Bjarne Schieldrop IMO Report

Macro research
IMO2020 Report
Wednesday 14 March 2018
New 2020 sulphur regulations for global shipping

Gasoil to HSFO price spread to rise above $450/bl
 IMO’s 2020 sulphur deadline a done deal
It is now impossible for the IMO to push the 2020 global 0.5% sulphur limit to a later date
without breaking its own rules. From January 2020 it will be illegal to run a ship using fuel
containing more than 0.5% sulphur without operating an exhaust cleaning gas system.
 Fewer than 2000 ships will have a scrubber in 2020
Currently, some 18,000 bulk carriers, crude oil carriers and container ships account for 76% of
the world’s DWT capacity. Together, they likely consume close to 4 m bl/d HSFO. By 2020, we
expect less than 2000 ships to possess a scrubber. We therefore expect that present HSFO
demand will fall sharply from 4 m bl/d to as little as 0.3 – 0.4 m bl/d. Demand will instead switch Bjarne Schieldrop
to higher quality oil products such as ultra-low sulphur fuel oil (ULSFO 0.5%) or Gasoil. Chief analyst commodities
(47) 9248 9230
 Gasoil to HSFO spread likely to widen to over $450/ton Bjarne.schieldrop@seb.no
As demand for HSFO almost evaporates in 2020 and instead shifts to ULSFO 0.5% or Gasoil, we
forecast global refinery upgrading capacity utilization will be stretched to its maximum. We
therefore expect the Gasoil to HSFO 2020 price spread to widen to more than $450/bl.
Historical Gasoil 0.1% to HSFO 3.5% product price spread - USD/ton
Source: SEB, Bloomberg

Macro research : IMO2020 Report Wednesday 14 March 2018 2
Contents
New 2020 sulphur regulations for global shipping ............................... 1
Gasoil to HSFO price spread to rise above $450/bl ........................................ 1
Executive summary ................................................................................... 3

The IMO 2020 Sulphur deadline is a done deal. ............................................... 3
Likely less than 2000 ships with scrubbers in 2020. ..................................... 3
2020 HSFO to Gasoil spread to rise above $450/ton .................................... 3
Paper scrubber, competitive hedge or plain bet .............................................. 3
Foreword ..................................................................................................... 4
Meeting with clients in Europe, Singapore and Hong Kong ........................... 4
Background ................................................................................................. 5
The graveyard of dirty oil........................................................................................ 5
IMO ending high sulphur emissions from global freight ................................. 5
Scrubbers? No thank you! We want fuel compliance! .......................... 6
Competitive concerns - What do others do? ........................................... 6

Risk-reward deemed far from good enough ..................................................... 6
IMO – will they or won’t they? .................................................................. 7

The IMO’s sulphur regulation is very different from the BWT regulation . 7
Focus shifts from IF to HOW ................................................................................... 7
IMO wants change, not havoc and disruption ................................................... 7
Who should pay? Shipowners, refineries or charterers? ...................... 8

Who should pay? Shipowners, refineries or charterers? ............................... 8
Catch 22 ....................................................................................................................... 8
Investing in a scrubber .............................................................................. 9
The need for switching fuel .................................................................... 10

3.2 m bl/d of out of today’s 4 m bl/d of HSFO to disappear to 2020 ...... 10
What can refineries do to 2020? ............................................................ 12
Surplus of bitumen, asphalt and sulphur .............................................. 13
Historical prices & spreads for HSFO 3.5%, Gasoil 0.1% and Brent . 13
Historical prices and spreads for ULSFO 0.5% and Gasoil 0.1% ....... 17
The HSFO to Gasoil Coker link ................................................................ 19
Compliant fuel to be Gasoil 0.1%, or ULSFO 0.5%?............................. 22
Recent price developments .................................................................... 23
Down the scrubber route unless they are forbidden .......................... 24
Summing up............................................................................................... 27
The road ahead ......................................................................................... 28

Executive summary
The IMO 2020 Sulphur deadline is a done deal.
The IMO 2020 deadline is a done deal. Legally it is now impossible for the IMO to change its decision before January 2020. Nor,
It may be softened peripherally by since its decision in October 2016, have there been any requests from IMO member
transitional measures but strong price states for any alteration.
signals are needed and wanted by the
Strong price signals in the form of a wider ULSFO 0.5% to HSFO or Gasoil product price
IMO to facilitate change.
spread are needed to drive the desired shift to lower sulphur emissions. The IMO will
likely favour a wider spread and support such an outcome. They will however also
probably ease the impact of worst possible scenarios, by softening transitional measures
to avoid unnecessary transitional havoc and disruption.
Likely less than 2000 ships with scrubbers in 2020.

Global shipowners do not want to We expect that fewer than 2000 ships will have a scrubber in 2020. Consequently,
install scrubbers. They wish to be fuel demand for HSFO will decrease dramatically in 2020, likely to less than 0.8 m bl/d and
compliant. Demand for HSFO is likely probably as low as 0.3 – 0.4 m bl/d, representing barely 10% of today’s marine HSFO
to drop from 4 m bl/d to as little as 0.3 consumption of 4 m bl/d. Demand will instead switch to compliant fuel with less than
– 0.4 m bl/d in 2020 0.5% sulphur content, i.e. either ULSFO 0.5% or Gasoil 0.5%.
This will push the global refining system’s upgrading capacity to the limit as 3-3.7 m bl/d
of HSFO suddenly need to be upgraded to ULSFO/Gasoil. Ripple effects of this
development will likely be felt across the whole oil product sector and further impact
pricing of different crude slates. There is a real risk of a repetition of events in 2008
when strong Gasoil demand and limited and fully utilized refinery upgrading capacity led
to an upward spiralling price dynamic between higher and higher Gasoil prices and
higher and higher light sweet crude oil prices. HSFO was then also priced at a deep
discount to crude.
2020 HSFO to Gasoil spread to rise above $450/ton

We expect global refinery upgrading The 2020 HSFO to Gasoil price spread traded at only $220/ton on a forward basis in the
capacity utilization to be pushed to its early autumn of 2017. Since then it has blown out to as much as $350/bl at the start of
limit in 2020 and that the Gasoil to 2018 while currently trading at $320/ton. The spread is typically and historically
HSFO price spread will in response proportional to the Brent crude oil price. It averaged $308/ton between 2011 and 2014
widen to more than $450/ton when Brent crude averaged $108/bl, and $447/ton in 2008 when Brent crude averaged
$98/bl.
Compared to the current forward 2020 Brent crude oil price of $57/bl, the 2020 HSFO
to Gasoil price spread is today trading expensively certainly from an historical
perspective, but is still more then $100/ton below an historical spread extreme of
$420/ton observed at a crude oil price of around $57/bl. In 2008 the spot spread blew
out to an extreme of $700/bl for a short period.
We expect worldwide refinery upgrading capacity utilization to be pushed to its limit in
2020 causing the Gasoil to HSFO price spread to widen to over $450/ton.
Paper scrubber, competitive hedge or plain bet

Our main view is that the HSFO to Gasoil price spread is likely to blow out to more than
$450/ton. Buying the forward 2020 Gasoil to HSFO product spread can be utilized as a
virtual scrubber for shipping fleets without scrubbers. This will provide such shipowners
with an extra source of income proportional to the incremental income advantage (due
to a higher spread) for scrubber ships and as such offer a competitive hedge for non-
scrubber ships compared to scrubber ships. A long Gasoil vs. short HSFO position for
2020 delivery may also be taken as a plain bet for a wider spread under the new
regulatory regime.
Foreword
This report reflects our involvement in the IMO 2020 sulphur emission
issue following meetings with more than 100 shipping clients and
refineries over the past 12 months.
It summarises what we have learned over the past year and our views and reflections on
the situation. It is not an in-depth technical study trying to pin-point global refinery
capacities vs. product needs in 2020.
A little more than a year ago the IMO decided that from January 2020 it will not be
allowed to run ships globally with HSFO fuel unless an exhaust scrubber has been
installed. Otherwise, a ship will have to use a fuel with maximum 0.5% sulphur content.
Today’s HSFO typically has a 3.5% standard product specification. The actual volume
weighted sulphur content in the 4 m bl/d HSFO consumed for marine propulsion today
does however contain closer to 2.5% sulphur on average.
Two detailed studies have been made concerning the projected balance between marine
fuel demand in 2020 under the new rules vs. global refinery product capacities.
The IMO’s Delft study concluded that there would be sufficient compliant fuel available
in 2020 to satisfy the new regulations. As a result, they decided in October 2016 that
the new regulations would take effect in January 2020. The Ensys Energy study
however came to a completely opposite conclusion. It determined that the world’s
refinery system would be put under extreme stress to such an extent that it would send
shock waves through all product markets as well as crude oil prices and grades.
Meeting with clients in Europe, Singapore and Hong Kong

To understand more clearly how the IMO’s decision will impact fuel markets and the
shipping industry in 2020, we decided to meet with market participants to hear what
they thought and were planning to do. Over the past year, we have travelled throughout
both northern and southern Europe, to Singapore and Hong Kong, to meet more than 100
shipping companies, refineries and technical experts, to learn how shipowners,
charterers and the refining industry are preparing for the IMO 2020 deadline.
This report summarises what we have learned over the past year and our present
reflections and conclusions.
We are grateful to all those clients who have taken time to meet with us, who have
helped us understand the issues at stake. Our increasing expertise enabled us to
contribute more to these discussions as we progressed.
Background
The graveyard of dirty oil
The global shipping fleet has been running on heavy fuel oil with high sulphur content
since the early 1970’s. Today this fuel is typically labelled HSFO or HSFO 3.5% (3.5%
sulphur). It is the bottom of the oil barrel, the residue of simple refining. It is the dirtiest
and heaviest product produced by refineries worldwide. Basically, it is a waste product
with little use outside the shipping market except (and less and less in recent years) in
power production. For this reason, the world’s shipping fleet has been dubbed “the
graveyard of dirty oil”.
Generally, it is the old oil refineries in Europe, Africa and Latin America who produce
HSFO. These are simple refineries with mostly straight through processing. Therefore,
crude oil used is basically just split into its different hydrocarbon components through
simple distillation and/or vacuum distillation. There is very little modification or after-
treatment of the molecules in the crude oil used. Conversely, the world’s most modern
refineries today are highly complex, using many after treatment stages that modify
molecules at high temperatures and pressure. Consequently, they produce very little
heavy residuum [“residue”]. Instead, long, heavy molecules are cracked apart and
converted to much more valuable middle distillate products.
For the world’s old refineries, the residuum [“residue”?] (the heaviest products from
simple refining) is basically a waste product which is sold at a discount to Brent crude
and consumed by the global shipping fleet. This symbiosis, which has lasted since the
early 1970’s, is now set to change or end. Unless the global shipping fleet installs
scrubbers, they will no longer be able to handle waste products from old refineries after
January 2020, at least not in its current form.
New refineries are in general built with after treatment modules so that they hardly
produce any heavy residue. It is mostly all cracked away and instead converted to higher
value middle distillate products. Thus as today’s old refineries
IMO ending high sulphur emissions from global freight

In October 2016, the IMO decided that from January 1, 2020 ships will be forbidden to
use fuel with more than 0.5% sulphur worldwide unless they are equipped with a
scrubber that cleans out the sulphur in the exhaust. However, the IMO did not announce
any other fuel guidelines, so generally fuel can be very dirty and of low quality provided
it contains no more than 0.5% sulphur.
The decision was long overdue and had been in the pipeline for since 2005. The end of
HSFO (without scrubber) in global shipping had been decided a long time ago. As of
October 2016, the only thing left to decide was whether the deadline would be January
2020 or 2025. It was all down to the fuel availability study, the Delft study which the
IMO had ordered and had received in the autumn of 2016. This study concluded that to
the best knowledge of various experts there would be sufficient fuel in required qualities
to implement the new regulations from January 2020. So, armed with the Delft report,
the IMO finally decided that the new regulations would be enforced from January 2020.
The Delft study has however been strongly contested by many who argue that the
transition will not be easy at all. A comparable in-depth report prepared by Ensys Energy
concludes in total opposition to the Delft study that an abrupt and complete switchover
from one day to the next will place the global refining industry under extreme duress
with consequences rippling throughout both oil products and crude markets. Further that
it will result in a large expansion in the Gasoil to HSFO product price spread as well as in
the price spread between high quality crude slates versus lower quality crude slates.
The Ensys study is not the only study or report arguing that this will be problematic.
Indeed, most reports we have studied agree with its authors to a greater or lesser
extent. We also concur much more with the Ensys study than its Delft counterpart. As
such, we expect a large and significant impact on global fuel and crude markets in 2020.
Scrubbers? No thank you! We want

fuel compliance!
One thing which became very clear to us as we travelled around the world was that
hardly any shipowners we met really wanted or planned to install scrubbers on their
ships. The list of “why nots” was almost endless. The almost unanimous response was:
“We want to be fuel compliant. We don’t want to install scrubbers on our ships”.
Shipowners do not want scrubbers. The idea of installing scrubbers on board every ship in the world very clearly did not
They want to be fuel compliant. come from the shipowners. They for sure don’t want scrubbers. They want to be fuel
compliant.
Their greatest concern is sunk cost The key reason for this view is that generally it is the charterer who indirectly pays for
capex on scrubbers which limits their the fuel as a pass through cost. It is much easier to pass on the specific fuel cost to
ability to pass on such expenses to charterers than to demand compensation for capex spending on scrubbers. For
charterers. shipowners a scrubber means capital expenditure, less free space on a ship, more
maintenance, greater crew competence, higher fuel consumption and uncertain sludge
Following several tough trading years,
disposal costs. It also means new legal obligations for exhaust pipe sulphur emissions. If
many shipowners have little cash to
shipowners run fuel compliant vessels without a scrubber, the fuel supplier is legally
spend on scrubbers.
obliged to ensure proper fuel quality and sulphur content. If a ship on the other hand runs
with a scrubber it is instead the shipowner who is legally responsible for the sulphur
content in the exhaust gases and thus that the scrubber works properly the ship-owner
may be fined.
In other words, almost unanimously shipowners do not wish to use scrubbers.
Competitive concerns - What do

others do?
No one needs to act so long as no one Also clear from our many meetings was that most shipowners were not very concerned
acts. A level playing field remains about higher fuel costs during the 2020 transition. What they really bothered about was
intact as most shipowners do not what other shipowners were doing. Fuel cost is mostly passed on to charterers, so long
install scrubbers. Charterers will bear as everyone else is doing the same thing within the shipowner community they will all be
most of the fuel costs. in the same boat - so to speak. Internal competition within the shipping market will be on
a level playing field with everyone just as well or badly off. What shipowners were and
Shipowners look at each other. What
still are concerned about is that a significant share of the global fleet is embarking on
matters is what other shipowners do.
installing scrubbers, placing others at a considerable competitive disadvantage.
Whether fuel costs are high or low is
less important. Risk-reward deemed far from good enough
Generally, shipowners we met thought the risk-reward for installing a scrubber was well
short of justifying capex on them. Such devices are still regarded as technically
immature, still at the test stage. Shipowners expect scrubber costs will continue to
decrease over time. They were not confident about the firmness of IMO’s 2020 deadline.
They feared that they would not be able to pass the capex over to the charterers, that
the Gasoil to HSFO price spread would not be wide enough to make the scrubber
installation profitable, that it could become very expensive to dispose of sludge from the
scrubber and that new environmental regulations governing CO2, PM and NOx in a few
years would mean that a scrubber installation today would be useless in a few years. All
in all that it was better to wait and see has been and probably still is the general view
within shipping.
IMO – will they or won’t they?

IMO’s 2020 sulphur regulation A year ago, there was huge uncertainty whether the 2020 deadline would be pushed
deadline appears immoveable unless forward or not. The shipping industry’s experience with the ballast water treatment
someone can prove that the market system regulations made it easy to assume that there would be endless delays, and that
will run into insufficient fuel sulphur regulation deadlines would also be repeatedly postponed. At that stage most
availability in 2020. companies we met felt uncertain about the 2020 deadline. Clearly, this view changed in
the summer of 2017. Going forward, the discussion switched from “if” to “how”.
A key factor for the IMO concerning the 2020 deadline decision involved the fuel
availability study. How the 2020 deadline would impact costs and fuel prices per se was
not at the heart of what was decided. Instead, the most important question was whether
physically there would be sufficient fuel available to enable the global shipping fleet to
operate from 2020. If it was to run solely on expensive Gasoil then that was probably
fine in the eyes of the IMO provided there was physically enough Gasoil for the fleet to
run on. So, if it was shown there would not be physically enough compliant fuels in 2020
on which to run the global shipping fleet then the IMO might possibly have shifted the
deadline to 2025. This is however very difficult to prove and as such the 2020 deadline
is today fixed.
Legally, it would take a minimum of By IMO’s own laws there is no longer any way that the January 2020 deadline can be
22 months to change the 2020 pushed back in time. To change that date will require an amendment to the MARPOL
deadline. It is therefore too late to Annex VI treaty. First, this would involve a proposal for such an amendment. Next, the
alter the deadline now consistent with proposal would have to circulate for six months before adoption. Afterwards, it could not
IMO rules. So far, the IMO has not yet come into force before at the earliest 16 months after adoption, i.e. the amendment
received proposals from any of its could not take effect until 22 months had passed. No such proposal by the IMO’s
members to change the deadline. members has been received since the 2020 deadline decision was announced in October
2016.
The IMO’s sulphur regulation is very different from the BWT

regulation
A key difference between the IMO’s sulphur regulation and the ballast water treatment
system regulations is that the sulphur regulations do not require any capex installations
onboard a ship. The IMO does not state that a scrubber is needed but that it can be used
if desired; otherwise compliant fuel should be utilized. The explicit need to install capex
on ships to comply with the ballast water treatment regulations was one of several key
reasons for extensions. Unless lack of fuel availability can be proved such excuses are
hard to use in the case of sulphur regulations. As far as we can see, the 2020 sulphur
regulation deadline is near rock solid absent “proof of lack of fuel availability”.
Focus shifts from IF to HOW

As the market began to accept fully the 2020 sulphur deadline, its focus shifted from IF
to HOW. How is it going to play out? What will happen to fuel prices? What can refineries
do and at what price? Will compliant ULSFO 0.5% be of acceptable quality and quantity
and will it be available worldwide? Will it be possible to buy HSFO globally for those few
ships that are running with scrubbers? Will there be a lot of cheating? How will the
regulations be monitored and how will they be enforced? Will there be waiver options
unless there are no available fuels to be bought etc. Many such questions remain
unanswered today.
IMO wants change, not havoc and disruption

Effecting change It is important to remember that the IMO’s decision is a regulatory decision on emissions.
The IMO wants change. It wants it so strongly that it may be willing to accept some
1) IMO’s 2020 deadline decision
disruption to get there. It has of course no desire for disruption if it can avoid it. As such
2) Forward 2020 pricing reaction
there is always the risk that the IMO looks kindly at softening measures which help to
3) Spot price reaction in 2020
avoid disruptions so long as they do not prevent changes. This could come in the form of
4) Capex spending
different exceptions and waivers for 2020 if fuel is not available. The process of driving
Shipping/Refineries
change is sequenced as follows: 1) IMO’s 2020 decision, 2) Forward based price
Strong product price signals in terms reaction 3) Fuel spot price reaction once we get to 2020 and lastly 4) Market participant
of a wide Gasoil to HSFO product reaction in terms of capex spending on either scrubbers or refinery upgrades. Neither
spread needed in order for capex shipping nor refineries are willing to make necessary investments before the market
spending to be undertaken sends the sufficient price signals. Today, these are beginning to emerge on a forward
basis.
Who should pay? Shipowners,

refineries or charterers?
Who should pay? Shipowners, refineries or charterers?
If the market solution is a refinery and It has been clear for several years that eventually the day would come when HSFO could
fuel compliant solution, then no longer be used without restriction in global seaborne transportation. Transport by sea
charterers will be handed the bill for will certainly become more expensive under the new regulations. The big question is -
higher costs for the new regulations who should pay for it? Shipowners, refineries or charterers? Clearly, in the long term,
directly or indirectly through increased shipowners will always have to pay higher environmental regulatory costs.
fuel prices passed on to them.
If the market solution for the global shipping market under the new regulations is fuel
compliance, then charterers will almost directly and immediately pay for the new
regulations through higher fuel costs which normally are directly passed on to them. The
higher fuel costs for ULSFO or Gasoil will in time become a payment to the refineries for
key investments they need to convert HSFO into compliant fuels.
If scrubbers are the market solution If the future solution mainly involves the use of scrubbers, then the world’s shipowners
then shipowners are unlikely to be will need to pay for the scrubbers and both their maintenance and operating
able to recover all of their scrubber expenditure. In a retrofitting of today’s shipping fleet, it is unlikely shipowners would be
capex. Over the longer term however able to recover all capex on scrubbers. Over time however it is clear that charterers will
the charterers will of course have to implicitly have to accept a freight rate high enough to pay for the building of new ships
pay sufficiently high freight rates to including a scrubber. Otherwise, new ships will not be built, at least not sensible,
incentivise the building of new ships economically viable vessels.
equipped with a scrubber.
There are however significant skews in the two solutions. It takes many years for a
refinery to upgrade their physical equipment by adding cokers or hydro-crackers.
Generally, it only takes a couple of weeks to retrofit a ship with a scrubber. Therefore, if
the market sends positive investment signals to both refineries and shipowners, the
latter have the capacity to react very quickly. Therefore, we think both action and
reaction may be taken by shipowners rather than by refineries.
Catch 22
Shipowners and refineries both fear When the IMO opened up to allowing both fuel compliance and scrubbers it created a
that the other part will invest so to stale-mate situation. The refinery sector is unlikely to undertake multi-billion-dollar
render their own possible investment investment decisions if it turns out that shipowners will end up installing scrubbers
unprofitable. across the fleet and therefore consume all HSFO anyhow. Then, there would be no need
for refineries to invest heavily to upgrade units. Amongst a myriad of issues, shipowners
are reluctant to install scrubbers because there is a chance that the refinery sector may
be able to produce a compliant ULSFO 0.5% product at only a small mark-up to the HSFO
price making it unprofitable to install a scrubber. Consequently, both shipowners and
refineries are afraid that the other party will render their investments unprofitable and
are therefore reluctant to undertake necessary investments for the upcoming transition.
Investing in a scrubber
The economics of a scrubber investment are straightforward: we assume an investment
of USD 3.5m for the scrubber and 200 days of sea time per year.
Payback in years for scrubber investment at various price spreads

Type -  Handysize VLCC VLCC Container Container Container
Tonnes  25 50 75 100 200 300
Fuel spreads
Probable long term average with ref 25 28.0 14.0 9.3 7.0 3.5 2.3
Brent $50-80/bl 50 14.0 7.0 4.7 3.5 1.8 1.2
Synthetic ULSFO to HSFO  75 9.3 4.7 3.1 2.3 1.2 0.8
Historical average (ref Brent $50- 100 7.0 3.5 2.3 1.8 0.9 0.6
80/bl) 125 5.6 2.8 1.9 1.4 0.7 0.5
Synthetic ULSFO to HSFO  150 4.7 2.3 1.6 1.2 0.6 0.4
175 4.0 2.0 1.3 1.0 0.5 0.3
200 3.5 1.8 1.2 0.9 0.4 0.3
2020 Synthetic ULSFO to HSFO  225 3.1 1.6 1.0 0.8 0.4 0.3
250 2.8 1.4 0.9 0.7 0.4 0.2
275 2.5 1.3 0.8 0.6 0.3 0.2
2020 Gasoil to HSFO spread  300 2.3 1.2 0.8 0.6 0.3 0.2
325 2.2 1.1 0.7 0.5 0.3 0.2
350 2.0 1.0 0.7 0.5 0.3 0.2
375 1.9 0.9 0.6 0.5 0.2 0.2
400 1.8 0.9 0.6 0.4 0.2 0.1
SEB 2020 forecast
425 1.6 0.8 0.5 0.4 0.2 0.1
2020 Gasoil to HSFO spread  450 1.6 0.8 0.5 0.4 0.2 0.1
The 2008 intra year high

Gasoil to HSFO spread  700 1.0 0.6 0.4 0.4 0.2 0.1
Source: SEB
Our assumptions are probably unrealistically simple as the scrubber investment cost
probably scales with the size of the ship with fuel consumption ranging from 25-300
tonnes per day.
There are in addition a lot of other uncertain costs associated with a scrubber installation
like: higher fuel consumption, sludge disposal costs, more maintenance, loss of space,…
Installing scrubbers on the world’s shipping fleet. Many ships are not suited for a
scrubber. The sum of crude tankers, Bulkers and Container ships is close to 18,000 and
accounts for 76% of the world’s DWT. So installing scrubbers on these 18,000 ships
would cover much of today’s consumption of HSFO. Possible feasible scrubber
installations could however amount to close to 40,000 ships
World Shipping Fleet

Category Number mDWT Average DWT Estimated need Number of ships
of ships per ship for scrubber suited for scrubber
Crude tankers 2,017 387.6 192167 100% 2,017
Product tankers 8,403 173.5 20647 70% 5,882
Chemical tankers 3,686 43.7 11856 50% 1,843
Other tankers 405 0.9 2222 100% 405
Bulkers 11,113 817.2 73535 70% 7,779
Combos 12 1.4 116667 100% 12
LPG carriers 1,452 24.3 16736 70% 1,016
LNG carriers 504 40 79365 0% 0
Containerships 5,164 252.8 48954 80% 4,131
Multi-purpose 3,183 29.3 9205 30% 955
General cargo 15,068 37.5 2489 30% 4,520
Ro-Ro 1,662 7.7 4633 100% 1,662
Car carriers 782 12.4 15857 100% 782
Reefers 1,458 4.8 3292 100% 1,458
Category Number mDWT Average DWT Estimated need Number of ships

of ships per ship for scrubber suited for scrubber
Offshore AHTS 4,680 9.6 2051 30% 1,404
World cargo fleet 59,589 1842.7 30923
Others 34,582 82 2371 15% 5,187
World Fleet 94,171 1,925 20,438 41% 39,054
Source: Clarksons
The need for switching fuel

Global demand for HSFO in 2012 was estimated at 228 m ton/year. Since then the global
shipping fleet has grown significantly. However, it has also moved into slow steaming
mode meaning ships consume 20% less fuel than when they were fast steaming.
Data on current global shipping fleet consumption of HSFO is hard to come by. This
makes it very difficult to project total demand for marine fuels in 2020. Consequently,
there is a very wide spread in projections for total marine fuel consumption and
composition in 2020. Our best guestimate is that current marine consumption of HSFO
largely the same as in 2012 since the increased fleet size is countered by its slow
steaming.
Demand for HSFO in 2020 will We believe few ships will run with scrubbers on January 1, 2020. The base case in the
collapse to as low as 0.3 m bl/d vs. IMO’s Delft Energy study was that by 2020 there would be 3,800 ships with scrubbers,
today’s estimated demand of 4.0 m and that these would consume 36 m tons of HSFO per year or 0.62 m bl/d. We expect
bl/d. Average forecasts project 2020 there will be less than half that number, i.e. below 2,000 ships out of a global shipping
HSFO demand of 0.8 m bl/d. Demand fleet of 94,000 ships. As such it looks more like demand for HSFO could fall to as low as
will switch to ULSFO 0.5% and Gasoil. 0.3 m bl/d in 2020.
If we consider the various forecasts by different companies such as BP and Shell as well
as projections made by agencies and independent research, we can deduce the
following: On average they expect HSFO demand of 0.8 m bl/d, Gasoil 0.5% demand of
1.4 m bl/d, and non-scrubber compliant ULSFO 0.5% demand of 2.8 m bl/d. There is
however a very wide projection for total marine fuel consumption in 2020. On average
the different forecasts projects a total marine fuel demand of 5 m bl/d.
Fuel demand projections for 2020 (m bl/d)

4.5
4.0
3.5
3.0 2.8
Million barrels per Day
2.5
2.0
1.5 1.4
1.0 0.8
0.5
0.0
HFO LSFO/Blends Gas Oil
IMO 2012 CE Delft BP Shell PIRA IEA 2020 RobinMeech Average
Source: SEB, Delft, Ensys, BP, PIRA, IEA, Shell, Robin Meech
3.2 m bl/d of out of today’s 4 m bl/d of HSFO to disappear to 2020

Today we estimate global marine consumption of HSFO at 228 m ton/year and marine
gasoil consumption of 64 m ton/year. This is equal to the IMO’s Delft study assumption
for marine fuel demand in 2012 of 4 m bl/d of HSFO production and consumption and 1.3
m bl/d of MGO consumption. The average market forecast we have seen expects 3.2 m
bl/d of today’s 4.0 m bl/d HSFO demand to disappear overnight to 2020.
That is a massive hit to demand to a marine oil product which only constitutes 4% of
global oil products.
Very little demand for HSFO in 2020 This means that in an already very small oil product market there will hardly be any
demand left for the product in 2020. If it is possible to convert the projected 3.2 m bl/d
of surplus HSFO in 2020 then of course it would not be all that problematic. That is
however the thing, it is not all that easy to convert 3.2 m bl/d of HSFO to a non-scrubber
compliant ULSFO 0.5% fuel.
In order to better be able to compare the different 2020 forecasts we have normalized
them all to a total 2020 marine fuel consumption of 5.5 m bl/d.
Fuel demand projections 2020 normalized to 5.5 m bl/d

6.0
0.8
0.9
5.0
1.5
1.3
1.7
1.8
1.9
4.0
Million barrels per Day
3.4
3.0
3.4
4.1
2.6
3.3
3.0
2.7
2.0
4.0
1.7
1.0
1.2
1.0
0.9
0.8
0.6
0.6
0.3
-
Delft 2012 Shell 2020 BP PIRA 2020 Average IEA 2020 RobinMeech Delft Base
2020 2020 2020
HFO 3.5% ULSFO 0.5% (Blends) Gas Oil 0.5% or lower
Source: Source: SEB, IEA, BP, Delft, PIRA, Robin Meech
In this normalized picture we have that the most extreme is Shell’s projection which
projects demand of only 0.3 m bl/d of HSFO and only 1.7 m bl/d of ULSFO in 2020. I.e. it
projects that two out of four m bl/d of today’s HSFO demand will shift all over to Gasoil in
2020. In terms of demand for HSFO in 2020 Shell’s projection is consistent with the
assumption that less than 2,000 ships will have scrubbers by 2020 which equally
implies HSFO demand of only 0.3 m bl/d.
SEB’s projection that less than 2000 ships will have a scrubber is actually consistent
with Shell’s very low projection of only 0.3 m bl/d HSFO demand in 2020.
Demand shifting from HSFO 3.5% to What stands out very clearly is a general projection that there will be a large shift to non-
ULSFO 0.5% scrubber compliant ULSFO 0.5% fuel. This fuel is still on a test-bed stage and very few
participants have been able to test it. The general view of the coming ULSFO 0.5% is that
it will be a hybrid, blended fuel and not a straight through refined product. As such it
cannot be easily mixed between different suppliers of the fuel and it is also assumed to
be quite unstable so that it can be difficult to use for ships running tramp trading.
If there really will be demand for 3 m bl/d of ULSFO or if refineries really will be able to
supply 3 m bl/d of ULSFO we do not know. Both sides of the equation could be restrained.
What is clear is that there will not be a lot of HSFO demand in 2020 and that demand
instead will shift to non-scrubber compliant ULSFO 0.5% or Gasoil 0.5% marine fuel.
What can refineries do to 2020?

There is no time for the world’s One of the major unknowns in the IMO maze is the question of what refineries really can
refineries to install additional do by the 2020 crossover deadline. What can they do with their current refinery
upgrading units by 2020 in response equipment, and additional equipment to be installed between now and 2020? The
to the IMO’s 2020 decision, at least refinery industry has been very tight-lipped about what it can or cannot do. Generally, it
not above what they have already has said that to install a new major installation such as a coker or deep conversion unit
planned to install. needed to convert HSFO to middle distillates, it will take five years to progress from
planning to completion. So, what will be installed by 2020 will have very little to do with
the IMO’s 2020 deadline decision in October 2016. New refinery upgrading capacity
from now to 2020 will basically be due to plans and investments taken ahead of the
IMO’s 2020 decision in October 2016.
The complexity of the world’s refinery One problem with the refining industry is that the huge refinery “machines” located
industry makes it very difficult to worldwide are not especially homogenous. It is possible to create general refineries that
estimate and predict what it is really can do everything, but this is not economical. It is much better to tailor each refinery to
able to do in 2020. what it is specifically required to do, i.e. the crude oils it is required to convert and
products to make.
There are more than 300 different qualities of crude oil worldwide and a myriad of
different products and needs. Consequently, there is also a very wide range of different
refineries. This is also why there is little general literature on the global refinery system
because it is so difficult to generalize. Even refineries themselves find it hard to maintain
a strong, clairvoyant view on their business outlook. What will refinery margins look like
one year from now? Based on communications with several refineries over the past 10
years, most, as far as we can see, do not hold especially strong views on forward cracks
and product spreads.
The IMO has only imposed a A clear message from one complex refinery we met with was that one good thing about
requirement on sulphur content to be bout the IMO regulation was that it was solely a regulation on sulphur content and not on
less than 0.5%. The many other the many other quality aspects of the marine fuel. In other words, compliant marine fuel
quality requirement aspects of the fuel in 2020 can be quite dirty and heavy in many respects. What matters is that it does not
are unchanged. This gives refiners a contain more than 0.5% sulphur. If there had also been a regulation on the many other
lot of freedom to make “dirty” ULSFO quality aspects of the fuel itself and not just sulphur, then it surely would have presented
0.5%. If IMO requirements had also a serious challenge for the global refining industry. Then they would have had no choice
been imposed on other quality other than to convert 4 m bl/d of HSFO into cleaner middle distillates using deep
aspects, they would have had to conversion units like cokers.
upgrade HSFO to Gasoil instead.
However, the IMO has only set a new standard for sulphur content for shipping fuel and
not many other quality aspects of the fuel. According to refiners we have met with, this
confers considerable freedom on global refineries on how they can modify the HSFO to
fuels that can be used under the new regulations. It is not so difficult to get down to
0.5% sulphur provided there are no guidelines and requirements governing the many
other aspects of fuel quality measures was the response we got from one complex
refinery. They had however no estimate of the aggregated global refinery capacity to
produce ULSFO 0.5%.
Sulphur is tied much deeper in the A key problem with HSFO is that it is very difficult and expensive to de-sulphur the fuel
molecular structure of HSFO directly. Running the fuel through existing de-sulphuring units quickly clogs up the
hydrocarbons. This reason, as well as catalysts and halt the process, partly due to the high level of impurities in the dirty fuel. It
its possessing a range of impurities, is however also attributable to sulphur molecules being tied much deeper into fuel
makes it difficult and expensive to molecules in heavy fuel oil than they are in Gasoil making them harder to remove.
remove sulphur from HSFO.
Therefore, existing de-sulphur units are unsuitable to de-sulphur HSFO. While it is
possible to build de-sulphur units to treat HSFO, they are however as expensive as deep
conversion units. So, it is much better to build deep conversion units in order to convert
low-quality fuel oil to high quality middle distillates than to convert low-quality HSFO
3.5% to ULSFO 0.5%, which is still a low-quality fuel.
If you “cut” the barrel differently However, according to the complex refineries we spoke with, there are other routes to
during the vacuum distillation stage to create ULSFO 0.5%. This involves different kinds of after-treatments and blending. One
obtain slightly less sulphur and heavy issue highlighted was that if you “cut” the barrel differently in the vacuum distillation
molecules and impurities, then that cut stage so that the cut contains somewhat less of very heavy elements and somewhat
can be run through existing de- more of lighter elements, the cut may then be run through a normal desulphurisation unit
sulphuring units. This helps to create to lower the sulphur content. What emerges is still a fairly heavy, dirty fuel but with
ULSFO 0.5%. much less sulphur.
Subsequently, a significant amount of blending of different fuels takes place, to produce

an acceptable fuel lately dubbed ULSFO 0.5%. So far, there has not been a unified fuel
quality description of this new fuel, adding to market unease.
ULSFO 0.5% is predicted to be fairly Another very unclear issue is the stability of new ULSFO 0.5% qualities. Since typically
unstable and best suited for steady they will be blended fuels rather than straight through processing products, they will
freight activity between two ports likely be more unstable. Arguably, these ULSFO 0.5% fuels will be better suited for fixed
routes link container liners. They can burn off the fuel continuously. They rarely risk
sitting in one harbour for long with the possibility of fall-outs in blended fuels. Freight
activity on fixed routes like this will also be able to source a stable quality of ULSFO
0.5% from a few suppliers, as they typically only trade between two locations.
Maersk has stated that they plan to Container company Maersk has clearly stated they plan to target fuel compliance with
run on fuel compliance, most likely by ULSFO 0.5% and not with scrubbers. Their argument is very clear: Scrubbers occupy
operating on hybrid ULSFO 0.5% space, add complexity requiring skilled on-board operatives, generate waste that must
products. be processed or disposed off at a cost, and give rise to higher fuel consumption.
Bulk carriers that run tramp trade could have issues with the new ULSFO 0.5% fuels.
They will trade from location to location and are subject to the risk they may receive very
different qualities of the ULSFO 0.5% they need. We understand these cannot be mixed.
Therefore, fuel tanks will need to be cleaned before they can be re-filled with ULSFO
0.5% from a different supplier. Bulk carriers also typically risk being land-locked for
periods with the risk of a fall-out in unstable ULSFO 0.5% fuel. How unstable the ULSFO
0.5% will turn out to be remains to be seen. It is hard to gauge at this stage with little of
these fuels on the market yet.
There is very low visibility on how It is very unclear what volume of ULSFO 0.5% the world’s refineries can actually
much ULSFO 0.5% the world’s produce. Those we have spoken with have said they have no clear views on global
refineries will in fact be able to capacity and magnitude, emphasising once again the highly complex and variable nature
produce in 2020. of the global refining business.
Surplus of bitumen, asphalt and

sulphur
Sulphur removal from HSFO by the The new maritime sulphur limit means that sulphur needs to be removed from HSFO
world’s refineries is likely to create the either before it is burned or after. Assume that sulphur must be removed from 3.2 m bl/d
need to dispose of 3.6 m ton of sulphur of HSFO before it is burned, this is equal to a reduction of sulphur in 182 m ton of HSFO
from average 2.5% sulphur to 0.5%. This is equivalent to sulphur production of 3.6
million ton of sulphur annually. To our understanding the global sulphur market is already
saturated. It may therefore be problematic for the world’s refineries to get rid of the
sulphur in 2020. The refineries may thus get a sulphur disposal problem in 2020.
A 2020 surplus of HSFO/residue also Bitumen which is used in asphalt is basically a variant of the old refineries’ residue
means a surplus in the production. i.e. it is part of the HSFO complex. Therefore, a 2020 market overflowing
bitumen/asphalt market. The with HSFO also means a surplus of bitumen. The European bitumen market is already in
European bitumen market is already in surplus with prices heading downwards, partly due to the increasing tendency to build
surplus. We expect more downside roads using concrete. The IMO 2020 event is likely going to lead to yet higher bitumen
pressure. surplus and thus even lower bitumen prices.
Historical prices & spreads for HSFO

3.5%, Gasoil 0.1% and Brent
Shipowners holding back on scrubber Much of the current market discussion is centred on the HSFO to ULSFO/Gasoil spread.
investments as they don’t know what The value of a scrubber investment will be much lower if the spread is low rather than
the fuel spreads will be in the future high. This is one of many reasons why many ship-owners have held back in terms of
investing in scrubbers because they are uncertain whether the spread will be wide or
narrow. They can see what it is today and what it has been in the past, but what will it
really be in the future? And, if the spread turns out to be wide in 2020 then how long will
it stay that way? One year, two years or longer?
So what is the correct spread to look at and to study? The HSFO to Gasoil spread or the
HSFO to ULSFO spread? In the previous section it is clear that the general market
expectation is that there will be a large shift from HSFO to ULSFO with ULSFO accounting
for 3 m bl/d of supply and demand in 2020. I.e. the expectation is that there will be a
refinery fuel compliant solution and that this solution will primarily be ULSFO. As such the
most important thing would be to investigate the HSFO to ULSFO spread. However,
historically and also currently there is no such thing as a ULSFO product, price or
contract.
Market looking at Gasoil to HSFO The lack of an historical ULSFO price is probably why most focus has centred on the
spread as there are no historical index HSFO to Gasoil price spread instead. As an alternative we have created a synthetic
for ULSFO 0.5% prices ULSFO 0.5% index constituted by 44% LSFO 1.0% + 56% Gasoil 0.1% which we will
get back to in the next section.
Gasoil typically has a larger multiplier relationship to Brent crude oil than HSFO 3.5%
HSFO 3.5% and Gasoil 0.1% prices versus Dated Brent crude oil
HSFO 3.5% Gasoil 0.1% Linear (HSFO 3.5%) Linear (Gasoil 0.1%)
1400
y = 8.3x + 25.2
1200
Gasoil 0.1% and HSFO 3.5% in USD/ton
1000
800
600
y = 5.6x - 33.5
400
200
0
10 30 50 70 90 110 130 150
Brent crude oil in USD/bl
This of course naturally means that the historical relationship between the Dated Brent
crude oil price and the Gasoil 0.1% to HSFO 3.5% spread has a multiplier of 2.7 times
the Brent crude oil price:
Gasoil 0.1% to HSFO 3.5% spread in USD/ton vs Dated Brent crude oil in USD/bl
Gasoil 0.1% to HSFO 3.5% spread in USD/ton Linear (Gasoil 0.1% to HSFO 3.5% spread in USD/ton)
800
700
Gasoil 0.1% to HSFO 3.5% spread in USD/ton
600
500
400
y = 2.7x + 58.7
300
200
100
0
0 20 40 60 80 100 120 140 160
Dated Brent crude oil in USD/bl
More clearly sorted as averages for each 10-dollar price slot of Dated Brent crude oil
prices we have the following:
Gasoil 0.1% to HSFO 3.5% spread in USD/ton vs Dated Brent crude oil in USD/bl
700
Gasoil 0.1% to HSFO 3.5% spread in USD/ton
607
600 581
500
408
400
USD/ton
335
316 319
300 264 271
253
237
213
200
153
100 87
58
-
10 20 30 40 50 60 70 80 90 100 110 120 130 140
Dated Brent crude in USD/bl
The Gasoil to HSFO 3.5% has What we see is that historically when the Brent crude oil price has traded in the range of
historically averaged $256/ton when $50/bl to $80/bl then the Gasoil 0.1% to HSFO 3.5% has averaged $256/bl. However,
Brent has been in the range of $50- what we see in the daily dots is that the price product price spread has traded all the
80/bl way up to $450/ton on individual days even when the Dated Brent crude oil price has
traded in the range of $60/bl.
If we instead sort average prices and spreads by year back to 2001 we get the
following:
Yearly averages for Gasoil 0.1%, HSFO 3.5% and the spread in USD/ton
1,000
900
800
700
600
USD/ton
500
447
400
300
313
311
310
307
300
293
292
283
277
275
275
258
200
232
225
224
214
197
182
182
100
100
89
68
Gasoil - HSFO spread in USD/ton HSFO 3.5% in USD/ton Gasoil 0.1% In USD/ton
The Gasoil to HSFO spread has rarely What we see is that the spread has rarely been much higher than about $310/ton for a
been above $300/ton for a full year full year. This happened from 2011 to 2014 when Brent crude oil average $100-110/bl
except in 2008 when it averaged and the spread was close to that as well also in 2006 and 2007. The real stand-out year
$447/ton was 2008 for which the spread averaged $447/ton. That was a year with strong middle
distillate demand and a very tight gasoil market. Gasoil prices and Brent crude oil prices
then spiraled higher and higher until Brent crude oil reached $148/bl.
In an historical perspective the current forward pricing of the 2020 Gasoil to HSFO
spread at $314/ton is basically above all historical normal years. It is just trading lower
than the extreme year 2008. If we also take into consideration that forward crude oil
prices are only trading in the range of $56-57/bl for 2020 and 2021 it looks on the face
of it expensive.
Yearly average Gasoil mark-up to Brent and HSFO discount to Brent in USD/ton
200
172
150
100
118
115
114
112
95
94
94
94
92
86
85
85
84
82
77
73
50
67
60
58
31
23
-
-57 11
USD/ton
-66
-69
-50
-109
-122
-124
-100
-136
-138
-149
-157
-158
-162
-164
-169
-150
-181
-198
-206
-208
-213
-218
-227
-228
-200
-275
-250
-300
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
Gasoil mark-up over Dted Brent crude oil in USD/ton HSFO disscount to Dted Brent crude oil in USD/ton
Firstly however we think that 2020 is really going to be an extreme year in terms of the
product spread in question. As such the relevant comparison in our view is the year
2008. We are not necessarily forecasting a Brent crude oil price spike towards $150/bl
even though that is very possible.
Refinery upgrading capacities will be What we do feel confident about is that the global refinery’ upgrading capacity will be
stretched to their limits. Product price stretched to its limit. To all our understanding of the product price spread dynamics this
spreads will widen out means a significant widening in the product price spread. Historically such events have
also implied a rippling effect into the pricing of the different crude oil slates. If the market
is in need for more middle distillates and refinery upgrading and and conversion units
have been maxed out then the next solution is to use more light sweet crude oil. Thus the
spiraling price between Gasoil prices and Brent crude oil prices in such historical events.
The market is already pricing in an What really stands out in the last graph is the mark-up in Gasoil prices over Brent crude
unusually tight Gasoil market in 2020. oil prices on a forward basis from 2020 to 2023. This mark-up is trading above all the
historical yearly averages except for 2008. This forward mark-up for Gasoil over Brent
Historically such situations have led to
is signaling a real market concern that the Gasoil market will be tight for this period. And
a spike in Brent crude oil prices
this is exactly the recipe for a spike in the light sweet crude oil prices as well.
Thus implicitly the forward market prices are implying a fairly deep concern for a
significantly tight Gasoil market in 2020 to 2023. This is also visible when we look at
Gasoil and HSFO prices in percentage terms versus Dated Brent crude oil prices:
Gasoil 0.1% and HSFO 3.5% mark-up and discount to Dated Brent crude oil in percent
40%
Percent disscount and mark-up versus Dated Brent crude

30%
28%
27%
27%
26%
20%
24%
23%
23%
21%
21%
20%
18%
18%
18%
16%
15%
14%
10%
13%
11%
11%
11%
10%
10%
6%
0%
-10%
-25%
-26%
-26%
-27%
-20%
-27%
-28%
-29%
-30%
-30%
-32%
-35%
-36%
-37%
-30%
-37%
-37%
-38%
-38%
-38%
-40%
-42%
-44%
-45%
-40%
-47%
-50%
-60%
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
HSFO 3.5% disscount in % to Dtd Brent crude Gasoil 0.1% mark-up in % to Dtd Brent crude
In this perspective we see that the forward market price for Gasoil for 2020 to 2023 in
percent versus Dated Brent crude oil prices is trading at levels above all historical years.
There is very little middle distillate In addition to the IMO 2020 event there is also another reason to be concerned about the
content in new ultra-light US shale oil. supply of middle distillates in 2020 onwards. On the face of it the current oil market
situation here and now looks fine. Global oil demand is growing strongly on the one hand
A tight Gasoil market could be the
while US shale oil production is growing comparably strongly on the other hand. This
result
looks balanced and good. This may however not be the case. The reason is that crude
slate produced by US shale oil contains hardly any middle distillates. It is ultra-light and
almost only contains light end products like gasoline and naphtha.
Thus we may get a situation towards 2020 and the following years where the high level
overall balance in the global hydrocarbon liquids market is balanced while there is
actually could emerge a growing deficit in middle distillate products.
Historical prices and spreads for

ULSFO 0.5% and Gasoil 0.1%
There are no historical prices for Though not proven at all in terms of feasibility the average forecasts are projecting that
ULSFO 0.5% the lion’ share of today’s 4 m bl/d HSFO demand shifts to ULSFO 0.5%. No such product
exists today and no such historical benchmark exists either. As such it is a little bit
difficult to review and analyse. The general expectation is though that the ULSFO fuel
will trade quite tightly towards Gasoil 0.5% prices in 2020 as it will be priced relative to
the alternative compliant fuel.
A synthetic ULSFO 0.5% given by From historical LSFO 1.0% prices and Gasoil 0.1% prices we have created a synthetic
44% LSFO 1.0% + 56% Gasoil 0.1% ULSFO 0.5% index price given as a mix of 44% LSFO 1.0% and 56% Gasoil 0.1%. The
historical price picture for this ULSFO index may give some indication of where the future
ULSFO 0.5% price will trade in the longer term while it may be far away from the prices
we’ll see in the first years from 2020 onwards.
Average Gasoil to HSFO and synthetic ULSFO 0.5% to HSFO spreads in USD/ton
Gasoil to HSFO 3.5% spread in USD/ton ULSFO 0.5% to HSFO 3.5% spread in USD/ton
700
607
600 581
500
Product spreads in USD/ton

408
400
335
316 319
369 365
300 263 271
253
237
213
251
200 153
190 202
185
86 152 147 159
100 58 126 141
92
- 50
33
10 20 30 40 50 60 70 80 90 100 110 120 130 140
Average Brent crude oil in USD/bl
The synthetic ULSFO 0.5% has What we see is that when Brent crude oil prices have ranged from $50/bl to $80/bl the
averaged $150/ton above HSFO in a synthetic ULSFO 0.5% mark-up over HSFO 3.5% prices has averaged $150/ton. In
Brent crude reference of $50-80/bl comparison the comparable spread between Gasoil 0.1% and HSFO 3.5% averaged
$256/ton for the same Brent crude oil prices.
So in a historical perspective the synthetic ULSFO 0.5% index has been $150/ton more
expensive than HSFO 3.5% while Gasoil 0.1% has been $256/ton more expensive when
Brent crude oil prices have averaged $50/bl to $80/bl.
Assume that the product market and refinery system is not stressed in 2020 onwards
and that product price spreads trade according to normal historical patterns and that a
freight market segment is set by non-scrubber ships running on ULSFO. Then the few
scrubber-ships running on HSFO would only fetch a freight premium equal to $150/ton
times the number of tonnes per day of fuel consumption.
A synthetic ULSFO is now priced at On a forward basis the current market pricing is for Gasoil to average $289/ton above
more than $200/ton above HSFO for HSFO from 2020 to 2023 while the our synthetic forward ULSFO 0.5% is priced
2020 delivery and beyond $216/ton above the HSFO prices. It looks like this:
Yearly averages for synthetic ULSFO 0.5%, HSFO 3.5% and the spread in USD/ton
900
800
700
600
500
USD/ton
400
300
281
200
223
204
202
201
200
199
196
190
174
173
171
169
100
141
137
136
131
119
118
116
52
42
65
Synthetic ULSFO 0.5% mark-up over HSFO 3.5% in USD/ton

HSFO 3.5% in USD/ton
Synthetic ULSFO 0.5% USD/ton

The HSFO to Gasoil Coker link

There is a very strong and fundamental link between HSFO or refinery residue on the one
hand and Gasoil (middle distillates) on the other hand. The link goes through refinery
upgrading units like cokers and crackers. These are often labelled deep conversion units
as they go deep into the molecular structure of the long and heavy residue molecules
and break them apart at high temperature and pressure into smaller and lighter
molecules.
The opex of a typical Coker conversion Cokers are very expensive and costs approximately one billion USD for a unit able to
unit has been given $29/ton while the convert 40,000 bl/d of residue to middle distillates. Thus to upgrade 4 m bl/d of HSFO
opex + capex cost is one would need to spend $100 bn in capex. To our understanding such a unit typically
has a Short Run Marginal Cost (SRMC) or opex of $29/ton residue converted and
$86/ton all in cost (opex + capex) or Long Term Marginal Cost (LTMC).
If that was all there was too it then the typical spread between HSFO and Gasoil should
typically have been around $86/ton. The historical average price spread between the
two products from 2001 to the start of 2018 was however $237/ton.
The cost of converting HSFO to Gasoil The key reason is that when HSFO is converted to middle distillates in a coker then 30%
in a coker unit is proportional to the of the feedstock is lost in the conversion process and instead falls out as Pet Coke which
HSFO price since 30% of the volume is typically only fetches a price of $60/ton. For each ton of HSFO converted to middle
lost to Pet Coke in the process. distillates there is thus an added cost on top of the all-in opex + capex cost for the coker
operation stemming from conversion losses. For each ton of HSFO converted there is
thus an additional cost due to the conversion loss equal to:
Eq1: Feedstock Coker conversion loss: 0.3*(HSFO price – Pet Coke price)
However, since one ton of HSFO is only converted to 0.7 ton of Gasoil or middle
distillates one needs to convert 1/0.7 = 1.43 tons of HSFO in order to get one ton of
Gasoil. Thus one needs to calculate the conversion cost of converting 1.43 tons of HSFO:
Total conversion cost in order to convert 1.43 ton HSFO to 1 ton Gasoil with Pet Coke
=$60/ton:
Eq2: 1.43 * [0.3 * (HSFO price – Pet Coke price) + 86] = 0.43*HSFO + 97
Putting in the historical average HSFO price of $340/ton and a Pet Coke price of $60/ton
we get that Eq2 is equal to $243/ton. That is very close to the historical average HSFO to
Gasoil spread of $237/ton over the given historical period.
If we look at the Gasoil price as a function of the HSFO price we get that Gasoil = HSFO
plus conversion cost in Eq2, or: Gasoil = HSFO + 0.43* HSFO + 97 = 1.43* HSFO + 97
If we define the Short Run Marginal Cost (SRMC) of conversion as conversion losses +
opex and Long Run Marginal Cost (LRMC) of conversion as conversion losses + opex +
capex we get the following equations where the gasoil price is written as a function of
the HSFO price:
SRMC:
Eq3: Gasoil(HSFO) = (1/0.7)* [HSFO + 29 – 0.3*60] = 1.43*HSFO + 15
LRMC:
Eq4: Gasoil(HSFO) = (1/0.7)* [HSFO + 86 – 0.3*60] = 1.43*HSFO + 97
The Gasoil to HSFO is proportional to What is clear both when one looks upon this from the mathematical point of view as well
the HSFO price. Higher HSFO price as the historical price spread point of view is that the Gasoil – HSFO price spread is
means a wider spread proportional to the price level of the HSFO. The higher the HSFO price is the higher is the
conversion loss and the higher is the price spread between Gasoil and HSFO.
When we graph the theoretical SRMC and LTMC as given by Eq3 and Eq4 on the basis of
the historical HSFO prices and also graph the actual HSFO and Gasoil prices we get:
Gasoil 0.1% vs HSFO prices and SRMC and LRMC Coker conversion costs - USD/ton
1400
1200
1000
Gasoil 0.1% in USD/ton

800
600
400
200
Historical Gasoil 0.1% prices in USD/ton Theoretical SRMC Cocker cost Theoretical LT Cocker cost
0
- 100.0 200.0 300.0 400.0 500.0 600.0 700.0 800.0
Fueloil 3.5% in USD/ton
Source: SEB, 37th IAEE International conference 2014
What is apparent is that the historical price points not at all are glued neither to the
SRMC nor to the LTMC, though very few price points are below the SRMC line which of
course makes a lot of sense.
The price spread between HSFO and The driving force for where the price spread settles is given by the need for conversion
Gasoil becomes exponential when of HSFO from day to day since 2001. When the need is very low the utilization rate of the
conversion needs exceed installed global coker conversion units is very low. This again means that market is cleared on the
conversion capacity. It did so in 2008. SRMC which is the lower blue line in the graph.
If the conversion need is high so that all coker conversion units in the global refinery
system are maxed out then the marginal price setting goes above the LTMC line of
conversion which is the green line in the graph. There are other marginal conversion units
than cokers which are less economic and less optimal for the treating and conversion of
HSFO. These have much higher treatment costs.
In extreme cases when the global conversion capacity is totally maxed out but the
market is still asking for more the price spread can go exponential. This is typically what
happened in 2008 when the Gasoil to HSFO price spread widened to $700/ton.
In the next graph we show the historical relationship between HSFO price on the x-axis
versus the Gasoil 0.1% to HSFO price spread on the y-axis. We have also drawn the
theoretical SRMC and LRMC conversion cost lines as given in Eq3 and Eq4 using $29/ton
and $86/ton respectively as the constants within the equation.
The dots which lay above the light green line are again typically situations where
upgrading needs have exceeded coker capacity making it necessary to move to more
expensive and uneconomical conversion units, driving up the conversion cost and
therefore the Gasoil to HSFO price spread.
The Gasoil to HSFO price spread is HSFO prices vs Gasoil to HSFO spreads, SRMC, LRMC Coker conversion costs - USD/ton
already trading high vs. theoretical
long term coker conversion costs. This 700
is a sign that the utilization rate of the
world’s refinery system is expected to 600
be significantly stressed in 2020 and
Gasoil 0.1% to FO 3.5% spread in USD/ton

2021.
500
400
2020
300
2021
2019
200 2018
100
Historical Gasoil to HSFO spread in USD/ton Short term conversion cost Long term conversion cost Forward spreads
-
0 50 100 150 200 250 300 350 400 450 500 550 600 650 700 750 800
Fueloil 3.5% in USD/ton
Source: SEB, 37th IAEE International conference 2014
However, the Gasoil to HSFO price In the above graph we have also pinpointed the market prices for forward Gasoil to Fuel
spread for 2020 and 2021 is still oil price spreads for the coming years to 2021. What we see is that only the balance of
priced within a reasonable historical the year for 2018 is trading below the LTMC of conversion with respect to the market
range. It is nowhere nearly priced price of HSFO. The other years from 2019 to 2021 are trading above. This shows that
alongside the severely stressed event the market has started to price in a wider spread as well as a lower HSFO price.
of 2008 which saw the spread move
What we have experienced historically is that the highest price spreads have occurred
up to $600-700/ton.
when the HSFO price has been high. This is of course obvious from the equations above
which shows that the spread is proportional to the HSFO price. The most extreme price
points are from 2008 when the Brent crude oil price traded up to $148/bl. It was very
strong demand for Gasoil and middle distillates and the Brent crude oil price spiralled
upwards hand in hand with higher Gasoil prices. As the global refinery upgrading
capacity was maxed out the Gasoil to HSFO price spread expanded to $700/ton at the
most.
The price of HSFO may need to fall What is important to remember from the 2008 incident is that it was still allowed to use
towards the comparable price of coal HSFO, it was just not so much need for it. Also, the real need in the market was on the
to burn surplus HSFO in power stations Gasoil side which again led to the need for maximum upgrading of HSFO to Gasoil.
instead of coal in 2020 and 2021.
What will be different in 2020 and 2021 is that it will no longer be allowed to use HSFO
With thermal coal today trading at in marine freight without a scrubber. Thus rather than moving from the lower left hand
$85/ton and with 40% more energy side corner in the graph to the upper right hand side we think that the 2020 price points
content in HSFO per ton, this implies a should head to the upper left hand side corner of the graph. The IMO 2020 event should
potential decrease in HSFO towards give us a very low HSFO price of about $120/ton, and a fairly high Gasoil price and a high
$120/ton. At the time of writing the spread.
2020 HSFO price in the ARA region is
It will basically be impossible to store a significant running surplus of HSFO over some
$220/ton.
time in 2020. Therefore, if demand is insufficient and there are not enough conversion
capacities in the refining industry action will need to be taken. In our opinion, the last
such option is to burn the surplus HSFO in on-shore power plants instead of coal. There
are probably sufficient such power plants available equipped with on-shore sulphur
scrubbers where the HSFO can be burned. There has been discussion whether refineries
would in fact have to pay to get rid of their surplus HSFO or residue.
We do not think it will be necessary for refineries to pay to dispose of their surplus
residue or HSFO. However, to burn the surplus HSFO in a power station, the HSFO price
will have to fall further so it becomes competitive vs. today’s much cheaper coal prices.
HSFO typically contains some 40% more energy per ton than normal thermal power
station coal. With a coal price currently at $85/ton it means that the HSFO price will need
to fall to around $120/ton to be competitive with coal and therefore be burned in a coal-
fired power station.
At the time of writing, the price of HSFO delivered 2020 is about $220/ton. If the power
station option needs to be utilized in order to handle a running surplus of HSFO in 2020, it
means that the 2020 HSFO price has potentially $100/ton further downside before it
finds solid support at the coal cost level.
If it really turns out that the market will need to burn HSFO in power stations in order to
get rid of the surplus, then it also means that the total liquids supply in the global oil
market is shrinking by a comparable amount. It signifies an overall tighter global oil
market with higher oil prices. This again pushes up the Gasoil to HSFO price spread based
on the relationship described earlier.
If cokers are used to convert a 3.2 m We assume that HSFO consumption is 4 m bl/d. If demand for HSFO is only 0.8 m bl/d in
bl/d HSFO surplus in 2020 to Gasoil 2020, 3.2 m bl/d will need to be converted to either ULSFO or Gasoil. If cokers were to
then 1.2 m bl/d of this will be lost to upgrade these 3.2 m bl/d of HSFO to middle distillates or more specifically Gasoil, 1.2 m
Pet Coke in the process. This results in bl/d of this would be lost to Pet Coke during the process. This means a comparable
a comparable tightening of the overall tightening in the overall supply of liquids in the oil market, increased crude oil prices, and
oil market. again a higher price spread between Gasoil and HSFO.
Compliant fuel to be Gasoil 0.1%, or

ULSFO 0.5%?
Product price spreads should revert to One thing is that product price spreads are likely to blow out in 2020 and for some years
historical norms as markets eventually following that as the global refinery system’ upgrading capacity is stretched to its limit.
normalizes. Probably not before 2025 Over time however the product price spreads are likely going to revert to the spreads we
have witnessed historically for different levels of Brent crude oil prices.
The following is a table of historical average product prices for different price levels of
Brent crude oil. We assume that these historical price spreads reflects refinery
upgrading economics over time. Thus as the global refining system adjusts over time one
should comparable spreads to emerge again.
Historical prices for Brent crude and products and spreads in USD/bl and USD/ton
Assume that a “normal” oil price is to be in the range of $50-80/bl in the years to come.
Then ships using Gasoil 0.1% as compliant fuel should expect to pay a mark-up in fuel
price over HSFO in the ball-park of $250/ton. Ships which instead run on a blended mix
between LSFO 1.0% and Gasoil 0.1% (44% & 56%) should expect to pay a fuel
premium of $150/ton over HSFO.
Complex refineries are however stating that they can do more than just blend LSFO and
Gasoil. They claim that they can do different kinds of upgrades of HSFO as well as partial
desulphurization by “cutting” the barrel differently in the vacuum distillation process.
Some have also claimed that they have come up with desulphurization methods for HSFO
directly (Rigby Refining LLC) though we have no details of this process in terms of
quality, cost or possible volume of magnitude.
In the longer term beyond 2025 the However, it seems clear that the complex refineries can do more than just plain blending
ULSFO 0.5% grade should probably of LSFO and Gasoil. As a consequence the price of ULSFO 0.5% products should end up
trade only $50-100/ton above HSFO being cheaper than our synthetic ULSFO 0.5% index extrapolated from LSFO and Gasoil
composition. This means that the spread between the future ULSFO 0.5% product and
HSFO should be less than $150/ton in the Brent crude oil price slot of $50-80/bl range. A
wild guess would be that it ends up somewhere between a $50-100/ton mark-up above
the HSFO with Brent ref $50-80/bl.
Recent price developments

Generally, markets are not good at Mostly, markets are not very good at pricing upcoming events especially not digital
pricing future events. In October, the occurrences such as the IMO 2020 decision. When the IMO made its 2020 decision in
IMO decision led to a temporary price October 2016, it led to a rapid appreciation in the forward 2020 and 2021 Gasoil to
jump in 2020 Gasoil to fuel oil spreads HSFO spreads. However, there was insufficient momentum, a lack of participants, driving
which faded away again. this move. There was too much disbelief and distrust in the shipping community
concerning the IMO decision for the price hike to stick, especially after the ballast water
treatment issue which has dragged on for many years. As the HSFO market accounts for
only 4% of global oil demand, it is a highly specialized market where most of the
participants are from within the shipping or refining industry. There is thus very little
appetite for position taking within this segment by financial, speculative participants.
Forward Gasoil to HSFO price spreads - USD/ton
Gasoil 0.1% minus HSFO 3.5% (Barges FOB Rotterdam in USD/ton)

340
320
300
280
260
USD/t
240
220
200
180
160
140
120
Nov-15
Dec-15
Mar-16
May-16
Nov-16
Dec-16
Mar-17
May-17
Dec-17
Mar-18
Jan-16
Feb-16
Jun-16
Jul-16
Aug-16
Sep-16
Oct-16
Jan-17
Feb-17
Jun-17
Jul-17
Aug-17
Sep-17
Oct-17
Nov-17
Jan-18
Feb-18
Apr-16
Apr-17
Y2018 Y2019 Y2020 Y2021 Spot product spread Gasoil 0.1 to HFO 3.5 in USD/t
Higher Brent crude oil spot prices in Also, as the calendar 2017 spread rolled off in January 2017, calendar 2018 forward
H2-17 helped lift the Gasoil to fuel oil contract became the front year spread contract. As such it became the forward contract
spot price spread, which again rippled of focus. As a consequence of being the front year spread contract it also became
down to affect product spread prices increasingly associated to what happened in the spot spread developments. The spot
for 2018, 2019 and 2020 onwards. spread traded down to a low point in mid-2017 alongside a drop in the Brent crude oil
price. OPEC & Co’ cuts in primarily heavy sour crudes also helped to tighten up the heavy
cracks which also helped to tighten up the spot spread. The forward spread for 2018
then traded down along with the declining spot spread. And lastly the forward spreads
for the years 2019, 2020 and 2021 traded as time spreads to each other and to 2018,
they were all dragged down along with the lower spot spread and the lower 2018
spread.
As the spot spread recovered strongly in H2-2017 driven by a rally in crude oil prices,
the Cal-2018 forward spread followed upwards as well and so did the forward spreads
for 2019, 2020 and 2021 etc. However, the market did fundamentally change in H2-
2017 as well. In early 2017, skepticism was high. Our clients focused especially on
whether the IMO would stick to the 2020 deadline or not. This attitude changed
completely over summer 2017. Then it was no longer a question whether or not IMO
would stick to its 2020 deadline. It became instead a question of how it would play out in
2020. The 2020 deadline was largely accepted. This led to more pricing in of the IMO
event in the forward spreads.
Forward 2020 Gasoil to fuel oil Even if the market now has much more confidence in the 2020 deadline, we still believe
spreads are likely to remain sensitive forward spreads are likely to be highly sensitive to changes in the spot spread. So, if the
to spot spreads. A pull-back in Brent current fairly strong spot spread was to fall back either due to changes in spot cracks or
crude and the spot spread is likely to because of a lower Brent crude oil spot price, we think it highly likely pull-backs in the
pull down forward spreads as well forward spreads for calendar 2019 and 2020 onwards will also occur.
The HSFO market is dominated by Typically, the shipping sector has a two-year horizon for forward fuel hedging. With less
industry participants from shipping than two years to 2020, its hedging activity will start to impact pricing of products in
and refining with little pure financial 2020. Normally the shipping sector would have begun to purchase forward 2020 HSFO
speculative activity. The market is too contracts by now. Instead they will buy Gasoil 0.1% on a 2020 forward 2020 hedging
small and illiquid for most financial basis or nothing at all. This will make the refineries product books more and more
participants. skewed with no offset for their projected production of HSFO in 2020. Consequently, the
forward spread will widen to counter and reflect their skewed books.
Forward Gasoil, HSFO and spread prices - USD/ton

600
557
551
550
542
540
500
400
USD/ton
300 341
310
293
283
277
263
259
257
240
200 216
100
0
2018 2019 2020 2021 2022
HSFO3.5% Barges FOB Rot Gasoil 0.1% Barges FOB Rot Gasoil 0.1% minus HSFO 3.5% in USD/ton
Pricing of the event is likely to be a However, forward pricing of the event is in our view likely to be muted compared to the
two-step process. Forward pricing actual 2020 spot event. So, partial pricing of the event on a forward basis will take place
ahead of the event, which will likely be until mid-2019. From mid-2019, the 2020 deadline will increasingly start to be reflected
muted. Then as we get to H2-2017 in the spot spread as tanks are emptied and cleaned with ships starting the transition. As
the event will start to unfold in the the event starts to be reflected in the spot spread it will immediately be comparably
spot spread. This will then reflected in forward spreads as well.
immediately be reflected in the
Since there is likely to be a huge surplus of HSFO in 2020, storage facilities for such fuel
forward spreads for 2020 onwards.
must be emptied as much as possible to make room for the surplus set to hit the market
That is likely to be the most explosive
in 2020. Therefore, HSFO needs to be sold cheaply in H2-19 to draw down HSFO stocks
part of the price event.
as much as they can be to create space for the 2020 surplus. Another way to look at it is
that the Gasoil to HSFO spread needs to widen out in order to facilitate maximum
conversion of HSFO to Gasoil ahead of the 2020 date line which will help to draw down
HSFO stocks.
As the HSFO surplus hits the market in 2020, stocks of the fuel are likely to rise strongly
which should result in a deep contango pricing of HSFO in 2020.
A significant surplus of HSFO is likely As we write, HSFO 3.5% is priced at $230/ton for 2020 delivery. In our view it seems
in 2020, resulting in deep contango plausible and likely that the market will run a significant surplus of HSFO in 2020 as
and most likely a drop in the HSFO demand drops from around 4 m bl/d to less than 1 m bl/d and maybe as low as 0.3 m bl/d
price from currently $230/ton to during the same year. We do not expect many scrubbers on the global shipping fleet in
$120/ton enabling the surplus HSFO 2020. There will be insufficient capacity to convert it to compliant fuel. As it is impossible
to compete with coal and be burned to store a large and growing surplus of HSFO, the remaining option is probably to burn it
off in power stations with on-shore in power stations instead of coal. In our view, this exit would require the HSFO price to
scrubbers. fall towards $120/ton.
Down the scrubber route unless they

are forbidden
It will be too profitable and too We believe that unless scrubbers are forbidden there is a considerable risk that the
tempting not to install a scrubber in global shipping fleet will gradually or rapidly install scrubbers from 2020. This is not
2020 because it is an optimal long-term solution but because it will be too tempting to let it
pass. In our view, come 2020 the HSFO to ULSFO 0.5% (or Gasoil 0.5%) price spread
will widen out considerably. Charterers looking to choose between two ships will
naturally select the one that incurs the lowest cost fuel. Ships using low cost HSFO and a
scrubber should be able to negotiate a higher freight rate than no-scrubber ships.
Freight premium of running with a The added freight premium for ships running scrubbers should be close to the difference
scrubber should be proportional to the in compliant 0.5% sulphur fuel and HSFO. Whether that will be the difference between
fuel price spread between the ULSFO 0.5% and HSFO or Gasoil 0.5% to HSFO will depend on which compliant fuel is
dominant non-scrubber fuel used in a dominant in each shipping segment.
shipping segment and the HSFO price
If we assume that a shipping segment is predominantly run without scrubbers with a
clearing freight rate of $10,000/day (fuel not included). Further that fuel consumption is
50 ton/day, low cost HSFO is $235/ton, and higher cost ULSFO is $445/ton. Then the
scrubber ship should be able to obtain a freight rate $20,500/ton vs. the non-scrubber
ship, which only receives $10,000/day. The difference is given by: 50*(445-235). Thus
scrubber-ships should ideally be able to negotiate a freight premium of $10,500/day on
top of the $10,000/day due to its lower fuel cost. It would look like this:
Non Scrubber ship at the margin. Large premium for scrubber ship with low cost fuel
VLCC freight rate in USD/Day Fuel cost for 50 ton/Day

35,000
30,000
11,750
25,000
Total Charter cost in USD/Day
22,250
20,000
15,000
10,000 20,500
5,000 10,000
-
Total Charter cost with Hybrid fuel in 2020 (USD/d) Total Charter cost with HSFO 3.5% in 2020 (USD/d)
Source: SEB
In this situation we think that it will be far too tempting to install a scrubber for those
ships which can do so. It is likely going to be a slippery slope that includes a gradual
increase in the number of scrubbers within the shipping segment.
Scrubber premium shifts to non- However, the moment the dominant share of the shipping market in a given shipping
scrubber pain when/if scrubbers are segment is set by scrubber ships then the going freight cost will be set by scrubber + low
the dominant solution in a freight cost HSFO. The ships that then still run without a scrubber will then be at a clear
segment disadvantage.
Assume the the cleared freight rate is still $10,000/day (fuel not included) when
scrubber ships are clearing the market. The non-scrubber ship running on expensive
HSFO/Gasoil would then have to accept a freight price reduction equal to high cost to low
cost fuel price times 50 tons per day.
Non-scrubber ships will hardly be able If we assume that the price picture is a little different when the scrubber solution is
to operate in within a segment setting the price with HSFO at $330/ton and ULSFO 0.5% at $480/ton then we get that
dominated by scrubber ships the non-scrubber-ship will have to accept a rebate of 50*(480 – 330) = $7,500/day
versus the clearing freight rate of $10,000/day. It would thus only be left with a freight
income per day of $2,500/day which of course would be totally unsustainable. It would
look like this:
Scrubber ship trades at the margin. Large penalty for non-scrubber ship
VLCC freight rate in USD/Day Fuel cost for 50 ton/Day

35,000
30,000
Total charter cost in USD/Day

25,000
20,000
16,500
15,000 24,000
10,000
5,000 10,000
2,500
-
Total Charter cost with Hybrid fuel from 2024 (USD/d) Total Charter cost with HSFO 3.5% from 2024
(USD/d)
Source: SEB
All non-scrubber ships should be fine in So, in the first couple of years between 2020 and 2023, it is likely going to be very
the first couple of years from 2020 profitable to install a scrubber as long as the overall freight cost and rate are set by non-
scrubber ships with high cost fuel. That will likely encourage one ship-owner after
another to install scrubbers. It will be too economically tempting. Those who do install
scrubbers during this period are likely going to be able to pay down their scrubber capex
costs within a couple of years.
Those who instead wait until scrubbers are dominant with low cost fuels setting the
overall freight cost in the market will have to install a scrubber out of necessity since
they no longer can compete in the market without a scrubber. Ship owners installing
scrubbers at a late stage right before their segment competitively shifts over to clear on
scrubber-ships + HSFO will likely face total sunk costs for their scrubber installations.
The time period where they can charge above normal freight rates due to scrubber and
low cost fuel usage on their ships would be very short.
If scrubbers are the market solution The speed at which the current global shipping fleet is retrofitted with scrubbers will
then a long transition is the best for the matter considerably to shipowners. Let’s assume that retrofitting for the whole fleet
global fleet. But for the individual happened overnight to 2020. Then the total market would immediately progress to a
shipowners a fast implementation is stage where scrubber-ships clear the market with low cost HSFO. In this extreme case
the best the world’s shipowners would have to foot a total scrubber installation bill of $100-
300bn. It would all be sunk cost with no pass-through to charterers.
If we assume instead that it takes 10 years to reach 80% penetration for scrubbers. In
that case, the market will not tip over into scrubber-clearing before 2030. This will allow
10 years for scrubber-ships to fetch an above market freight rate and so cover their
scrubber installation costs. One then would assume that a lot of ships would have been
able to install a scrubber and fetch above market freight rates long enough to pay them
down.
The global freight market market is however highly fragmented. As such the uptake of
scrubbers by the individual segments is what matters. There are for example only about
2000 large crude carriers. Thus one would probably only need to install some 1500
scrubbers before this segment tipped over to scrubber-ships setting the price.
Summing up
Few scrubbers in 2020 The IMO 2020 deadline is firm. We expect that less than 2000 ships will be equipped
with scrubbers by 2020 and as a consequence that most of today’s 4 m bl/d of HSFO
marine consumption will have to shift to ULSFO 0.5% or Gasoil 0.1%.
We expect the Gasoil to HSFO spread We expect the world’ global refinery upgrading capacity to be pushed to its limit and as a
to widen to above $450/ton in 2020 consequence the price spreads between light and heavy products will widen
significantly. We expect the Gasoil 0.1% to HSFO 3.5% spread to widen to more than
$450/bl as we get to spot price delivery in H2-2019 and 2020.
Brent crude oil is likely to be affected A strained refinery upgrading capacity with the market craving for more middle
by the 2020 transition and move distillates will lead to stronger demand for light sweet crudes like Brent crude which
higher typically are rich on middle distillates components. There is clearly a potential to a larger
or lesser degree for a 2008 like repetition where strong middle distillate demand led to
an upwards price spiral between Brent crude and gasoil with Brent peaking at $148/bl
by mid-2008.
The HSFO price needs to move down We expect refinery upgrading capacities to be maxed out and as such not be able to
to energy price parity with coal in convert all that is needed of HSFO to legally compliant fuels in 2020. There should thus
2020 be a significant surplus of HSFO (or refinery residue) in 2020 and we thus expects the
price of this product to collapse down towards $120/ton (coal price energy equivalent)
in order for surplus HSFO to be burned off in power stations with onshore scrubbers.
IMO wants change but no disruption A significant widening in the light to heavy product spreads is needed in order to drive a
change to lower sulphur emissions through capex spending by either refineries or the
Transitional measures in 2020 likely
shipping community. The IMO will likely look kindly at such a product price development.
A disruption is however not at all what the IMO is looking for. Transitional measures are
thus likely to emerge from the IMO in order to reduce the risk for the most sever possible
outcomes of product price spread blow outs and Brent crude oil price spike.
High scrubber investment return in Ships equipped with scrubbers should be able to earn a significant extra premium in
2020 and the following 2-3 years 2020 and the first years following that. The premium is likely to be equal to the fuel price
spread between HSFO and whatever is the dominant compliant fuel in each shipping
segment. If the compliant fuel in a given shipping segment is Gasoil 0.1% then the
premium is likely to be equal to the Gasoil to HSFO spread times tons of consumption per
day. If however the dominant compliant fuel is the cheaper ULSFO 0.5% then the
premium is going to be proportional to the ULSFO 0.5% to HSFO 3.5% price spread
instead.
Scrubber investments will be too Installing a scrubber on a ship only takes a few weeks. Building a new refinery upgrading
tempting to resist in 2020 unit instead typically takes up to five years. This clear asymmetry between capex
spending between the two sectors leads us to the conclusion that when product price
spreads blows out in 2020 and sends strong investment signals to the two sectors then
the primary capex move will take place within the shipping segment and scrubbers will
be installed. It will be too tempting to install a scrubber. It will be too lucrative.
Late scrubber investments may be We expect scrubber ships running on HSFO to earn a significant freight premium as long
sunk cost as they are in minority within their segment. However, as soon as scrubbers and low cost
fuel (HSFO) becomes the dominant solution within a segment there will no longer be any
premium for having a scrubber. There will only be a penalty and a pain if you don’t have
it.
ULSFO 0.5% to trade close to Gasoil in The coming ULSFO 0.5% fuel grade will likely trade close to Gasoil 0.1% at the start in
2020 as an alternative cost/price. 2020 as supply is likely to be on the short side and it will be priced according to its
alternative. Over time, as capex is spent on both scrubbers and refinery upgrading
capacity, the light to heavy price spreads should revert to their historical norms with
respect to different Brent crude oil price levels. Over time we expect ULSFO 0.5% to
trade at a premium of $50-100/ton above HSFO (maximum $150/ton above) with a
Brent crude oil reference level of $50-80/bl.
Availability of HSFO may be an issue Ships running with scrubbers from the start of 2020 may face some problems of HSFO
for scrubber ships in 2020 availability in all ports. Demand will be very low and all ports may not bother supplying
the fuel. The main ports are however highly likely to supply HSFO in 2020. Refineries do
need to get rid of their residue production. So if someone will buy it then the refineries
will sell it.
The road ahead

Refineries are likely to try to make as Going forward we expect increasing clarity with respect to the quality and availability of
much ULSFO 0.5% as possible in order compliant non-scrubber fuel being ULSFO 0.5%. It will be in the interest of the refineries
to get rid of their surplus residue. to produce as much as possible of the ULSFO 0.5% in order to get rid of their heavy
residue. Selling Gasoil will not solve their problem since they will not have enough
upgrading capacity to convert 4 m bl/d of HSFO to Gasoil (or middle distillates).
Market will not price the event It is very difficult for markets to price in future events which deviate from historical
properly before the event hits the norms. As such we do not expect the forward market to price in a $450/ton or higher
Gasoil to HSFO spot spread Gasoil to HSFO spread until we get to mid-2019 when we expect to see the new
regulations increasingly being reflected fundamentally and physically in a much wider
spot spread. Until then the forward pricing of the 2020 spread is likely to shift around
along with higher or lower Brent crude oil prices and the spot Gasoil to HSFO spread as
well as varying regulatory IMO signals.
Will most shipping segments clear on If refineries can make a large amount of ULSFO 0.5% with adequate quality by 2020
Gasoil or ULSFO 0.5%? It will for sure then most shipping segments which today runs on HSFO will in 2020 instead run on
not clear on HSFO 3.5% in 2020 as ULSFO 0.5%. In that case the total added cost to freight in 2020 will be proportional to
hardly any ships will have a scrubber the ULSFO to HSFO spread rather than the Gasoil to HSFO spread. The profitability of a
scrubber will likewise be proportional to the ULSFO to HSFO spread. If refineries cannot
make a lot of ULSFO 0.5% then the Gasoil to HSFO spread will instead be what matters
and will thus be the measuring yardstick for scrubber profitability with Gasoil or a Gasoil
like fuel to be the marginal fuel in most shipping segments. Our view is tilted towards the
latter scenario with Gasoil predominantly being on the freight cost margin in 2020.
Tight or loose crude oil market with Developments in the global crude oil market will be important for the spot and forward
high or low crude oil prices will impact spreads. Lower crude oil prices means lower Gasoil to HSFO spreads which again means
spot spreads and forward pricing lower 2020 forward Gasoil to HSFO spreads. Likewise a strong crude oil market will
ahead of the 2020 date line drive spot spreads and 2020 forward spreads higher. There is clearly a risk that a
significant shift by the global shipping fleet towards Gasoil in 2020 could lead to a 2008-
like situation in 2020 where Gasoil prices and light sweet crude oil prices chase each
other in an upwards spiral.
Early scrubber adoption may now be a With current clarity that there will be few ships with scrubbers and thus that almost all
winning strategy as the 2020 prior HSFO shipping segments will be either cleared by ULSFO 0.5% or Gasoil in 2020
deadline now is a done deal and there and that IMO’ 2020 decision is firm it may suddenly make sense to be an early scrubber
will clearly be very few scrubber-ships adopter. An early adopter will now be able to take advantage of wide product spreads in
in the market in 2020 making freight 2020 and the few years after that. More precisely a scrubber-ship will be able to take
markets clear on either Gasoil or advantage of a freight market where total freight costs are cleared on a high cost fuel
ULSFO 0.5% while a scrubber ship will run on low cost HSFO. This will help to pay down the scrubber
investment quickly and before the penetration of scrubbers in a given shipping segment
drives the whole segment over to clear on low cost HSFO. We are thus likely going to see
more interest in installing scrubbers going forward. Especially in smaller, narrower
shipping segments which can more quickly tip over to clear on low cost HSFO if enough
ships in the segment are equipped with a scrubber. The risk for such a strategy is the
longer term outlook for the availability for HSFO.
The longer term fuel availability The longer term outlook for marine fuel supply is however foggy. Will there be a HSFO
outlook for HSFO is however foggy and market in the longer term or will it be too small to sustain as the larger share of ships
is likely going to hold back scrubber moves to ULSFO 0.5%? Already today the marine HSFO 3.5% market is very small as it
investments. only accounts for a mere 4% of global demand. If demand shrinks to only 1 m bl/d it will
only constitute 1% of global demand. It will however be the dirtiest of the lot. If there are
enough ships with scrubbers to consume 1 m bl/d then they will definitely be consuming
the bottom of the bottom of the barrel. As such they may be an important solution for the
world’s refineries in terms of the disposal of their residue and thus a market which they
then will want to maintain and keep alive. Also, the world’s refineries will always have a
choice between feeding their residue through an upgrader or selling it as HSFO. If the
demand and price for HSFO is good enough they’ll rather sell their residue as HSFO.
Oil product spreads to revert back to Over time as we have well passed the 2020 time line plus a few years we expect
historical averages over time product spreads gradually to revert back to their historical norms with respect to
reflecting the underlying refining relative Brent crude oil price levels as depicted in the table on page 22 since these
economics historical spreads in our view typically reflects fundamental refinery economics of
conversions and upgrading. Howe quickly is again a huge uncertainty with respect to a
potential scrubber investment or investments in refinery upgrading units.
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Commodity Research
Bjarne Schieldrop, Chief Commodity Analyst

bjarne.schieldrop@seb.no
+47 9248 9230

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Macro research

New 2020 sulphur regulations for global shipping

Historical Gasoil 0.1% to HSFO 3.5% product price spread - USD/ton

Source: SEB, Bloomberg

Executive summary ................................................................................... 3

Scrubbers? No thank you! We want fuel compliance! .......................... 6

Competitive concerns - What do others do? ........................................... 6

IMO – will they or won’t they? .................................................................. 7

Who should pay? Shipowners, refineries or charterers? ...................... 8

Investing in a scrubber .............................................................................. 9

The need for switching fuel .................................................................... 10

What can refineries do to 2020? ............................................................ 12

Surplus of bitumen, asphalt and sulphur .............................................. 13

The HSFO to Gasoil Coker link ................................................................ 19

Compliant fuel to be Gasoil 0.1%, or ULSFO 0.5%?............................. 22

Recent price developments .................................................................... 23

Down the scrubber route unless they are forbidden .......................... 24

The road ahead ......................................................................................... 28

Likely less than 2000 ships with scrubbers in 2020.

2020 HSFO to Gasoil spread to rise above $450/ton

Paper scrubber, competitive hedge or plain bet

Meeting with clients in Europe, Singapore and Hong Kong

IMO ending high sulphur emissions from global freight

Scrubbers? No thank you! We want

Competitive concerns - What do

IMO – will they or won’t they?

The IMO’s sulphur regulation is very different from the BWT

Focus shifts from IF to HOW

IMO wants change, not havoc and disruption

Who should pay? Shipowners,

Payback in years for scrubber investment at various price spreads

The 2008 intra year high

World Shipping Fleet

Category Number mDWT Average DWT Estimated need Number of ships

The need for switching fuel

Fuel demand projections for 2020 (m bl/d)

IMO 2012 CE Delft BP Shell PIRA IEA 2020 RobinMeech Average

3.2 m bl/d of out of today’s 4 m bl/d of HSFO to disappear to 2020

Fuel demand projections 2020 normalized to 5.5 m bl/d

Source: Source: SEB, IEA, BP, Delft, PIRA, Robin Meech

What can refineries do to 2020?

Subsequently, a significant amount of blending of different fuels takes place, to produce

Surplus of bitumen, asphalt and

Historical prices & spreads for HSFO

Source: SEB, Bloomberg

Source: SEB, Bloomberg

Source: SEB, Bloomberg

Source: SEB, Bloomberg

Source: SEB, Bloomberg

Percent disscount and mark-up versus Dated Brent crude

Source: SEB, Bloomberg

Historical prices and spreads for

Product spreads in USD/ton

Source: SEB, Bloomberg

Synthetic ULSFO 0.5% mark-up over HSFO 3.5% in USD/ton

Source: SEB, Bloomberg

The HSFO to Gasoil Coker link

Gasoil 0.1% in USD/ton

Source: SEB, 37th IAEE International conference 2014

Gasoil 0.1% to FO 3.5% spread in USD/ton

Source: SEB, 37th IAEE International conference 2014

Compliant fuel to be Gasoil 0.1%, or

Source: SEB, Bloomberg