The value of crude is derived from the slate of products that can be produced from it, with sulphur having a relatively minor impact on its price.
But this is about to change. As IMO 2020 approaches, sulphur is going to play a much more prominent role in determining crude prices.
In this blog post — part four of our five-part series on IMO 2020 — we look at why IMO 2020 is expected to impact differentials between sweet and sour grades, as well as potentially lift the outright crude price. As discussed in part one, the introduction of the 0.5pc sulphur limit on bunker fuel from 1 January 2020 is likely to lead to a significant fall in the value of high-sulphur fuel oil (HSFO). Refiners will want to minimise its production, which will have a knock-on impact on prices of crude grades that yield significant amounts of HSFO.
Normally, a refiner will only pay a particular price for a crude grade that will generate an equal or higher margin than would be obtained by processing an alternative. With HSFO expected to make a significant dent in margins for refiners that are unable to desulphurise residue, there will be a strong incentive to pay a premium for very-low sulphur crudes. Complex refiners on the other hand, which are capable of upgrading and desulphurising high-sulphur residue, will benefit from the expected fall in the price of high-sulphur crudes.
For a period, there will be a fundamental change in the definition of “conversion units” in refining. The higher refining margins associated with upgrading will no longer just focus on converting heavy petroleum fractions to light petroleum fractions but will also focus on units that can remove sulphur.
Very-low sulphur crudes
These crudes have a sulphur content of 0.3pc or below and yield residue with a sulphur content of around 0.5pc, without any desulphurisation. These low-sulphur residues will command a premium to crude, similar to that achieved by light-end transportation fuels, because of their importance in producing 0.5pc IMO 2020-compliant bunker fuels. Refiners processing very-low sulphur crudes will therefore be incentivised to forego cracking very-low sulphur residues and instead divert them directly to the bunker pool. This will make the crudes in this category less popular with full conversion refineries and those with fluid catalytic cracking units.
Simple refineries with limited ability to upgrade and desulphurise residue will opt to pay a premium for very-low sulphur crudes because they can be used to produce a high proportion of compliant bunker fuel or bunker blendstock. Crudes with a higher sulphur content will be cheaper, but will leave them with low-value residue that will have a worse impact on their margin.
In crude, sulphur compounds are more common in residue than in the lighter products. Very-low sulphur crudes therefore tend to be light, while high-sulphur crudes are typically medium and heavy. The majority of very-low sulphur crudes are similar in quality to Nigeria’s Bonny Light, but a rather small number of very-low sulphur medium and heavy crudes do exist.
These grades are a good fit for producing IMO 2020-compliant grades because they yield a large amount of very-low sulphur residue. This was briefly discussed in blog two. These qualities have led to an increase in demand for these grades in recent weeks, which combined with their relative scarcity, has driven up their values against the North Sea Dated benchmark.
Earlier in the year, these grades received a boost from production cuts by Opec and some non-Opec producers that predominantly affect medium and heavy grades, but the recent rises can be attributed to the so-called ‘IMO effect’.
Crudes with sulphur content of between 0.3pc and 0.7pc are considered to be low in sulphur, but the residue they produce will typically be above 0.5pc sulphur. Since they cannot produce an IMO-compliant fuel directly, their residue will need to be treated further or blended with lower-sulphur material before going into the bunker pool. These crude grades therefore will be less appealing to simple refineries. But they are more likely to produce positive margins for FCC and full conversion refineries.
Refiners with the ability to either upgrade residue or remove the sulphur from it will benefit significantly from the discounted price of higher-sulphur crudes — those with more than 0.7pc sulphur. But this opportunity is forecast to have a short-to-medium term timeframe, as investment in scrubbing technology and refinery upgrading/conversion units to capitalise on lower HSFO prices and positive margins, respectively, will eventually return the market to equilibrium within a few years after 2020. Any investment based on residue desulphurisation and production of IMO 2020-compliant bunker fuel must be completed by 2020 in order to fully achieve the potential returns.
Beyond the differentials between sweet and sour crude, IMO 2020 has the potential to strengthen the outright crude price. As explained in previous blog posts in this series, producing sufficient compliant bunker fuel will come at the expense of other products. To offset this, there could be an increase in refinery throughputs that could drive up the outright crude price. Running counter to this are the gathering macroeconomic storm clouds weighing on oil prices. The market is looking relatively well balanced heading into 2020, but following the recent attacks on Saudi Arabia’s oil infrastructure, supply-side disruption is now being factored into the price outlook.
For the latest news, insight and market activity related to the IMO’s 0.5% sulphur cap, you can sign up for our free bi-weekly newsletter.
The forward-looking data and analysis contained within this blog comes from the Argus Consulting team, who publish the Argus Marine Fuels Outlook. This is a quarterly service that provides news and insight, market fundamentals data and price forecasts for global marine fuels two years ahead.