With the International Maritime Organization’s (IMO) 2020 Sulfur Regulation deadlines looming on the not-so-distant horizon, tumultuous marine fuel prices are expected to continue throughout 2019, with new regulations, economic conditions, and other market risks triggering significant and lasting marine fuel price volatility.
Even with the New York Mercantile Exchange’s recent decision to begin selling marine fuel futures contracts, trading behavior has given very little insight into where prices may be headed given the current environment. Because of this difficulty in elucidating market sentiment, evaluating the strength of global economies and production of crude oil and refined products may offer a better window into the direction of marine fuel price movement.
These dynamics encompass five key market drivers that have the power to impact marine fuel prices throughout 2019. While the only certainty regarding the post-IMO 2020 maritime landscape is uncertainty, the direct and indirect impacts of the following dynamics on marine fuel promise to be substantial.
Top Five Sources of Price Volatility in Marine Shipping
1. Crude Oil Production
Cost buildup for all fuel types begins at the crude oil level. As such, market dynamics that affect the baseline price of crude often amplify price movement as oil transitions from its raw initial commodity to refined final states.
The price of crude itself is highly volatile, and especially subject to supply and demand pressure due to fluctuating production from the most substantial global oil producers: the US, Russia, and member nations of the Organization of Petroleum Exporting Countries (OPEC). For the US, the recent boom in shale production of crude oil since 2016 flooded the market with “light sweet crude” with a low sulfur content. This type of crude oil is an attractive product to global importers, and subsequently triggered supply-driven downward movement of oil prices globally. As a result, OPEC announced in December at their most recent meeting that they and their allies would be cutting production by 1.2 million barrels per day to stabilize a higher price threshold.
The current 2019 economic outlook shows signs of weakening demand growth across developed and emerging economies alike. Despite these expectations, several factors have the potential to rebalance the market in the near term. Such drivers include OPEC oil production cuts reaching as mentioned above (impact estimated in chart above), crude oil production cuts from Canada due to severe pipeline bottlenecking, and other unexpected supply shocks like the recent seizure of one of Libya’s largest oil fields by an armed group of militants.
On the heels of the OPEC announcement alone, WTI and Brent prices both rose over 2 percent –a demonstration of OPEC’s sustained power over market price projections. As prices begin to increase from the lows seen at the end of 2018, US production and OPEC cuts will continue to trigger price volatility—first at the crude oil level, but later moving downstream to refined marine fuel products as well.
2. Growing Crude and Refined Product Differential
2019 will likely also see low sulfur fuel reach higher premiums, while high sulfur products reach steeper discounts with regards to the crude oil from which it is derived. This is a result of several factors including changing crude oil quality, as well as anticipation for higher demand of IMO-compliant fuels.
Ultra-low sulfur diesel (ULSD) inventories remain below five-year average levels, despite crude and gasoline inventories’ sustained highs. As IMO 2020 sulfur regulations approach, refiners have tremendous economic incentive to make more ULSD product to meet ocean freight carriers’ increasing demand for compliant fuels.
Given the influx of light sweet crude oils in the marketplace due to US dominance in shale oil production, however, refiners are less able to keep pace in production of middle distillates like ULSD and fuel oil. Though by nature they have a lower sulfur content, light sweet crude feed stocks are much less effective at producing ULSD than they are at producing gasoline and naphtha. In the US for example, light sweet crude yields roughly 50 percent gasoline refined product, while diesel comprises only about 32 percent. As more of this crude variety enters the market, refiners end up with excess quantities of gasoline, even as they strive to maximize production of ULSD.
Fuel oil has historically traded at a discount to crude oil, but a changing crude slate to higher API gravity (less-dense crude oil), as well as gradual reduction in global inventories in anticipation of the maritime industry moving onto cleaner alternatives may be sustaining a premium for fuel oil. The Port of Singapore’s bunker fuel premiums (as shown in the graph above), help exemplify these changing dynamics, with fuel oil premiums (IFO 380 prices shown in the chart) at their highest level in years.
While additional steps can be added to the refining process to maximize production of ULSD, updating facilities with new equipment is costly, adding to already substantial low-sulfur diesel premiums. With the pace of low-sulfur diesel production remaining much slower than that of demand, an environment where volatility associated with price differentials and high premiums on ULSD will likely continue to be commonplace throughout 2019.
3. Global Economic Outlook
Global economic outlook also creates the potential for fuel price volatility, as economies that matter most to crude oil production and consumption—such as the US, China, Russia, Europe, and the nations of OPEC—are projected to experience weaker economic performance throughout 2019.
One factor triggering this economic weakness are the lingering trade tensions between the US and China, as both nations grapple with the implications of imposed tariffs. Though they decided in early December to forego tariff hikes and negotiate more mutually beneficial trade terms, Presidents Trump and Xi continue to have difficulty reaching longer term trade solutions, as both face unique economic pressures from their home countries.
A comparison of the OECD’s May and November GDP growth projections, shown above, help to model an abrupt change in economic perceptions.
Additionally, tightening monetary policy in both the US and Europe may also play a role in a weakening global economy in 2019. In the wake of interest rate hikes in the US, and the end of its asset purchase program, the European Central Bank may take similar action, raising interest rates by summer of 2019 .
Besides threatening the strength of the global economy, changing economic tensions and policies have the additional ability to reduce demand for crude and refined oil products. As demand for consumer goods cools, so too does the demand for the fuel that moves them – leading to oversupplied inventories and volatile fuel market dynamics.
4. Risk from Emerging Markets
Weakening demand for oil products is also impacted by currency depreciation against the US dollar in emerging markets such as Argentina, South Africa, and Turkey. As the dollar strengthens–a result of economic turmoil in Brexit-era Europe and rising interest rates at home in the US—currency in developing economies cannot keep pace. Since many commodities are traded in dollars, its value weighs heavily on buying power in emerging markets. A strengthening US dollar and weakening of local currencies often stalls economic growth and development potential.
The purchase of crude oil and refined products is directly affected by interaction. Barrels of crude are traded in US dollars—if the peso, rand, or lira respectively buy fewer US dollars, those dollars are also limited in the quantity of oil they can purchase. This results in weakening demand for global crude oil and subsequent price volatility on the global oil stage for both crude and other refined products like marine fuels.
5. Continuation of the Changing Regulatory Environment
Even with a year remaining before IMO 2020 regulations take hold, changing maritime regulations continue to impact current and future marine fuel prices. These new regulations are taking shape through the creation of new emission control areas (ECAs).
In China for example, new coastal and inland shipping areas have been designated ECAs. Coastal waters now have a 0.5 percent sulfur content cap and inland waters have a more stringent 0.1 percent cap. This action was preceded by an announcement in late 2018 that Norway would be instituting its own regulations for sulfur emissions by banning scrubber technology in Fjord waters.
China and Singapore have also decided to take a stand on scrubber technology, with the former’s maritime authorities recently enacting a decision to ban open loop scrubber technology and water discharge in river and coastal ports. Though many ocean freight carriers have chosen to comply with IMO regulations by updating vessels with scrubber technology, this decision could prove unviable in Chinese waters, pushing more carriers to instead adopt 0.5% S marine fuel, or other more expensive compliant fuels. The impact of such action in 2019 may thus result in additional demand-driven upward price pressure on compliant marine fuels.
Prepare for Volatility by Updating Your Marine Strategy
To account for the changing regulations and volatile fuel prices shaping today’s maritime freight landscape, shippers can benefit immensely by utilizing a robust and data-driven fuel management program.
By gaining transparency into how these price movements impact shippers’ marine fuel spend, Breakthrough helps our clients—and their carriers—account for fuel costs more accurately, ensuring that both parties operate equitably while moving goods. Through this visibility, shippers then have the tools necessary to drive costs down, while also advocating for technology and efficiency improvements in their maritime freight strategies.
To learn more about Breakthrough Marine Fuel Management, please visit our solutions page, or tune in to one of our monthly webcasts.