The sleeper oil issue for transport sector

Justin Smirk
07:00am March 05 2019

The International Maritime Organisation has locked in January 1st 2020 for major changes to limit the pollution ships emit. (Getty)

Heard of “IMO 2020”? Don’t worry if not, you aren’t alone.

Basically, major new global shipping regulations are coming into force from January 1, 2020 to reduce emissions, affecting not just global fuel oil and shipping markets but other major sectors, like road transportation. For the air travelers out there, fuel makes up around 20 per cent of some airline’s cost base, so any upward pressure can flow through to ticket prices.

On the ground, other potential flow-on effects include hastening the death of the diesel car and reshaping the economics of thermal power generation.

So if you haven’t heard of IMO 2020, it’s likely you may in the next 12 months.

Historically, large ships have used “bunker” oil, the heaviest commercial fuel obtained from crude oil that contains relatively high amounts of pollutants, particularly sulfur. It’s so viscous that it must be heated before use and requires large, robust engines to cope with the forces produced, thus making it impractical for smaller vehicles and boats. These undesirable properties make it very cheap. However, it has been estimated that a cruise liner belches out as much sulfur as 380 million cars. Responding to this, the International Maritime Organisation has locked in January 1st 2020 for major changes to limit the pollution ships emit.

Any solution – such as installing exhaust gas cleaning systems, or “scrubbers”, to remove sulphur from the emissions – requires considerable investment without knowing the financial benefits until after the new regulations have been implemented. A further complication is the risk of non-compliance from parts of the industry given most shipping takes place in international waters outside sovereign jurisdictions and the IMO does not have authority to enforce fines for non-compliance on shipping or fuel suppliers.

Thus, to date both refiners and ship-owners have been slow to invest. 
 

The whole supply chain may be impacted as commercial logistics providers transfer costs across all goods that require a shipping and/or heavy trucking element. (Getty)


For example, even after a recent surge in retro fitting of scrubbers, it is estimated that some 510 large ships out of a global fleet of around 55,000 will have scrubbers by January 1, 2020. Other solutions to meet IMO’s new rules include the refining industry producing lower sulphur bunker oil or ship-owners switching to alternative low sulphur fuels, such as LNG or marine gasoil, and blending this with bunker oil.

Given restraints on LNG usage, it’s likely shipowners will switch to gasoil to meet the new specifications. However, this would affect gasoil (diesel) prices via a significant lift in demand and have a knock-on effect to other fuel oil products, such as jet fuel (or kerosene).

For diesel cars, IMO 2020 may be a further nail in the coffin. While diesel had long been the fuel of choice in Europe, recent shift in consumer preferences due to pollution, the VW emissions/fuel efficiency scandal, increasingly punitive taxes and higher price compared to gasoline have weighed on demand. Along with the likely release of electric vehicle models from major manufacturers, the outlook is increasingly bleak. 
 

VW, maker of the Tiguan model above, in 2015 admitted to systematically cheating US air pollution tests. (Getty)


IMO 2020 will also have an impact on the aviation industry. Put simply, if gasoil prices rise and encourage the diversion of more crude to the production of gasoil, jet fuel prices will also increase as a shortage appears in the market. That has ramifications for travellers and the movement of goods around the world by air freight.

Indeed, the whole supply chain may be impacted as commercial logistics providers have fewer alternatives, transferring the higher cost across all goods that require a shipping and/or heavy trucking element to distribution networks.

In terms of broader impacts, a rise in a broad range of transport fuels, regardless of the price of underlying crude oil, may cause a surprise bump in global inflation this year. Greater consumption of high sulphur fuel oil by power generators, as ships reduce their usage, could also reduce demand for coal, a market already under pressure amid the global push to reduce carbon emissions.

Although IMO 2020 may be little known, it’s just another larger structural force that by the end of the decade could result in the transport industry looking vastly different to what it does today. 

 

This material contains general commentary, and market colour. This material does not constitute investment advice. This information has been prepared without taking account of your objectives, financial situation or needs. We recommend that you seek your own independent legal or financial advice before proceeding with any investment decision. Whilst every effort has been taken to ensure that the assumptions on which the forecasts are based are reasonable, the forecasts may be affected by incorrect assumptions or by known or unknown risks and uncertainties. The ultimate outcomes may differ substantially from these forecasts. Except where contrary to law, Westpac and its related entities intend by this notice to exclude liability for this information.
 

Justin Smirk

Justin has 17 years’ experience in Financial Markets. He joined Westpac in 1999 following his early training at the Reserve Bank of Australia. He has spent time in Westpac’s London office and has had a secondment as Chief Economist at St George Bank. Justin’s areas of interest are the international economy, commodity markets and the resources sector. He also analyses the Australia labour market and prices.

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