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. This expectation included not only the low-sulfur marine fuels directly impacted through the regulation but consequently other low-sulfur fuels like diesel fuel used for truckload and railroad freight movements.
But what was once a primary concern in December of 2019 has taken a firm backseat to the circumstances of COVID-19 less than a quarter later.
For in-depth commentary about current fuel and freight market impacts of COVID-19 visit our coronavirus resources page.
No one in the industry was able to foresee 2020’s unprecedented circumstances. Dramatic changes across the economic and crude oil landscapes due to the spread of COVID-19 and the OPEC+ price war resulted in plunging refined product prices in Q1. Wholesale diesel prices reached $2.69 per gallon in the U.S. on January 6, before falling to a March average of just $1.93.
This post will address the IMO market transition thus far in Q1, discuss the factors contributing to a watered-down IMO regulatory effect on diesel prices, and offer insights for what to expect in the months ahead.
Initial IMO 2020 OTR Diesel Fuel Price Expectations
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 at the beginning of November 2018. Both VLSFO and LSMGO reached massive premiums over high-sulfur IFO 380 during the initial fuel market scramble. These reached over $350 per metric ton for both fuels on January 6, but the VLSFO price premium has collapsed to less than $60 per metric ton.
As several major downside price pressures emerged, the intense upward price pressure proved to be short-lived. Market forces needed one month to remove the initial IMO price shock, just as they had needed one month to build it.
Interested in Q4 expectations before the IMO’s regulations took effect? Read about them here.
COVID-19’s Diesel Demand Destruction Insulated Prices from IMO’s Upside Risk
Many outlets expected a price spike on January 1, but the near-immediate emergence of COVID-19 in China incited an unprecedented downward price pressure trend that has endured today. COVID-19 has dramatically diminished crude oil demand as consumers are forced to stay home, manufacturing is suffering as demand for durable goods dries up, and consumer sentiment is dropping because of an uncertain labor market.
COVID-19’s diesel fuel demand destruction led to the break-up of the OPEC+ crude oil production-cutting agreement, too. Crude oil’s bear market has been exacerbated by Saudi Arabia’s crude oil price war with Russia that has conceivably left behind a production glut. Although the break-up of OPEC+ may prove to be temporary, disagreement among member countries already helped push nominal WTI prices to their 18-year lows.
As you can see in the chart above, diesel fuel prices are tightly entwined with the underlying commodity price of crude oil. Looking at the cost build-up of diesel illustrates why crude oil price dynamics are imperative to the diesel fuel price behavior we have experienced through Q1—because crude oil accounts for roughly 40-60 percent of the cost of diesel fuel.
Read more about diesel fuel price buildups, here.
COVID-19 Surpassed One of the Marine Industry’s Largest Regulatory Disruptions Ever
The coronavirus has steeply reduced the price of crude oil and transport fuels based on expectations for weak demand in the near-term. This behavior has the potential to endure as the outlook for the outbreak remains uncertain and consumers significantly alter their spending patterns – increasing non-durable goods stockpiles and significantly contracting durable goods expenditures.
Read more about how consumer sentiment is influencing fuel and freight in the U.S., here.
We expect markets will rebound once the virus is better contained around the globe. The duration of this market shock factors significantly into the time horizon for economies to return to a robust growth cycle. The net effect of the coronavirus through the first half of the year will keep diesel and low-sulfur marine fuel price ceilings lower, and the state of over-production of crude oil will further stifle prices.
Although IMO 2020 significantly shifted the demand profile for the marine industry – putting additional demand pressure on low sulfur fuels, the surrounding global circumstances have nearly snuffed out the long-awaited price impacts.