Viewpoint: Asia delivered, cargo bunker markets diverge

The delivered bunker fuel market is likely to become even more dislocated from the cargo market in the lead-up to the January 2020 implementation of the International Maritime Organisation (IMO) cap on sulphur content in marine fuels. This will have adverse implications for marine fuel market participants that need to hedge their physical exposure — and could encourage a switch to swaps that settle on delivered bunker prices, in order to reduce any increase in basis risk.

Market participants in Singapore hedge their bunker positions using swaps that settle against Singapore 380cst physical cargo spot assessments. But this is an imperfect hedging tool, given the fuel oil cargo market has different characteristics and dynamics than the delivered bunker market.

The cargo market trades in fixed quantities of 20,000t for loading 15-30 days from the trading date, while delivered bunkers mostly trade in smaller clips of 500-3,000t for delivery 4-12 days out. And dynamics in the two markets are different, with cargo markets influenced predominantly by regional price differences and arbitrage flows, while delivered bunkers are more exposed to changes in local supply and demand, as well as blending economics.

Delivered bunker premiums can sometimes experience large increases in volatility as a result. Delivered cash premiums for 380cst bunker fuel to Singapore 380cst cargo assessments shot up to a record $25-35/t in November 2018, well above more normal levels of $12-16/t. The volatility was a result of weak demand from refiners to use fuel oil as a feedstock, as well as shutdowns of secondary units, which boosted supplies of low-density and low viscosity fuel oil — as well as straight-run fuel oil — to the regional trading hub of Singapore. This left the market with a grade mismatch and created a shortage of 380cst bunker fuel.

IMO deadline looms

There is now only around a year before the IMO implements its 0.5pc sulphur cap, down from current levels of 3.5pc, meaning there is a high likelihood that the importance of Singapore cargo assessments as a pricing basis for delivered bunker fuel will fall even further. There are two main reasons for the declining relevance of the cargo assessments — they can be subject to manipulation when compliant fuels become available and speculative activity in the swaps market picks up; and premiums can fluctuate strongly because of uncertainty over the availability of barges and tank storage, as well as possible terminal congestion.

The IMO-driven shift in the entire marine fuels supply chain towards a low-sulphur, lower-viscosity product raises the question of whether suppliers will keep a sufficient number of dirty barges available. It is unclear how much of the high-sulphur fuel oil (HSFO) market will remain intact after 2020 as it remains difficult to gauge how many vessels will have scrubbers installed, as well as the level of non-compliance. But it is safe to assume that the large majority of the 60,000 or so vessels in the global fleet will no longer opt for HSFO and so will instead have to switch to burning a 0.5pc low-sulphur fuel oil (LSFO) or gasoil blend.

The exact composition of the supply pool remains unclear, with tank operators struggling to estimate how much HSFO, LSFO and low-sulphur marine gasoil they will need to store. This is likely to lead to terminal congestion should there be insufficient supplies of possibly incompatible IMO-compliant fuels. These logistical factors are likely to lead to large swings in delivered bunker premiums.

Delivered, physical assessments diverge

It makes sense for the market to adopt the use of financial derivatives that settle on a delivered bunker price assessment, rather than on a physical cargo assessment, given the correlation between the two is bound to weaken after the IMO regulations take effect. Delivered swaps are not readily susceptible to manipulation as they are preferably based on actual deals reported. And over-the-counter swaps markets are more liquid than the physical market, enabling suppliers and owners to react to price swings more effectively.

Any sharp decline in crude prices would most likely lead suppliers to hold off on satisfying the surge in demand from owners, as they bet on prices picking up again later. Owners could therefore find better value in the swaps market, where contracts would trade closer to prevailing market conditions. The opposite would apply during a rising market, with suppliers choosing to sell paper contracts that are trading higher than what they would be able to fetch in the physical market.