The Likely Future Direction of Fuel Oil

  • 5 Sep 2017
  • By Paul Wightman
  • Topics: Energy

Sulphur levels are being drastically cut for the world’s shipping fleet, impacting about 70,000 vessels following the October 2016 decision by the International Maritime Organization (IMO) to implement a global sulphur cap of 0.5% in 2020. The bunker pool will transition from high to low sulphur in 2020, and this will have knock on effects for both the shipping industry and the refiners who must supply fuels into it.

There are not only questions about future fuel availability but also how the market will adapt to the tighter regulatory environment, and the choice of bunker fuel that it will make from 2020. The CE Delft analysis1 on which the IMO decision was based strongly indicated that sufficient quantities of fuel oil would be available to the market. This report examines some of the other factors outside the supply chain that are likely to influence the market dynamics as the 2020 timeline approaches.

Bunkering costs look set to rise sharply with the ship owners likely to bear the brunt unless they can pass them on to the chartering parties. Industry consultants Wood Mackenzie suggests that the cost of compliance with the new standards could run to as much as $60 billion per year by 2020 on the assumption that the bunker market switched to a distillate-based solution – currently the most likely scenario.

Where Europe Leads, the World Follows

The latest IMO ruling does not affect the Emission Control Areas (ECAs) in Europe where the sulphur oxide levels have been 0.1% since 2015. The ECAs fall under the IMO MARPOL Annex VI2 for the prevention of Air Pollution from Ships and affect shipping routes in the North Sea, Baltic Sea, the English Channel, the Coastal areas of the United States and the Caribbean.

The IMO 2020 ruling expands limits on sulphur oxides globally and brings into compliance areas that were previously exempt from the restrictions on sulphur. Countries that were not previously covered by sulphur oxide restrictions have been setting up their own Emission Control Areas. In China, the Maritime Safety Administration3 set up its own Emission Control Area for selected coastal areas in December 2016. Based on the ruling, the maximum permitted sulphur content is 0.5%, which matches the IMO 2020 regulations. The map below shows the extent of the 2020 IMO regulations and as can be seen, there are different sulphur regulations applying to different regions but the global sulphur cap is set at a maximum sulphur content of 0.5%.

Source: DNV GL4

How Large is the Bunker Market?

The maritime fuels market is estimated to be about 230 million tons per year or 4 million barrels per day5 but looks set to rise depending on the outlook for economic growth. The current bunker fuel market consists of both heavy fuel oil and marine distillates, but the majority of the bunker market is heavy fuel oil, mainly due to the cost advantage compared to alternatives. Around 10-20% of the bunker market is marine distillates and/or Liquefied Natural Gas (LNG). As the 2020 emissions deadline looms, there is expected to be a switchover from heavy fuel oil to lower sulphur alternatives such as marine gasoil or even natural gas based alternatives such as LNG.

It is not possible to determine how much of the bunker fuel market will switch to middle distillates, but the IEA believes that around 75% of the current bunker fuel market could switch to marine distillates. Based on a bunker fuel market of 230 million tons per year, this could be over 170 million tons per year accounted for by distillates. Any switch from the heavy sulphur bunker pool means that refiners would have to seek ways to remove high sulphur products from the market and boost the production of lower sulphur alternatives.

There are questions about where the market’s preference for bunkering will be once the sulphur cap comes into effect and much of this choice will depend on fuel availability as well as price. In Rotterdam, the price of IFO 380CST fuel oil and marine gasoil remains competitive when compared with Singapore and Fujairah but much will depend on how available the fuels are in the 2020 period.

Europe has a strong reliance on cheap Russian fuel oil to supply the bunker market but is a net importer of middle distillates. Fuels Europe estimate6 that OECD Europe import around 15 million tons of distillates per year with over half of this volume coming from Russia (the remainder arriving mainly from North America). Asia and the Middle East may have higher availabilities of distillate bunker fuels meaning that ship owners may have to bunker outside Europe to have a wider fuel supplier choice at a competitive price.

Based on data from Ship and Bunker, the marine gasoil price for a four-port average7 is around $170 per metric ton higher than the 380CST fuel oil price. The four-port average represents around 25% of global bunker volumes. As the demand from the marine sector begins to compete more directly with the broader transportation market, prices for middle distillates are expected to rise. The biggest rise is likely to come in and around 2020 as shippers try and ensure compliance. Wood Mackenzie estimates that “cost of compliance” with the bunker regulations could rise by as much as $60 billion per year.

We have done some analysis on the bunkering cost impact on a charter voyage from the Saudi port of Ras Tanura to Japan, which is a common shipping route for crude oil traders. The bunkering costs are established as the total cost of the fuel and the port charges. We have used a spot bunker price for IFO 380CST in Singapore of $311 per metric ton and a Singapore marine gasoil price of $474.50 per metric ton*. For a standard voyage, we have assumed the following criteria.

Activity #days Cost – IFO 380cst* Cost – MGO*
Loading days 2 days @ 20 metric tons per day $12,440 $18,980
Laden days 22 days @ 70 metric tons per day $478,940 $730,730
Ballast days 23 days @ 53 metric tons per day $379,109 $578,415
Discharging days 2 days @ 110 metric tons per day $68,420 $104,390
Total   $938,909 $1,432,515

*Prices are effective end-July 2017

Based on this analysis, a typical charter for a ship from the Middle East to Japan would cost an additional $500,000 in bunkering costs for using marine gasoil rather than heavy fuel oil.

Do Ship Scrubbers Have a Future?

It is unclear to what extent the shipping market will rely on the use of scrubbing technology to continue burning higher sulphur fuel oil. Scrubbing technology effectively removes the sulphur dioxide and other unwanted chemicals from its emissions whilst on-board a vessel. The technology comes at a cost and Finnish engineering firm Wartsila estimates that the cost of installation is typically between $3 million and $12 million per vessel. With such high up front capital expenditure, it is not clear whether all shipping companies would be able to take on the required investment as many companies are struggling to access credit. Shipping companies would also have to be prepared to dry dock their vessels for up to a month to install the technology.

What is the Forward Curve Indicating?

Fuel oil prices for 2020 remain weak indicating a likely drive towards compliance with the IMO regulations. The 3.5% fuel oil forward curve has flattened significantly over the past few months. Looking at the forward curve for gasoil and fuel oil, generated by derivative clearing through CME Clearing, the spreads have also been widening for the deferred contract months, indicating a switch to distillates and away from fuel oil. Based on Exchange Futures settlement prices as at the end of August 2017, the value of the spread between 0.1% gasoil and high sulphur fuel oil for Rotterdam delivery was trading at $187.50 per metric ton for the December 2017 contract month. However, the spread for the December 2020 contract month was trading at over $235 per metric ton (effective end August 2017). The spread between distillates and fuel oil for the December 2017 contract month was aligned broadly to where the price for the spot was trading, based on Platts data.

Chart 1: The Spot Spread Between European High Sulphur Gasoil and European High Sulphur Fuel Oil

Source: Platts data

With such a negative backdrop, refiners would appear to be expecting fuel oil prices to weaken over time, which is reflected in the structure of the forward curve. The structure would also seem to show the natural long side (i.e. the refiners) of the market selling into any price recovery at the back end of the curve, which is also pressuring crack spreads, especially at the back end of the curve. The data shows a year ago, before the IMO ruling came into force, that the curve was largely in a contango structure.

This also reflected more normalized market conditions. Forward crack spread prices have fallen, especially for the deferred contract months, partly reflecting the future demand for fuel oil. Refinery hedging at the back end of the curve may also have contributed to weaker prices. Effective end August 2017, the high sulphur fuel oil crack spread reached around -$5.5 per barrel, supported in part by the decline in sour crude supply due to the OPEC cuts. However, crack spreads for the deferred contract months were around $10 per barrel lower at -$5 per barrel.

The chart below shows the crack spread Futures forward curve for high Sulphur fuel oil in Rotterdam at selected points in the past 12 months. The thicker Green and Blue lines show the forward curve before the IMO fuel oil change whereas the other lines show the evolution of forward curve from the end of 2016 until the summer of 2017. The cracks for high sulphur fuel oil as well as the outright fuel oil products are all clearable at CME Clearing and trading via CME ClearPort or on CME Globex.

Chart 2: European High Sulphur fuel oil crack spread forward curve (USD per barrel)

The market view would appear to indicate an increase in demand for low Sulphur at the expense of high Sulphur. In the fuel oil, the spreads between high and low Sulphur continue to widen especially for the deferred contract months in the 2020 period. Based on the activity in the futures contract, the spreads for the high-low Sulphur fuel oil spreads reached around $60 per metric ton at the end of August 2017. One reason for this could be that the market is starting to price in an anticipated rise in demand for lower Sulphur fuels, around the time of the IMO 2020 regulation. This spread is also tradable at NYMEX and clearable via CME Clearing.

What is the Supply Side Response?


One issue for the refiners is that there is not currently a globally accepted refining method for producing 0.5% Sulphur fuel. This will lead to some complications around blending where possible. For the distillates, the Sulphur specs are generally lower than 0.5% Sulphur and therefore refiners would be giving away value by selling traditional distillates with a lower Sulphur content.

The European experience moving to 0.1% bunker fuel in 2015 for the ECAs showed that a possible fragmented market may emerge. Bunker suppliers may focus supply on the larger ports leaving the smaller ones short on compliant fuels.

As the Sulphur specs tighten this is likely to favor the most sophisticated refineries or those that can produce 0.5% Sulphur fuels as cheaply as possible. Platts suggested that it might be possible to produce 0.5% fuel oil from some sweet crudes.


However, in most cases, refiners would require some form of deep conversion involving the injection of hydrogen to produce the compliant fuel. This will all come at a much higher processing cost compared to how the 3.5% fuel oil is produced currently.

Those regions where refinery complexity is higher will tend to cope better than those where the refining infrastructure is more simplified. Refinery complexity in the US, along the Gulf Coast, tends to be higher along with parts of Asia but the European sector is typically less complex in terms of deep conversion and therefore some refiners may be less agile at producing required volumes of compliant fuel. This will impact their profitability compared to other more complex refineries.

Consultancy firm PIRA energy provides a forecast for refinery capacity additions. They believe that the net supply of high Sulphur products could decline by 1.4 million barrels per day by 2020 and low Sulphur supply grow by 900,000 b/d.8 They  also believe that around 3 million barrels per day of residual fuel oil will need to be destroyed but at the same time increase low Sulphur supply by 1 million barrels per day as well as ensuring that there are sufficient volumes of distillates available. Currently the market remains long of high Sulphur fuel oil and short on distillates – but this may change with the ongoing reduction in supply of heavy high Sulphur crudes (hampering the supply of fuel oil).

One way to meet this challenge maybe for some refiners to increase runs on Coking facilities which will further destroy the fuel oil or to switch the feedstocks going into catalytic crackers which would remove the higher Sulphur elements from the crude oil barrel.

Alternatives for the Bunker Market?

The LNG (Liquefied Natural Gas) suppliers are hopeful that some of the shipping fleet will migrate to LNG as a bunker fuel but this might be limited to smaller vessels such as ferries, cruise ships and some offshore vessels like floating storage and tug boats rather than large scale oil tankers. The LNG bunkering terminals, which are used by ships for loading and discharging are relatively costly to install given the volume of LNG that some of them can supply and this is one deterrent which may limit its uptake, especially at the smaller terminals. Industry estimates put the costs at between $50 and $100 million for an LNG bunkering terminal or Floating Storage Regasification Unit (FSRU).

Retrofitting an existing tanker to burn LNG is also a high cost and one which some cash strapped ship owners may be unable  to bear. LNG engines tend to be larger than traditional engines meaning that ships typically will be able to carry less cargo. Based on a 2016 report from the European Commission9, one significant issue with LNG is the so-called Methane slip meaning that hydrocarbon and carbon monoxide emissions are higher than with marine fuels. Their analysis of exhaust gases showed that 85% of hydrocarbon emissions from LNG were methane. The use of LNG maybe considered less favorable if it’s true environmental impact were factored into law when establishing overall emission levels. Methanol, due to its environmental benefits is another non-fossil based fuel that is being considered but it is still relatively expensive to use as bunker fuel and requires significant investment. There are also questions about the future reliability of methanol being available at all ports, something which is the not currently the case.

The Non-Compliance Issue

There are many factors that will come into play when determining whether the shipping industry and the charterers would contemplate non-compliance and continue to burn high sulphur fuel oil irrespective of the regulations. It is doubtful that publicly listed companies would risk shareholder revolt by non-compliance. To reduce this risk, all countries must develop robust enforcement systems before 2020 which we believe are not currently in place. If the price spread between high sulphur fuel oil and 0.5% sulphur bunkers widens significantly this could prompt more shipping firms and charterers to look for cost savings  and some may choose this option if possible.

The International Chamber of Shipping said in mid-2016 that the spread between compliant and non-compliant bunker fuel  oil could rise to as much as $400 per metric ton were the crude oil price to rebound to the $70 per barrel level.10 It is not clear whether all countries will adopt strict monitoring regimes like the US and Europe. The testing of emissions in open seas remains the biggest challenge. “Remote island testing” could happen over time but it is doubtful in time for 2020.


The expansion of the sulphur cap in marine transportation represents a significant challenge to both the shipping industry, the chartering community but also the suppliers and storage operators. From the shipping side, bunkering costs look set to rise   as more resort to bunkering with distillate based product. Refiners and bunker traders/suppliers will be challenged to make sufficient volumes of lower sulphur material available at all ports. Whilst alternative bunker fuels such as LNG and methanol could play a role in the shipping fuel market, there are also challenges with this approach, mainly cost related that may see more traditional fossil fuel based products remaining the fuel of choice post 2020. The role of fuel oil would seem to be limited, but much depends on developments down the road that have yet to fully play out.

NYMEX is actively involved in providing suitable risk management tools to provide hedging solutions for the market. A series   of different markets including futures on the fuel and distillate oil outrights, crack spreads and inter-product spreads are available. Option products in fuel oil and distillates as well as Futures in LNG are also available for trading which maybe a useful way to manage the uncertainty looming in the shipping markets from 2020. Full details of these products and our entire energy portfolio can be found at



All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author(s) and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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