Upcoming changes in marine fuel sulfur limits will affect crude oil and petroleum product markets (continued)

The January 30 feature article of This Week in Petroleum examines the medium- to long-term implications of changes to marine fuel sulfur limits. This feature article is a continuation of the January 16 feature article that examined the short-term implications of the same topic.

In January, the U.S. Energy Information Administration (EIA) released the Annual Energy Outlook 2019 (AEO2019) that includes an analysis of the medium- and long-term implications of upcoming changes to marine fuel sulfur specifications on crude oil and petroleum product markets. This analysis follows the release of EIA’s January 2019 Short-Term Energy Outlook (STEO) that examined the same marine fuel change implicationsthrough 2020. 

Set to go into effect January 1, 2020, the International Marine Organization’s (IMO) new regulations limit the sulfur content in marine fuels used by ocean-going vessels to 0.5% by weight, a reduction from the previous limit of 3.5% established in 2012. This upcoming change has wide-scale repercussions for the shipping industry and refineries worldwide. 

Globally, marine vessels account for about 4% of global oil demand and are a critical part of the global economy, moving more than 80% of global trade by volume and more than 70% by value. Consumption of bunker fuel (the fuel mix consumed by large ocean-going vessels) is a relatively small share of energy demand in the United States. In 2018, total U.S. consumption of bunker fuel was 411,000 barrels per day (b/d), representing about 3% of total transportation energy use and just 1% of total U.S. petroleum and liquid fuel use. 

Residual oil—the long-chain hydrocarbons remaining after lighter and shorter hydrocarbons such as gasoline and diesel have been separated from crude oil—currently accounts for the largest component of bunker fuel. Although distillate fuels, the other large component in bunker fuel, have alternative uses and markets outside of marine fuels, residual oils have few other alternative markets as about 80% of total U.S. residual fuel demand is for marine bunkering. Therefore, the steps vessel operators take to comply with the new IMO sulfur limits have major implications for the use of residual fuel oils in marine fuels, for the price of residual fuel oil and its competitors, and for the refineries that produce residual fuel oil. 

One option vessel operators have is to switch to a lower-sulfur fuel compliant with the new IMO rules, likely increasing demand for distillate and low-sulfur residual oils. Another option is to use scrubbers to remove pollutants from ships’ exhaust, allowing them to continue to use higher-sulfur fuels. Ships also have the option to switch to nonpetroleum-based fuels, such as liquefied natural gas (LNG). In the AEO2019 Reference case projections, the fuel mix of ocean-going marine vessel bunkering in the United States changes significantly because of the new global sulfur fuel limits (Figure 1). 

The share of high-sulfur residual fuel oil drops from 58% in 2019 to 3% in 2020 but rebounds to 24% in 2022. Despite a recent increase in installation and orders, the number of vessels installed with scrubbers required to continue using high-sulfur residual fuel oil remains limited. Therefore, AEO2019 projects a large but brief increase in the share of distillate fuel oil and low-sulfur residual oil in the years immediately leading up to and after 2020. A recovery in high-sulfur residual fuel oil consumption as a result of scrubber installations does not occur until two years after 2020, and at levels far lower than before the 2020 IMO implementation. After 2023, high-sulfur residual fuel oil consumption declines throughout the AEO2019 Reference case projection, down to a 5% share of U.S. ocean-going marine vessel bunkering by 2050. 

As 2020 approaches, EIA expects refineries to continue to announce plans to upgrade high-sulfur residual fuel oils into higher value products and increase the availability of compliant low-sulfur marine fuel oils. However, uncertainty still exists regarding the IMO-compliant fuel specification and, in turn, what its supply chain will look like. In AEO2019, EIA projects that the share of low-sulfur residual fuel oil consumed in U.S. ocean-going marine vessel bunkering will increase from 38% in 2020 to 49% in 2050. Similarly, EIA projects that the need to use distillate in lower-sulfur bunker fuels will increase distillate’s share of U.S. bunkering demand from 36% in 2019 to 57% in 2020, although this share declines to 36% by 2050. 

Outside of residual fuel oils and distillate, the use of LNG in marine bunkering is forecast to be limited in the January STEO through 2020, and similarly the AEO2019 Reference case projects limited use in the next five years, reflecting the limited infrastructure to accommodate LNG bunkering at U.S. ports. In the medium and long term, this infrastructure barrier decreases, and LNG’s share of U.S. bunkering grows to 7% in 2030 and to 10% by 2050. 

Similar to the January STEO forecast, the AEO2019 Reference case projects the U.S. refining sector will respond to the projected lower demand for residual fuel oils as well as increased demand for low-sulfur fuels by increasing refinery utilization and switching to lower-cost inputs. 

Much of U.S. refining capacity, especially on the U.S. Gulf Coast, has downstream units that upgrade residual oils into more valuable and lower-sulfur products, and thus these units can process heavier and higher-sulfur crude oils that yield large quantities of residual oils. As a result, in the AEO2019 Reference case, U.S. refinery utilization peaks in 2020 at 96%—and remains between 90% and 92% for the rest of the projection after 2026—as these complex refineries take advantage of increased prices for lower sulfur fuels. To facilitate this increase in utilization, AEO2019 Reference case projects that U.S. refineries will increase imports of high-sulfur residual fuel oil, as its use in marine fuels will decline after 2020. The increased imports of high-sulfur residual fuel oil for additional processing would appear as increased imports of unfinished oils, and they are projected to peak at 842,000 b/d in 2020 and then decline to 537,000 b/d by 2050 (Figure 2). 

The increase in fuel production resulting from increased refinery utilization and the increased demand for low-sulfur fuels after the IMO rule goes into force in 2020 will contribute to higher U.S. exports of diesel and low-sulfur residual fuel. As a result, in the AEO2019 Reference case, the portion of U.S. refinery throughput that is exported increases, as more petroleum products are exported between 2020 and 2040 and as domestic consumption of refined products decreases. U.S. exports of diesel fuel and residual fuel are projected to peak in 2020 at 2.7 million b/d, with most of this increase coming from low-sulfur diesel and low-sulfur residual fuel. The portion of U.S. refinery throughput that is exported decreases after 2036 when domestic consumption increases. 

Projected widening of price spreads between low- and high-sulfur crude oil and shifts in demand from high-sulfur fuels to low-sulfur fuels result in U.S. refinery run increases. The AEO2019 Reference case projects refinery margins, or crack spreads, for low-sulfur fuels will increase in 2020 as a result of the IMO 2020 rule. From 2019 to 2020, EIA projects that the diesel fuel crack spread will increase more than the jet fuel and gasoline crack spreads from $11.11 per barrel (b) to $19.67/b. In the AEO2019 Reference case, the jet fuel crack spread increases $6.66/b to $17.62/b in 2020, and the motor gasoline crack spread increases $3.85/b to $11.89/b in 2020. The diesel price and, consequently, its crack spread will increase the most when compared with other fuels because of the ability to blend distillates, like diesel, with high-sulfur residual oils to produce a potentially IMO-compliant fuel (Figure 3). 

AEO2019 projects most of the supply-side effects of the IMO regulations fade out of the market by 2026.