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Aug.7, 2017

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TRADING PLACES 70 THE JOURNAL OF COMMERCE Peter Tirschwell AUGUST 7.2017 LOW SULFUR'S HIGH PRICE IT'S STILL MORE than two years away and on the radar of few beyond ship- owners for whom a state of disquiet would certainly be understandable. On Jan. 1, 2020, a 0.5 percent sulfur cap on marine fuel consumption globa lly seems cer ta in to ta ke effect. Unless an owner plans not to comply — and law-abiding players are already sounding the alarm about the need for enforcement — ships have limited options. They must run on liquefied natural gas; be fitted with exhaust gas cleaning sys- tems, better known as scrubbers; or switch from heavy bunkers to low- sulfur fuel. No option comes without significant cost, and in shipping there is no guarantee that market dynamics will yield the additional revenue needed to fund the switch. For container shippers, it would be easy to ignore the mandate and its effect on carriers, because, well, it's a few years down the road. Besides that, what additional costs imposed on carriers have ever translated directly into higher rates for ship- pers? Even surcharges that are intended to be linked to specific car- rier costs frequently are swept away by the undertow of supply-demand dynamics unfavorable to carriers. But this mandate may be worth looking at differently, if only because the sulfur cap will come into force after the most intense period of consolidation in the industr y's 60-year history. By 2020, the cur- rently announced deals will be implemented fully, and it's possible that additional M&A activity will have occurred, considering today's handful of sub-scale mid-tier car- riers that will find it increasingly difficult to compete. Following the acquisition of OOCL by Cosco Shipping Hold- ings, only 12 global container car- riers will remain in operation by early 2018, versus 20 in 2016, accord- ing to research analyst Alphaliner. The biggest question facing the container industry is whether carri- ers will finally get their acts together as a result of this consolidation and learn how to responsibly and legally price their services so as to earn an adequate rate of return. A costly new mandate imposed on a newly con- solidated industry might help them come to their senses. The additional cost to the indus- try to comply with the sulfur cap isn't known yet, but the costs almost certainly will be substantial. One esti- mate put the price to the maritime industry overall at $60 billion annu- ally. According to the International Chamber of Shipping, the cost of compliant low-sulfur fuel is currently about 50 percent more than the cost of residual fuel, and as demand for low-sulfur fuel grows after 2020, the differential will widen. This will make shipowners think twice about committing to low- sulfur fuel as a compliance strategy versus continuing to burn traditional bunkers and cleansing the emissions using scrubbers. But scrubbers them- selves aren't cheap, and they fail to address the need for greater engine energy efficiency that potential CO2 reduction mandates on shipping eventually could require. To understand the impact, it's necessary to look at what the sul- fur cap will mean for the refining industries. Although marine bun- kers account for only 4 to 5 percent of total fuel product demand glob- ally, a spike in demand for low-sulfur grades will be felt throughout the refining industry, according to IHS Markit energy analysts. "The bunker fuel sulfur reduc- tion in 2020 will potentially be the most disruptive product quality change in decades," IHS Markit energy analyst Stephen Jew said. "The primary challenge with the bunker fuel quality change is the displacement and re-disposition of high-sulfur residual fuel out of the bunker pool, not the ability to pro- duce low-sulfur bunker fuel." In other words, there will be a strong demand and higher price pressure in the bunker market for low-sulfur fuel while higher-sulfur fuel oil will have to find another out- let. Because the low-sulfur bunker fuel will be more largely gasoline- based, cost of production will be significantly higher, and the same gas oil components will compete with other gas oil sectors such as on-road diesel and power. To dispose of the excess high-sulfur fuel oil into non- maritime markets, such as the power market, it will have to be priced com- petitively at thermal power pricing parity instead of fuel oil pricing parity. "High-sulfur fuel oil will be forced into lower-value markets as the new rules take effect," Jew said. That's why he thinks many ship- owners eventually will turn to scrubbers as a lower-cost solution. "The large, high-fuel consumption ships will install scrubbers, but the rate of uptake will be limited by installation capacity, drydock schedules, and shipowner financial constraints," he said. Others within IHS Markit agree. "Based on what I'm hearing, the low- sulfur avenue is the least popular one, in part because it's hard to pre- dict where oil prices are going to go," said John Gallagher, who has been following the developments as the global regulatory editor at Fairplay, a sister product of The Journal of Com- merce within IHS Markit. At least publicly, some shipown- ers say bunkers are impractical and that the industry needs to embrace a future of low-sulfur fuel. Maersk, for example, told marine fuel publication Ship and Bunker that scrubbers "are not a long-term solu- tion. By allowing the continuous use of cheaper fuels, (scrubbers) may ruin any kind of business case for enhancing energy efficiency." JOC Contact Peter Tirschwell at and follow him on Twitter: @petertirschwell.

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