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Continuing Response to IMO 2020 | New Carrier BAF Formulas

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In response to upcoming IMO 2020 sulfur regulation changes, a number of ocean freight carriers are revisiting and adjusting the mechanisms previously used to calculate their Bunker Adjustment Factor (BAF) programs.

IMO 2020 – Compliance Options

As 2020 approaches, new IMO regulations are changing the allowable sulfur content in marine fuel from 3.5% to 0.5%S m/m. Though there has been much speculation on how firm this deadline will be, a recent Marine Environmental Protection Committee (MEPC 73) meeting in October confirmed that the regulatory timeline will remain firm, upholding a January 1, 2020 deadline. To ensure compliance with these new regulations, vessel owners and operators have a variety of options, including switching to consumption of low-sulfur fuels, using exhaust gas cleaning technology (scrubbers), or transitioning to vessels capable of utilizing newer fuel alternatives such as LNG.

The economic viability of each of these compliance options is heavily influenced by market dynamics. Vessels with scrubbing technology installed will be able to consume high-sulfur fuel at a significant discount to low-sulfur fuel, but with significant up-front capital expenditures. The expected cost of equipment is between $1.23 million and $7.38 million per vessel, with variable labor and installation costs adding significantly to the final price.

Source: HIS Markit Maritime Portal, Bloomberg Intelligence. Exhaust gas scrubbing technology (scrubber) adoption increased through 2018 but the commercial maritime industry is overwhelmingly expected to choose low-sulfur fuel as their method of compliance with the 2020 sulfur cap. The price premium for low-sulfur fuel – which will be driven upward by increased demand for low-sulfur products – is encouraging freight carriers to modify their BAF programs and fuel surcharge practices.

 

Choosing instead to consume low-sulfur fuels, despite requiring no new technological additions, will include paying a premium for the higher-quality fuel, with an additional price bump and anticipated price volatility as the refined product market transitions 2.0-2.5 million barrels per day to low-sulfur fuel. Finally, though more LNG-capable vessels are being added to global shipping capacity each year, use of the technology is limited and unlikely to have a significant short-term cost impact.

Based on these three options, most carriers are committing to compliance by choosing to front the high and volatile costs of consuming low-sulfur fuels, exploring the remaining options on a limited basis in small portions of their fleets.  Regardless of the compliance choice, however, much speculation has been made into how increasingly volatile fuel costs will affect BAF pricing, as well as how visibility into the formulas used by carriers to calculate their BAF charges may change. Adding to this uncertainty are early predictions from different carrier lines on per-TEU cost increases, which range from $115 for CMA CGM to over $300 for Hapag-Lloyd.

The Carrier Response to New Regulations

Motivated by the firm regulatory timeline, to manage these increasingly volatile costs of low-sulfur fuel and provide new visibility, multiple carriers have announced changes to their BAF cost calculation. Whereas previously shippers had limited market-based indications of how fuel price dynamics played into their BAF, new formulas specifically contain components calling out the price of fuel and its consumption.

Maersk’s new BAF, for example, will now include a fuel price component representing the average fuel price at key bunkering ports around the world. According to the carrier, this will allow shippers to more accurately predict and calculate BAF tariffs for given fuel prices and trade routes. Beginning in 2019, this BAF will be based on the average cost of high-sulfur fuel in bunkering ports, but will transition to that of low-sulfur fuel by Q1 2020. Finally, while contracts made before 2019 will continue to utilize the previous Standard Adjustment Factor, all contracts created afterwards will use this new updated formula.

Other carriers have provided a less specific breakdown of how they will manage increasing fuel costs, instead offering a general plan for accurately representing the cost of compliance in BAF pricing. CMA CGM has stated that they will be reevaluating their fuel charges within their overarching sales policy. Providing a bit more detail with regards to their strategy, OOCL has stated they will be accounting for factors like fuel type used, fuel price fluctuation, ship size and capacity, and vessel utilization levels to better reflect the changes in the industry environment by introducing a floating formula into their BAF calculation. Whether by acknowledging that some change will happen to their calculation methodology, or elaborating on new cost calculation mechanisms, what is clear is that carriers are taking these upcoming changes seriously and working to prepare for them beforehand.

What Shippers Can Expect in 2020

Though more and more carriers will likely be changing their BAF strategy, an important caveat is that this process will remain far from standardized. Like before the IMO regulatory changes were announced, each carrier will possess their own unique BAF program formula, with drastically different cost components whose calculation remains obscured from shippers’ view. Especially for shippers with large networks utilizing several different carriers, the complexity of multiple different BAF calculation mechanisms will continue to warrant more visibility into marine freight costs, especially as low-sulfur fuel prices continue to rise.

To mitigate the effects of rising fuel prices as well as changing BAF mechanisms, shippers can benefit immensely by utilizing a robust and data-driven fuel management program that is standardized across their entire carrier base. With Breakthrough Marine Fuel Management, shippers gain ability to advocate for myriad strategy enhancements, such as a diversified fuel portfolio, and efficiency gains like slow steaming and vessel size optimization, through data-driven industry benchmarking. This allows them — and carriers — to account for fuel costs more accurately, ensuring that both parties receive the correct price. By managing their marine fuel spend, shippers can create a strategy that both helps them navigate upcoming changes associated with IMO 2020, and continues adding value in the years that follow.

To learn more about how Breakthrough Marine Fuel Management can elevate your freight strategy, please visit our solutions page.

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