Forty percent of the world’s fuel oil - the residual oil left over after extracting lighter products from crude oil - is used as bunker oil to power Ocean going vessels. Much of that fuel has relatively high sulfur content. Given that refineries sell fuel oil for less than the cost of crude – the bunkers market has traditionally been a convenient dumping ground for unwanted high sulfur residual fuel oil. New international regulations that came into force in 2012 drastically reduce the permitted sulfur content in bunkers after 2015 in the world’s populated coastal regions. Today we describe the impact the new rules could have on refiners.
This is installment six in our series on fuel oil in the Gulf Coast region. In the first episode we provided definitions for some of the many types and grades of fuel oil (see Yo Ho Ho and a Cargo of Bunkers). In episode two we looked at the Houston Fuel Oil Terminal Company (HFOTCO) that has been the dominant player in fuel oil blending, storage and export on the Gulf Coast for thirty years (see The Houston Fuel Oil Terminal). In episode three we covered the brand new kid on the Houston Ship Channel block – Battlefield Oil Storage Company (see The Kinder TransMontaigne BOSTCO Terminal). Parts four and five of the series were a two part survey of fuel oil terminals in the Caribbean (see Pirates of the Caribbean Terminals – BORCO and Pirates of the Caribbean Terminals Part 2). We discussed several advantages of the Caribbean from its deep water ports that allow transshipment of larger cargoes into smaller batches for delivery to the Gulf Coast to its strategic position on Atlantic and Pacific trade routes and looked at several Caribbean fuel oil terminals. This time we review ongoing changes to marine fuel oil regulations that threaten the bunker market for fuel oil.
We pointed out in the first episode of this series that marine vessels consume about 40 percent of world fuel oil output or about 3MMb/d. A great deal of that trade is international – serving marine fuel centers in Singapore, Dubai and Rotterdam. Houston is now also a growing center for the trade in fuel oil – as witnessed by the opening of the brand new BORCO terminal earlier this month. Marine fuel oil, known as bunkers, is one of the few large-scale markets for the residual fuel oil left over at the end of the refining process. The most common bunker grades are residual marine “G” and “K” – known by the acronyms RMG and RMK. Large Ocean going vessels use fuel oil because it is cheap compared to other refined products – generally selling for less than the price of crude oil.
For many years the fact that Ocean going vessels travel in International waters – outside of individual government jurisdiction, meant that the quality of fuel oil was not regulated. Big ships could happily burn fuel oil containing higher levels of materials like sulfur and nitrogen than were permitted for use on dry land. These materials have been subject to increased scrutiny and regulation by governments leading to tightening fuel oil quality specifications and emissions controls for their use in applications such as power generation. But the absence of such controls at sea meant that bunkers became a convenient market for refiners to offload high sulfur residual oil when no other outlet was available. All that is changing now.
In October 2008 the International Maritime Organization (IMO) adopted new standards to control emissions from the engines that power ocean going vessels. The new standards are geographic - ships operating in areas where air quality falls below certain standards (designated Emission Control Areas – ECA’s) are required to meet tighter emission limits. Beginning in July 2010, new and existing ships operating in ECAs were required to use fuels with maximum 1 percent sulfur content, decreasing to 0.1 percent in 2015. From January 2012 ships operating outside of ECA’s were required to use fuels with maximum 3.5 percent sulfur – reducing to 0.5 percent sulfur in 2020 (subject to review in 2018 but no delay past 2025). In addition, from 2016 onwards ships operating in ECA’s must acquire certificates proving that each engine has reduced nitrogen oxide exhaust by installing emission control devices.
The IMO regulations are enforced by geography. In effect the ECA areas cover the coastal regions that any vessel delivering cargo to large populations is likely to travel to. In the US for example, the map below shows that the ECA effectively covers all of the East, West and Gulf Coast regions (green lines) within a 200 mile distance – with the notable exception of the Caribbean (more on that later). The IMO regulations are enforced in the US by the Environmental Protection Agency (EPA - see the regulatory announcement here). They mean that any vessel visiting the US mainland is already restricted to using 1 percent sulfur bunker fuel and after 2015 will only be able to use 0.1 percent sulfur or 1000 parts per million (ppm). These restrictions are less severe than current US ultra low sulfur diesel (ULSD- 15 ppm) or proposed US “Tier 3” gasoline sulfur levels (10 ppm - see The Tears of a Refiner) but they nevertheless represent a significantly higher standard for refiners to meet. Once outside the ECA vessels are able to use higher 3.5 percent sulfur bunkers until 2020. Although these regulations have been predictably slow to materialize because they require agreement between participating nations, they have now placed an end date on the use of high sulfur bunker fuel in 2020.
Source: Environmental Protection Agency
Which presents refiners with a big challenge – because they either need to find a new market for 40 percent of their fuel oil or they need to reduce its sulfur content to meet the new bunker specifications - soon. A third choice would be for ship owners to install onboard scrubbers to remove the sulfur from engine exhaust – a process known as “flue gas desulphurization”. But that solution is considered expensive and unlikely to happen.
The challenge for refiners is that investments in the “bottom of the barrel” do not normally contribute positively to refinery margins. Fuel oil is usually sold for less than the cost of crude and there is no guarantee that investing to remove sulfur from fuel oil is going to change that fact. This year, for example, the premium of low sulfur fuel oil (LSFO) to high sulfur fuel oil (HSFO) at the US Gulf Coast has averaged $3.73/Bbl but West Texas Intermediate (WTI) crude still averaged $1.14/Bbl more than LSFO over the same period (see chart below – LSFO premium over HSFO is the blue line, WTI premium over HSFO is the green dotted line). So if LSFO is worth less than crude most of the time then spending money to upgrade refineries to reduce the sulfur content in fuel oil is basically a losing proposition. Significant investment would be required for refineries to produce fuel oil with very low sulfur. Unless that low sulfur fuel oil can be sold for a reasonable premium over the price of crude oil the return on investment probably would not be justifiable.
Comments
In reply to Sulfur content conversions by Philip Lewis
Thanks for the correction to my parts per milion logic. I updated the article to reflect that.
Sandy
Sandy,
Excellent article, as usual. Since there is a 30% premium for ultra low sulphur diesel and that seems to be the best current alternative to meet the new standards, isn't there an opportunity for refiners to invest in "scrubbing" equipment for fuel oil and and price it say at a 15% premium, undercutting diesel??
I religiously read the RBN blog every morning, actually arriving at my office early to do so. Great stuff!
Sincerely,
Jeff Miller
Practice Leader, Energy & Polymers
Hylant
I wonder what all this will do to the production of petroleum coke? Will we see an increase in sulphur levels as a result of these changes?
FO (and cracking margins) are just not adapted for USG refinery output configuration.FO is cheaply outsourced from countries with low complexity ratio refineries and remarketed to high-demand market.FO favors international Traders with blending and shipping logistics. When you take a look at Platts e-windows, VLCCS are carrying cheap russian FO residual for long-haul voyages to demand in Asia. FO is outsourced and blended into LSFO with ULSD. Blenders don't care about origin of products, they buy distressed products streams. Feedstocks like FO have often to be priced at a "Fire Sale discount" and available.
I quoted RBN here http://wp.me/p3k7lL-CL
Simon
Another alternative to adhering to North American ECA and IMO standards: Liquified Natural Gas. Increasing sulphur standards are greatly assisting the transition from traditional (RMG, RMK, other) fuels to either dual fuel or strictly LNG, a no-brainer for new ship builds, a little more financially challenging, but still +NPV (payback 3-5 yrs) for current ships depending on size and utilization.
I agree- another great article. I am not a technical guy, so I am interested in knowing the relative expense for a refiner to pull out all the sulfur at a refinery, like at the US Gulf. Also, following up on Simon comment- what's the feasibility of shipping out high sulfur fuel residual to someplace that can use it and import some low sulfur fuels. Another one- please clarify, exports of residual what be OK? It's just crude oil that is prohibited at this point?
Many years ago, I was VP Marine Ops for a large bulk fleet, and purchased about $60 million annually in bunker fuel (at l970's prices.) I am not sure I would quickly reach the same conclusions about vessel conversion that you have. For historical perspective, here is some background. Before the Arab oil crisis of l973, we paid about $16 PER BARREL for fuel oil, ie, it was dirt cheap and not a big consideration in vessel operations; labor costs were the driving factor, which led to the demise of the American flag merchant marine and the dynamic growth of foreign flag crews. Right about that time, Chevron built a new fleet of US flag product carriers for movement of refined products up and down the West Coast. These new vessels were equipped with gas turbine engines, which were the talk of the town. Union Pacific also built a small fleet of gas turbine locomotives. As fuel oil prices rapidly escalated, these motive power solutions became uneconomic; Chevron converted those ships to standard marine diesels; Union Pacific retired the locomotives very early in their lives.
About that time, LNG vessels came into being, and it made sense to power them with their own cargo. But if I were still running a fleet, I would look at the problem differently. I do not have any costs for flue gas desulphurization equipment, so this is theoretical. But you start with assessing your fleet. The oldest vessels do not warrant major investment, so you buy compliant fuel wherever you have to. For your newer (and therefore more expensive) ships, you look closely at the comparison of desulphurization versus engine conversion. Remember that LNG looks great on the US Gulf Coast, because we are drowning in natural gas, and planning to export it. However, fueling a ship in Asia with LNG means very expensive LNG, which is why the US is going to export it to take advantage of the spread. If I install desuphurization equipment on my best--and longest remaining life vessels, I can buy the crappiest fuel anywhere in the world at deep discounts for a long time.
It would be interesting to see a life cycle investment analysis like this. I think there is an analogy to coal fired generating plants. The oldest and least efficient are slated for shutdown or possible conversion to gas. The newest, (in the context of having been built before tighter emission controls) you reequip with scrubbers rather than shut them down.
JCK
Like Barry suggests, FO is an international trade with many arbitrage. FO shouldn't be benchmarked with ULSD but with L/H crudes. FO with 11.9 API @650$/MT = roughly 102$/Barrels.
In a similar way russian refiners use FO exports to escape Oil Exports tariffs, USGC Refiners can produce more FO if blended with foreign FO to circumvent Oil exports restrictions. If there is an arb, I predict that somebody will do it.
JCK, I like your perspective about Turbine engine and life cycle investment analysis.
Turbine engine were made for the Middle-East- EU/US Crude Oil arbitrage after the closing of the Suez Canal in 1967. Tankers owners started building High-speed VLCCS to make Gulf-Us-Europe trip around Cape of Good hope. This Long haul route was so much longer, resulting in higher freight rates, shipowners ordered a lot of ships but after a Yom Kippur and the reopening of the Suez Canal in 75, bunker wasn't cheap, price of crude increased, killing oil demand and killing tanker freight rates.Turbine engine were made for speed regardless of the Size of the engine, plus fuel tanks needed that were reducing Cargo capacity. Fuel comsumption of these turbine ships was much higher than Diesel fueled ships, T/C rates were lower because the t/c operator had to pay for extra-fuel. The only way to reduce fuel compsumption for charterers was to reduce speed, however reducing speed created combustion problems, shipowners were opposed to this. Result: most turbine driven VLCCs were sent to the breakers. (en of the cycle).
The Life cycle investment analysis is still valid in 2014..
These new engine are still adapted for high Speed but also have Fuel Flex features, I quote the MAN ME-GI that offer flexibility towards, LNG, HFO, LPG, LPG, Methanol, Dimethyl-E. This engine unlike its predeccesors is small, compact so doesn't reduced the cargo size carried by ships.
But everything comes at a price, in this case, it's 80M$ for a ship engine. Consider that financing a new ship equiped with a 80M$ engine or retrofitting an engine requires very long-term fixed Cash-Flows ! It's a big up-fronth cost. But here is something interesting:
I did calculations based on HFO at 650$/MT, The Teekay LNGC equipped with the ME-GI at 19,5 Knots and save 30 ton of HFO equivalent per day, so roughly 19,500$ per Day for the charterer plus very low maintenance cost, consider this a major evolution. http://www.teekaylng.com/.
Economists say that Changes are driven by costs. Considering that Daily hire is 18,000$ per day and the ship comsumes FO 60MT/Day @650/MT, or 39,000$/D, Fuel costs accounts for 68% of the freight cost.
Remember that we are still in the early begining of a world economics recovery and FO is priced at 650$/Ton a 100 years high, FO with 11.9 API = 102,40$/Barrels, no matters what you say the FO-Crude discount/premimum is not very big. We must test higher prices before we see elasticity substitution like in the 70's.
Simon