Much of the commentary surrounding IMO 2020 is that nothing has happened so far in oil markets. But this seems rooted more in a belief that when the market sees an impact from IMO 2020, it’s going to be all at once. It will be the type of event that everyone will know when it happens and can say “IMO 2020 is here.”
It tends not to work that way. As we’ve written in this space previously, there are movements in physical distillate markets that are showing reaction to the new rule. And a few market observers are starting to take notice.
Refineries are coming off their heavy fall maintenance season. It’s been common to see some of these price movements attributed almost exclusively to that maintenance season, when a drop in refining runs inevitably tightens up supplies. For a few weeks at the start of maintenance season, making the case that IMO 2020 was knocking on the door was supported by the fact that while diesel spreads were strengthening, gasoline spreads were not.
That has mostly ended, and gasoline’s spreads against benchmark crudes are starting to show significant gains, in some cases greater in percentage terms than that of diesel. That is a movement that might suggest that the strength in diesel is related to maintenance and not to IMO 2020.
But those basic visible spreads, known in the industry as cracks, are less interesting than some other signals. And those signals were highlighted in a recent report by Tudor Pickering Holt & Co. (THP), a boutique investment bank that focuses solely on the oil industry.
“With less than three months until the IMO’s new low-sulfur marine shipping regulations power up, we are seeing a number of positive price signals that indicate IMO impacts are beginning to roll into the market,” THP said in a recent report.
Among the market shifts that THP says are a sign of IMO 2020 preparation is the fact that the price of vacuum gasoil (VGO) is at a five-year high relative to Brent. VGO is a key product in the shift to lower sulfur marine fuels under IMO 2020. It can be used to make very low sulfur fuel oil (VLSFO), a quasi-fuel oil product that can displace the high sulfur fuel oil now used by ships and which will not be compliant with IMO 2020. We refer to it as quasi-fuel oil because the biggest part of it is going to be VGO, which is a diesel-like product that now can be used to make either gasoline or diesel. The assumption is that when IMO 2020 starts to kick in, you’ll see movement in VGO prices. According to THP, that’s happening.
There are other signs in the market. As THP points out, both high-sulfur fuel oil and Mars crude (which is a high-sulfur crude) are plummeting in value relative to international crude benchmark Brent. And S&P Global Platts this past week carried an article that said the bidding for Azeri crude out of Azerbaijan had put that market at six-year highs relative to Brent. Azeri crude is sweet (meaning it has a low sulfur content) and is rich in middle distillates, so it would produce a good amount of VGO in the refining process.
The story contained a quote from a trader that pretty much said it all, “Maybe the IMO effect has arrived already. Everybody is looking for Azeri.”
The January 1 deadline for IMO 2020 compliance is close enough that compliant fuels are available at multiple ports around the world, according to Unni Einemo, who is a writer but also a representative to the IMO for the International Bunker Industry Association. She recently spoke at a symposium of the IMO on the sulfur cap rule and Petroleum Argus reported that she gave a long list of areas that are selling compliant fuels. According to Argus, quoting Einemo, “IMO-compliant fuel is increasingly selling in Singapore and Fujairah, the two biggest bunkering ports, and at smaller ports in China, Japan, South Korea, Colombia and Brazil.” The story went on to say that it’s available in Europe as well.
The irony is that while U.S. diesel consumers might be impacted by IMO 2020, this country is not a significant bunkering port. But diesel, like all petroleum products, is a global market so shifts in the bunker market will reverberate through the entire fuel supply chain.
The U.S. Energy Information Administration (EIA) has been the most up-front in predicting what the price of diesel would do under IMO 2020. Its monthly Short Term Energy Outlook (STEO) has long had a prediction for the average retail price of diesel. If they’re right, we’re getting near the peak.
The latest DOE/EIA weekly retail diesel price, the basis for fuel surcharges, was $3.051/gallon. Last week, Timothy Hess, an EIA official who is one of the lead analysts in producing the STEO, said at a New York networking event that the agency’s calculations on how much diesel prices would rise relative to crude benchmarks like Brent and WTI were mostly driven by their calculations on the cost of making complaint marine fuels and how that would kick back down into the diesel market. That is about the most conservative approach that can be taken though it leaves little room for any sort of projection on how markets might react.
The EIA’s current estimates, which have changed little over time, is that the wholesale spread between diesel and Brent will rise from about 14 cents/gallon from 2018 to a 57.5-cent spread. But in terms of retail, that spread was seen actually declining to about $1.02/g from $1.05.
The end result is that if the EIA is right in all its forecasts, we’ve seen just about the highest diesel prices for the switch until next October. Because of projections of declining crude prices, even with the wider projected wholesale spread, the retail price of diesel projected by EIA drops down to $2.95/g in May before rising to $3.095 a year from now.
It’s a reminder that if the price of crude falls, the price of diesel can rise relative to it but still might not seem so bad, particularly coming after warnings of a significant spike. The price of crude will always be the main determinant in the price of products like diesel. One caveat: if the diesel market goes berserk because of IMO 2020, it can pull the price of crude up with it.