Beginning on January 1, 2020, the International Maritime Organization (IMO) will enforce a new 0.5 percent (50 parts per million) global cap on the amount of sulfur (S) in marine fuel, lowering the S content of marine fuel from the present 3.5 percent limit. The global cap on S is known as IMO 2020, and is part of the IMO’s response to heightening environmental concerns, contributed in part by emissions from ships.
As IMO 2020 nears, speculation and some early cost assessments by price reporting agencies have made their way into various discussions trying to answer the question: how much more will the rule cost me?
Overnight Thursday into Friday, oil markets had what is believed to be the first public instance of somebody putting their money down on what the change in marine fuel specifications will mean.
On the CME platform, during the Singapore day, the first trade was made in the new derivatives contract that is settled against an also-new Singapore IMO 2020-compliant 0.5 percent S marine fuel assessment. That marine fuel assessment was launched at the start of January by S&P Global Platts.
Like all derivatives, the contract on the CME is a cash-settled contract that needs some sort of benchmark to settle against. The new Platts assessment is that benchmark.
According to an article published by S&P Global Platts, the trade was made for December 2019 at a price of $500 per metric tonne (mt). The article also notes that the trade is believed to have been done as part of a spread trade with the widely-traded Singapore Fuel Oil 380 CST contract, which is a key benchmark for the bunker fuel market. Bunker fuel is the term for the sulfur-rich heavy oil that is now the primary fuel for powering ships and which is going to be mostly eliminated from that market when IMO2020 goes into effect next year. Distillate fuels – of which diesel is one portion – are expected to be a major substitute for bunker fuel under the new rule.
At the time of the $500 0.5%S trade, Platts reported that 380 CST fuel oil was believed to be trading at $325/mt for December 2019. How does that sort of a gap equate to a per gallon price? The conversion factor that Platts lists for IFO 380 is 6.35 barrels per metric tonne. Dividing that into the $175 spread, it works out to $27.55/barrel. Dividing that by the 42 gallons contained in a barrel, it is about 67 cents per gallon.
That doesn’t mean that the price of diesel is going to rise 67 cents per gallon when IMO 2020 takes effect. First of all, the new Platts assessment is for a low-sulfur fuel oil, not a distillate product – of which diesel is one kind – so there is no actual diesel in the comparison. Secondly, there is nothing to compare the 67 cents against, because this spread effectively did not exist until this month.
But the 67 cents is awfully close to the 65-cent estimate that the U.S. Energy Information Administration (EIA), in its most recent Short Term Energy Outlook, put on its expected gap between the price of Brent crude oil and the rack price of ultra low sulfur diesel in the U.S. when IMO2020 takes full effect next year. The comparison between those two estimates is far from perfect: one is a crude to refined product comparison while the other is a comparison of two different grades of fuel oil. One is an estimate put together by the economists at the EIA; the other is in one trade – and the first one at that – for a contract whose volume recorded on the first day of trade was a grand total of 20 lots. Finally, the 65-67 cents is not a projection of how much prices might rise. While you can’t compare the 67 cents to the past, because there is none, the 65 cents is against what the EIA’s report said is a normal spread that averaged 43 cents in 2018 and is expected by EIA to rise to 48 cents in 2019.
Still, for the first time, it isn’t just speculation by analysts or economists on what might happen. While there has been a marker on the price since the launch by Platts and also by its rival Petroleum Argus, the reality is that for today at least, there’s a trade with real money behind it and not just a number published by a price reporting agency.