12-04-2018

The 2020 global sulphur limit and the Scrubber exercise

It has been a long-standing objective of the IMO to reduce the sulphur content in marine fuels for quite some time now hence, its latest decision to lower the cap to 0.5% sulphur content from January 1st, 2020 is of no surprise to anyone. As expected, this decision aims to reduce the adverse impacts of the SOx, NOx and Particulate Matter emissions produced by the world fleet on human health and to improve the air quality of this world.

Although transportation of goods by sea is by far the most environmentally efficient method of trade – far more than road or air transport; these latest regulations will inevitably impose even stricter environmental criteria for the shipping industry. However, the inherent paradox in this, is that the pollution ratios for shipping are constantly improving while the totality of cargo carried by the global fleet is constantly increasing. This has been achieved through design improvements to modern ships, their engines and their respective propulsion, resulting in significantly lower consumption and emission figures along with an increased cargo intake.

Shipping should be the one of the last industries which are subjected to the environmental microscope and there are still numerous questions posed surrounding the net effect of the global sulphur limit cap on the environment. It goes without question that the introduction of such a regulation will decrease the SOx, NOx and PM emissions from ships but at the same time will increase the pollution from the refineries which have been tasked with production of the VLSFO. Come 2020, most of the marine fuel demand will be for the compliant VLSFO and the refineries will have to produce the VLSFO to satisfy the demand of the industry. Such production comes at a environmental cost from both de-sulphurisation and additional fuel blending. Not to mention that such demand can only be satisfied after refineries undergo an ‘upgrade’ in order to host these new production capabilities which would impose an additional environmental burden. Also, the existence of VLSFO will create additional storage and segregation needs both onshore and on board barges.

Notwithstanding the above, ship owners have the option to continue to burn the 3.5% sulphur content fuel post 2020, provided they install exhaust gas scrubbers on their vessels. These devices are designed to remove the sulphur oxide present in the exhaust gas with seawater. This reaction generates sulphates which then are either discharged as wastewater at sea (Open Loop Scrubbers) or kept on board until the vessel can discharge it at suitable onshore facilities (Closed Loop Scrubbers). Therefore, the question that seems to eventually form, is where the pollution will be redirected (between air, water and shore – all of which are connected).

Scrubber Exercise

Nevertheless, the shipping industry must and will comply, and the additional costs associated with the implementation of the low sulphur regulations will eventually be passed to the end consumer. In the medium term, the freight market has no other option than to adjust for the (increased) bunker cost. The spread between FOB and CIF cargo prices will increase as the transportation cost increases by way of increased voyage expenses. Every single individual consumer around the world is going to pay for the new regulations through the increased cost of raw materials and eventually consumer goods.

On the financial side, the natural position of a ship owner is long on ships. The implied ‘Risk vs Return’ curve of the business for any shipowner would naturally reflect the risk of any future legislation being imposed and the costs associated with its compliance. For that reason, someone could say that, installing scrubbers, is a decision against the natural position which for all intents and purposes is no different than hedging the bunker prices for marine fuel or otherwise. Therefore, the decision to install scrubbers is inherently a speculation which, hopefully, would turn out to be financially beneficial to those that will opt for it. There is nothing wrong with that provided this is an informed decision.

A speculation can be translated into a prudent business decision, when the return from such is as certain as possible at minimum risk. This is the reason why there is so much noise surrounding the thousands of “Scrubber Repayment” schedules that exist in the market which aim to justify such decision. The whole scrubber exercise is a bit controversial as the benefit from installing a scrubber would be bigger in older ships with larger consumption. All going well, that would make any amortization schedule shorter, however, as older assets tend to have a limited residual life, that would increase the risk of the project (as new regulations may, although not likely, intercept scrubbers’ operations at any time in the future) and these thoughts are repeating in a never-ending cycle. Also, smaller ships that consume less fuel would require a longer amortization period.

Eventually, whether the installation of a scrubber is going to be in an older ship, a modern one or a newbuilding, it all comes down to the price differential between the HSFO and the compliant VLSFO post 2020. Obviously, the greater the differential between the fuels – the greater the benefit from installing the scrubbers – the faster the amortization of the project – the lesser the risks. There are many bunker experts expecting a differential that could be as big as 300-400$/MT upon inception of the regulations (where logic dictates that the wider differential should be witnessed due to the uncertainty and volatility of the transition period). If one were to take such a differential, then the amortization of a scrubber on a dry bulk capesize vessel on a retrofit basis, would be something less than a year – always dependent on the operational speed. Therefore, anyone would think that this is a no-brainer. Well, it is provided you get it right. Good thing is that once the scrubber has been fully amortized any additional benefit exponentially adds to the return. However, it should be noted that the benefit will only exist as long as the majority of the ships burn VLSFO and the spread with the HSFO holds good as the majority of ships are compelled to burn the most expensive fuel. For example, assume that on January 2020, all ships where fitted with scrubbers there would simply be no benefit as the fleet fuel demand would not switch towards the VLSFO and the loss would amount to the total cost of the scrubber installation.

To sum up, the shipping industry has adopted a wait-and-see stance so far, however, it seems that the latest regulations may present an opportunity for those that are willing to take on, amongst others, the risk of the fuel oil differential between VLSFO and HSFO post 2020.

Source: Global Sulphur Limit (John Yallouridis)

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