The trucking industry should keep a close eye on the forward curve of low-sulfur diesel fuel as implementation of IMO 2020 nears, according to speakers during the third day of Transparency19.
Under the IMO 2020 regulation, marine fuels must have a sulfur content of 0.5 percent or less, or scrubbers must be used to remove sulfur from emissions, starting January 1, 2020. The new sulfur cap for the global ocean shipping industry will increase demand for distillate fuel, which is expected to hike the price of diesel for land-based consumers.
John Kingston, editor-at-large of FreightWaves, cited an analysis by Baker & O’Brien and explained how the marine fuel rule translates into a cost risk for trucking.
The analysis estimated that about 700,000 barrels per day of non-compliant high-sulfur fuel will continue to be used by ship operators breaking the rule, and another 700,000 barrels per day would be consumed by ship operators using scrubbers. “The higher that number is [for continued high-sulfur fuel use], the better for the trucking sector,” said Kingston.
The risk to trucking stems from ship operators that comply with IMO 2020 by using either very low sulfur fuel oil (VLSFO) or marine gas oil. VLSFO is a blended product that incorporates vacuum gas oil, which is a distillate, meaning that ship owners would partially compete with diesel buyers to the extent the VLSFO is comprised of vacuum gas oil. Marine gas oil is a diesel product, so its marine buyers would fully compete with land-based diesel buyers.
“The big concern I have is that even though marine gas oil tends to be more expensive than VLSFO, ship owners know marine gas oil,” said Kingston. “They use it. They’re comfortable with it. But they haven’t used VLSFO and some ship owners have said that at least in the beginning, they’ll probably use marine gas oil, because they’re afraid their ships will stall out in the ocean if they use VLSFO.
“If there’s a rush to buy marine gas oil, it all comes from the same pool that produces diesel, whereas if they buy VLSFO, some of that, the vacuum gas oil that’s blended in, is distillate, but it’s not 100 percent distillate molecules.”
The potential for a diesel price spike is not yet apparent in the diesel futures market. According to Scott Sussich, director of data analytics at business intelligence company DTN, “The best indicator is the futures curve of ultra-low sulfur fuel and the prices for December 2019 and January 2020. If it looks like it’s going to hit the fan, there will be a lot of buying pressure and those prices are going to be driven up,” Sussich explained.
“If you look at the curve right now, the difference between June 2018 and January 2019 is only a few cents, which is normal. The market is saying, ‘Hey, we’ve got this under control.’ But if you see this spread widen out significantly and it’s not related to weather, that’s your clue that the industry thinks there’s going to be an issue and maybe you should start looking at what you can do to mitigate the risks through futures positions,” Sussich said.
Asked about risk-mitigation strategies, Matt Muenster, senior manager of applied knowledge at supply chain advisory company Breakthrough, responded, “Most of our clients are very heavily dependent on truckload. They’re limited in their ability to diversify their network and move away from diesel. We’re a very diesel-dependent country when it comes to moving our freight.”
Muenster continued, “They could look at a fixed-price solution, where they use hedging to lock in a price for a certain period, such as between the fourth quarter [of 2019] and the first quarter [of 2020], when we think the transition will reach its climax in terms of pricing.”
Some market participants are more comfortable with fuel hedging than others, noted Muenster. In some cases, larger companies are more open to doing so than smaller ones; in other cases, it relates to the nature of the company’s business.
“A lot of the food and beverage companies are already heavily involved in hedging their food and raw material costs, so they may be more comfortable with hedging the transportation,” he noted.
Beyond the diesel futures curve, another indicator to watch is the spread between low-sulfur and high-sulfur fuel. Current pricing is $1.55 per gallon for high-sulfur fuel oil, $1.97 per gallon for marine gas oil and $2.14 per gallon for VLSFO.
“If the spread between high-sulfur fuel oil and marine gas oil and VLSFO really widens, then the economics of putting scrubbers on ships and continuing to use dirty fuel get better,” said Kingston. The more scrubbers that are installed, the less ocean shipping will compete with trucking in the distillate fuel market, and the less upward pressure on diesel prices.