1,000 of its vessels sailing in the European ECA are checked for sulphur emissions. Some European port authorities have been reluctant to unilaterally enforce the regulations more strictly, wary of driving demand away to nearby ports with more lax regimes. But emissions regulation enforcement in the US has been much stricter so far, and policymakers may seek to emulate the US at the EU level if non-compliance is widespread in 2015.
In 2015, 500cst and 700cst RMK fuel oil is likely to continue taking up a large share of the market. Container ship companies and other operators of vessels with relatively modern engines have been increasingly burning denser and more viscous RMK instead of the more common 380cst RMG grade to cut fuel costs. Refinery upgrades in Russia will eventually bring an increased supply of RMK into Europe, but the pace of these upgrades has been slowed in 2014 by sanctions and the drop in crude prices. In the meantime, discounts to RMG barges for RMK are expected to remain tight at Rotterdam with a steady stream of exports to Singapore.
Amsterdam-based ING Bank forecasts fuel oil exports from the US and Europe to the Asia Pacific region will climb to about 700mn bl in 2015 from 600mn bl in 2014 as the blending of LSFO into the HSFO pool cuts prices in the west. But demand in Asia Pacific is unlikely to grow at this rate, further weakening fundamentals. Demand growth in Europe is also expected to remain weak. And with increasing shale oil production in the US cutting demand there for European straight-run fuel oil as a feedstock, more straight-run fuel oil is being blended into the bunker pool.
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