The International Maritime Organization’s (IMO) sulfur cap began on January 1, 2020, and expectations leading up to the event anticipated low-sulfur fuel prices would increase across the distillation column.
Breakthrough’s perspective during this time was that low-sulfur fuel cracks, including the diesel premium, would rise above its seasonal trends, but ultimately diesel prices would fall below the high prices of 2018.
While commercial maritime fuels experienced a price surge through the transition, enduring upward price pressure for ultra-low-sulfur diesel (ULSD) has not materialized.
This post will address what has occurred through the market transition thus far in Q1, discuss the factors contributing to a watered-down IMO regulation effect on diesel prices, and offer insights for what to expect in the months ahead.
A Price Wave: From Market Crest to Market Trough in Two Months
The IMO 2020 fuel regulations’ market transition began as anticipated. Conventional, high-sulfur fuel oil (HSFO 3.5%S) prices fell significantly as its discount to crude oil grew from mid-September. HSFO experienced a short period of market tightness after the attack on Saudi Arabia’s crude oil infrastructure to end the third quarter. Its prices dropped swiftly shortly thereafter as suppliers decreased their stocks of HSFO to make way for compliant, low-sulfur fuel.
As demand for high-sulfur fuel transitioned to low-sulfur fuel, particularly in December, the price pressure on the existing low-sulfur marine gas oil (LSMGO 0.1%S) and newly formulated very-low-sulfur fuel oil (VLSFO 0.5%S) increased dramatically. The quick change in market demand led to a logistical shuffle, as anticipated, and a surge in prices for both VLSFO and LSMGO. This is illustrated by the chart that follows.
Low-sulfur bunker prices only took one month to reach their crest in early January. During that period, VLSFO prices climbed, on average, by over $150 per metric ton while LSMGO prices increased by over $100 per metric ton. This helped VLSFO reach its highest price to date, and LSMGO climbed to prices last touched in the beginning of November 2018.
As several downside price pressures emerged, the intense upward price pressure proved to be short-lived, though. Market forces needed one month to remove the initial IMO price shock, just as they had needed one month to build it.
A Watered-Down IMO Effect for Diesel Prices
Several factors provided transport fuel markets with nearly continuous downward pressure through January once prices reached their highs on January 6:
- The growing tension between the U.S. and Iran that instigated risk premiums subsided after the countries’ leadership declared their unwillingness to pursue further military action. A geopolitical risk premium onto diesel prices, particularly from the tension among Persian Gulf nations, has been priced out of the market for now.
- The Coronavirus in China was the primary driver of crude oil prices falling by over 20 percent through January. Crude oil prices responded to the perceived negative impact of the virus on global crude oil demand. Industries from travel and tourism to automotive manufacturing have experienced supply chain disruptions due to the virus. The ultimate impact and duration of this disruption remain uncertain. This market shock will likely continue to factor in the price of crude oil and refined products through the first half of 2020.
- Fuel Market Fundamentals for low-sulfur fuels reduced price pressure through the transition. VLSFO and its blending components were stockpiled ahead of the transition. The ample fuel supply removed the risk of drawing refinery feedstocks away from ultra-low-sulfur diesel as was feared in the lead up to the transition.
Diesel stocks were also building ahead of January 1, 2020. Diesel sales fell behind 2018 levels through much of 2019 as the pace of U.S. and international economic growth slowed, and heating oil inventories benefitted from a mild beginning of winter. These developments helped diesel inventories grow and pulled inventory levels near the five-year average.
This occurred more recently in the U.S.; diesel inventories increased from 11 percent below the five-year average during the week ending November 29, 2019, to within 3 percent of the five-year average to finish January.
The quick change in diesel inventories pushed diesel cracks from their seasonal norms early in 2020. The diesel crack had remained relatively strong from October through January in previous years, highlighted in the chart above. Growing international diesel inventories and the prospects of the coronavirus further disrupting the movement of freight internationally resulted in the lowest diesel premiums since June 30, 2017.
At just 38.4¢ per gallon, the diesel crack on February 3, 2020, marked the first time the premium for diesel fuel from crude oil had fallen below 40.0¢ per gallon in a year-and-a-half. This was hardly the anticipated outcome expected during the IMO transition.
Has the Impact of IMO 2020 on Diesel Prices and OTR Shipping Already Receded?
The coming carriage ban on March 1, 2020, and the steady destocking of VLSFO will likely usher price pressure into the market as we move through the second quarter. Refineries typically go through maintenance between the end of February and the end of April, which reduces the stocks of refined products due to a lower rate of production to keep up with demand. VLSFO, much like gasoline and diesel, will experience seasonal price pressure that comes through refinery maintenance and turnaround season. Tighter supplies of VLSFO may result in tighter overall blending stocks for low-sulfur fuels, also leading to upward price pressure for diesel.
The coronavirus has steeply reduced the price of crude oil and transport fuels based on expectations for weak demand in the near-term. We expect markets will rebound promptly once the virus is better contained around the globe. The net effect of the coronavirus through the first half of the year will keep diesel and low-sulfur marine fuel price ceilings lower than where prices were to begin the year.
Slowing economic growth ultimately led to low-sulfur fuels being comfortably supplied to begin the IMO transition and saw prices fall through January when price support was anticipated due to the significant fuel demand shift. A rebound across international economies will be necessary to strengthen oil and transport fuel demand for the IMO transition to develop premiums for ultra-low-sulfur diesel later this year.