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The United Nations’ International Maritime Organization (IMO) implemented its low-sulfur fuel mandate on January 1, 2020. Full enforcement begins in earnest on March 1. Referred to as IMO 2020, it updates Annex VI of the MARPOL (or Marine Pollution Treaty of 1973). Annex VI covers a variety of airborne pollutants from vessels. Local jurisdictions, however, have the option to enforce even tighter standards. Thus, IMO 2020, as a minimum standard, applies to international waters.
The scale of the pollution problem is highlighted in a 2018 study by Goldman Sachs. The marine sector is responsible for 90% of the sulfur-dioxide generated by all modes of transportation. Just 15 of the world’s largest ocean vessels generate more sulfur-dioxide than all the automobiles in the world. Sulfur-dioxide is a pollutant that is harmful to the respiratory system and adds acidity to the air which can harm crops and vegetation.
The IMO oversees 174 signatory nations. The global fleet of merchant vessels is around 53,000 units with almost 18,000 being general cargo and 12,000 being bulk cargo. Containerized vessels, typically carrying the most valuable cargo per ton, are barely 5,000 in number. Therefore, different types of water-based operations are affected by the new regulation. Some of these carriers are better able to take on the extra cost of compliance.
Under IMO 2020 the maximum sulfur content of bunker fuel to be used on ocean vessels falls from 3.5% by weight, set in 2012, to 0.5% (i.e., an 86% reduction in sulfur content). This applies to all fuel used on board – in main engines, auxiliary engines and boilers. This is certainly the largest one-time change in international sulfur emission standards and, though it has been on the industry’s radar since the IMO announced it in 2016, many ocean carriers will be scrambling this year to comply. Moreover, the IMO designated certain Emission Control Areas (ECAs) where the standard is even stricter at 0.1%. The ECAs cover: the Baltic Sea, the North Sea and designated coastal areas of Canada, the Caribbean (specifically Puerto Rico and the U.S. Virgin Islands), and the United States.
Ocean carriers have three choices: convert to low-sulfur fuels; retain the heavier, and less expensive, bunker fuel but take on the cost of installing scrubbers (i.e., exhaust cleaning systems); or apply to the flag state for a waiver on behalf of the IMO. Of course, the ocean carrier would have to demonstrate that acceptable alternative fuels were not available for purchase. Flag states, for their part, are required under Regulation 18 of Annex VI to “take all reasonable steps to promote the availability of fuel oils which comply with this Annex and inform the [IMO] of the availability of compliant fuel oils in its ports and terminals.” The IMO also noted that exceptions are possible for emergencies involving risk to life and damaged vessels. It is also up to each flag state to determine appropriate fines for non-compliance. Thus, while the rules are uniform the sanctions are not.
The famously dismal science known as economics suggests that if demand for low-sulfur fuel rises faster than the available supply (via refinery output and inventory draw-down) prices will rise in the near-term. Beyond basic economics are the logistical constraints of time, physical space and location. This means that some ports may have enough compliant fuel to service their customers while others may not. If this is the case, one cannot expect supply chains and ocean transportation networks to adjust quickly enough to prevent such a price increase. Until adequate fuel supplies are available where needed, the adjustments likely to take place would involve what one would expect in any large neighborhood where there is only one gasoline station. Drivers would either: hoard their fuel early on (creating traffic congestion in the area); or drive more slowly and plan trips carefully all the while hoping that a fresh supply will be on hand before the gas tank runs dry. In like manner, ocean vessels would curtail their speeds in-between ports of call and hope to ride out any shortages.
Yet things have not been dismal so far. To date there has been no price spike in diesel fuel – a low-sulfur option. This is good news given that IMO 2020 indirectly affects other modes of transport that use diesel fuel (i.e., trucks and railways). Very low sulfur fuel oil (VLSFO) also meets IMO 2020 standards and is available at the major ports (e.g., Rotterdam and Singapore). BIMCO, the world’s largest association of ship owners, characterizes VLSFO prices as having been on a “rollercoaster” since December 2019. The Singapore price peaked on January 7, 2020 at $740 per metric ton and has since fallen to $641 on January 22, 2020. Along the way the price spread between VLSFO and heavy bunker fuel reached a high of $340 per metric ton before falling to $284. Despite the narrowing price spread between the two fuels many carriers will likely invest in scrubbers. Installation cost per vessel starts at about $2 million and can rise to several million more. This is the classic cost-benefit problem of taking on up-front costs versus estimating the present discounted cost of a more volatile commodity over time. Still, BIMCO estimates that using scrubbers will take anywhere from 0.5 to 1.5 years to have a lower cost impact than switching to VLSFO. This range is dependent, of course, on the installation cost and annual maintenance costs of the scrubbers as well as the daily volume of fuel consumption.
Despite the eventual savings that come from scrubbers relative to VLSFO, there is still a monetary risk from external sources. This is the classic social cost-benefit problem in which a firm must consider larger environmental impacts beyond its own market. The IMO could eventually ban heavy bunker fuel and thereby invalidate the purpose of scrubbers. The scrubbers themselves could be banned due to the effluent that they generate, which must be disposed of after arrival at a port. As scrubbers become more prevalent under IMO 2020 will trading off sulfur particulate matter for effluent waste dumps, and the associated risk of ground contamination while awaiting treatment with caustic soda, be ignored by some future update to IMO regulations? The Exhaust Gas Cleaning Systems Association estimates around 6,500 vessels will have scrubbers in place by 2021.
In any case ocean carriers will be taking on more costs as they adjust to IMO 2020. They will certainly try to pass those costs along to their customers as a bunker adjustment factor (BAF) or surcharge. This is where things may get dismal indeed as freight rates factor into upcoming contract negotiations. Typically, trans-Pacific contracts run from May 1 through April 30. Big liners such as Maersk applied a BAF on December 1, 2019 to containers shipped under spot rates and under contracts of less than three months.
Who bears most of the regulatory burden is a problem that economists study at length. Again, carriers buying the same fuel type face roughly the same cost per ton but they may carry bulk or containerized cargo of much different values per ton. For consignors of bulk cargo versus those of containerized consumer goods, if each faced the same BAF in straight dollars, the latter would find it easier to absorb since the value of their shipments are higher on a per ton basis. On the other hand, any excess capacity in a shipping lane puts the consignor in a better position to hold off surcharges. The trans-Pacific trade lanes have slowed amid the U.S.-China trade war. It is too soon to tell what the effects of the “Phase 1” U.S.-China trade deal will be. There can be several opposing forces that complicate estimating the net effect. Some consignors may feel pressure to accept the carrier’s BAF formula while others may be able to negotiate its structure. Nonetheless, it should take until 2022 before the BAFs have helped to stabilize the fuel-related costs of ocean carrier operations.
Liquified natural gas (LNG), creating no sulfur emissions at all, is another option but the conversion from heavy bunker fuel is even more expensive. Since LNG density is lower than bunker fuel, LNG tanks need to be quite a bit larger. TOTE Maritime Alaska was an early adopter of this technology. It is the first carrier in the U.S. to retrofit a vessel for LNG power. Its two diesel-powered Orca-class roll-on, roll-off (RO-RO) vessels (built in 2003) were retrofitted with two LNG cryogenic tanks placed on the weather deck behind the ship’s bridge. Each tank has a 1,100 cubic meter capacity.
After taking around eight weeks to retrofit, the North Star returned to its Tacoma-Anchorage service in early 2018. Its sister ship Midnight Sun will be retrofitted in 2021. Of course, as a Jones Act carrier, TOTE would no longer be dependent, unlike other carriers, on oil refinery deliveries to U.S. ports. TOTE is planning to buy its LNG at the Port of Tacoma from Puget LNG once the company begins operations in late 2021. Until then the two vessels will still be running on diesel. The North Star had one of its two engines converted to LNG in December 2019. Since these two vessels play a large role in the delivery of consumer goods to Alaska it has been necessary to stagger the retrofitting process. While less than 5% of the global fleet runs on LNG there is no doubt that IMO 2020 will boost its prospects when carriers consider new vessel orders over the coming decades.
The years of planning for IMO 2020 have paid off thus far. All key players were in it together so to speak – the ports, the carriers and their flag states. Some flag states may be quick to fine carriers arriving at port with non-compliant bunker fuel and some may not. Some carriers may choose not to comply with IMO 2020 until they are caught. Such is the nature of a diverse global industry made up of developed and less-developed nations. In any case, such discretion adds slack when needed in the fuel markets. Green policies for blue skies will surely occupy business and government relations for decades to come.