IMO 2020 Impact on Diesel Prices | How Will the Sulfur Regulations Influence Over-the-Road Trucking?

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sulfur diesel

In anticipation of the impending international maritime organization (IMO) 2020 sulfur regulations sources are predicting vastly different outcomes on fuel prices. 

Expectations range from having no effect on prices to drastic price increases. But a growing number of factors are limiting the chance of a price spike, including a well-supplied oil market and the global slowdown in diesel demand.  

In reality, low-sulfur fuel cracks, or diesel premiums, will likely increase above their historical trends, but it is also likely the diesel price ceiling will remain lower than 2018’s highs

Understanding the Diesel Fuel Price Buildup Is Important for this Analysis

When addressing any likely price shock to transport fuels, like diesel, it is important to focus on underlying price fundamentals.

Read more about the buildup of the price of a gallon of diesel here.

Analyses of the impact of the 2020 fuel regulations on ultra-low sulfur diesel – like trucking and rail diesel – prices have varied dramatically. Analyses that do not consider specific portions of the diesel fuel cost buildup may be misleading, because they may not give enough consideration to relatively static costs (taxes) and the global oil market. Source: Breakthrough Calculations

 

A thorough analysis of these fundamentals has been unfortunately left out of many industry conversations and projections regarding IMO 2020 price impacts on diesel.

Recently, the wholesale price buildup of a gallon of diesel is as follows:

  • 50 percent attributed to the underlying price of crude oil
  • 30 percent attributed to taxes and transport costs
  • 20 percent attributed to the premium of manufacturing diesel fuel from crude oil (diesel crack spread)

The diesel crack spread refers to the pricing difference between a barrel of crude oil and the diesel fuel refined from it.

Taxes and transport costs will remain relatively static in the near term, so they do not factor in the IMO transition. The majority of diesel fuel price volatility will be instigated by crude oil fundamentals and diesel price premiums.

Downside Price Pressure for Crude Oil may Mute the Impact of IMO 2020 on Diesel Prices

While IMO 2020 may bring price pressure to low-sulfur fuels, particularly the middle distillate portion of the refined barrel, it is unlikely to boost demand for crude oil to the point that crude oil prices rise dramatically.

Additionally, recent supply disruptions that drove price volatility into the market – like the attack on Saudi Arabia’s Abqaiq crude oil processing infrastructure – have shown the world is seemingly well supplied with crude oil because prices were not sustained at higher levels for long.

 A well-supplied oil market and weakened global demand for its refined products, like diesel, will likely offset some of the effects of IMO 2020.

U.S. Oil Supply Responds Quickly to Oil Prices Increasing

U.S. producers are capable of quickly ramping up production when incentivized by higher prices. U.S. producers have also been helped by growing crude oil pipeline capacity that will more efficiently move light, low-sulfur oil from the Permian Basin of West Texas and Southeastern New Mexico, and the Eagle Ford Basin of Central Texas to ports for export (see chart below).

Completed crude oil pipeline construction between major Texas basins and the Gulf Coast has helped U.S. crude oil exports reach new records. The chart above shows an additional pipeline capacity of about 2.5 mmbd being completed by Q3 2021. These investments highlight expectations for Texas oil production growth to remain significant for years to come. Source: U.S. Energy Information Administration

 

Remember that crude oil accounts for as much as 50 percent of diesel prices. These market characteristics and developments make it unlikely for crude oil prices to increase rapidly in the near term or remain elevated for a significant period. As a result, diesel price volatility has reduced the upside risk exclusively from IMO effects.

IMO 2020 Will Most Directly Impact the Diesel Premium

The diesel premium (diesel crack) has recently accounted for about 20 percent of the final cost per gallon. The seasonality of diesel demand and its impact on inventories heavily influences the premium refiners receive for diesel fuel – and ultimately the price of diesel at the pump. The chart below helps call attention to seasonal trends in diesel inventories, or stocks, during the past five years.

The chart shows the range of U.S. distillate inventories from 2014 – 2019, with 2019 year-to-date levels called out by the blue line. The five-year average is shown as the gray dotted line. Note that 2019 distillate inventories, of which ULSD is a substantial portion, have trended below the five-year average for much of the year. IMO 2020 is expected to continue strong demand for distillate fuels, maintain pressure on inventory levels, and ultimately lead to higher prices for low-sulfur transport fuel. Source: U.S. Energy Information Administration

 

At present, diesel stocks are about 12 percent below their five-year average (as highlighted by the light blue line in the chart). Seasonally speaking, diesel stocks are expected to continue to decline through the middle of November as demand remains robust leading up to the holiday season. From December to February, however, diesel supplies have historically grown and reduced price pressure due to relatively weak demand for diesel through the end of Q4 and into Q1.

How Much Will IMO 2020 Impact Truckload Diesel and for How Long?

Fourth-quarter diesel cracks represented the highest premiums for diesel fuel during 2017 and 2018. Thus far into 2019, diesel cracks are in close parity with 2018 figures and have reached as high as $28.28 per barrel as of this writing (67.3¢ per gallon). If 2019 fundamentals remain in line with 2018 then the diesel premium may grow another 10.0¢ per gallon before the end of November (see chart below).

NY Harbor ULSD diesel cracks typically increase during refiners’ autumn maintenance and turnaround season because diesel production slows as refinery utilization decreases. Diesel demand to begin Q4 typically remains robust thanks to the coming holiday season before tapering once the holiday rush has passed. Diesel cracks have historically weakened as we enter a new year due to weaker Q1 diesel demand. Source: CME Group

 

The IMO push toward low-sulfur fuels is expected to offer additional, unseasonal pressure onto diesel stocks and therefore increase its price premium. Each $1.00 per barrel increase in the premium for diesel results in about a 2.4¢ per gallon increase in the cost of diesel at the pump.

Other forecasts have commonly portrayed the IMO “bump” as increasing diesel crack spreads by $2.00 to $8.00 per barrel, which converts to about a 5-20¢ per gallon increase for diesel.

U.S. distillate sales during the second and third quarter trailed 2018 sales by an average of 120,000 barrels per day, so weaker demand may lead to lower diesel cracks than what the IMO effect had been widely speculated to build upon.

U.S. distillate sales during the second and third quarter of 2019 lagged 2018 diesel sales. Diesel sales were above the five-year average during September but remained lower year-over-year. Source: U.S. Energy Information Administration

 

The risk of upside price pressure will be greatest from Q4 2019 to Q2 2020. This timeline considers initial price upside as vessels meet compliance for January 1, as well as upside price risk should a large cohort of vessel owners and operators not become fully compliant until the carriage ban for non-compliant fuels takes effect on March 1.

Conclusion: Significant Price Spikes Due to IMO 2020 are Unlikely

Diesel prices will not likely “soar” as an outcome of the IMO sulfur regulations. This perspective is supported by a well-supplied global oil market and the slowdown in diesel demand because of sluggish economic growth across many economies.  Low-sulfur fuel cracks will likely increase above their seasonal trends, but ultimately the diesel price ceiling will remain lower than the high prices experienced in 2018.

While the IMO impact for the commercial maritime industry will undoubtedly lead to higher fuel costs for moving ocean freight, geopolitical risk – and not the effects from IMO – remain the greatest lingering risk for elevated volatility in transportation costs as we enter the next decade. Contact Breakthrough to learn more about opportunities to manage risk stemming from the cost, consumption, and emissions of energy used to move your goods to market.

Learn more about how shippers can navigate IMO 2020 here

Information updated from the original post date on 10/4/2018.

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