\From the window of a jet plane, it can be hard to see ships crawling across the seas. Yet what’s burning in those engines thousands of feet below may determine the fate of airline profits in the next few years.

In about 18 months’ time, the world’s oil refineries are going to have to supply shipping companies with better-quality fuel to comply with international regulations agreed back in 2016 in a nondescript building on the banks of the River Thames in London.

While the regulators’ target was to lower sulfur emissions from ship fuel, it’s becoming increasingly clear there will be an accompanying—and significant—impact on the supply of jet fuel, the aviation industry’s single biggest expense. The trouble is, there’s profound disagreement about whether the result will be a glut or a shortage of the fuel.

“These rules are going to impact airlines,” said Mark Maclean, managing director at Commodities Trading Corporation Ltd., which advises on hedging strategies. “The impacts will not be isolated only within the shipping industry, these changes will affect the entire oil and middle-distillate complex,” the part of refining that includes jet fuel and diesel.

From Jan. 1, 2020, the world’s ships will need to consume fuels containing less sulfur under the 2016 rules set out by the International Maritime Organization, part of the United Nations.

Oil refineries are likely to face an initial demand surge from shippers for diesel-type products when the rules kick in. Diesel is critical in determining the cost of normally more-expensive jet fuel, so if that historic price relationship holds, then the aviation industry’s fuel bill could surge as well.

Refining Puzzle

How it plays out in practice hinges on the way refineries make jet fuel and—critically—how much flexibility they’ll have to adjust their output once the new rules enter into force.

Jet fuel is made in one simple refining process, meaning that if more crude gets distilled to make diesel, then there will be an unavoidable surge in jet fuel supplies too. Several traders say that could result in a surplus.

But not everybody agrees. For one thing, increased amounts of jet fuel will be blended into fuel oil to meet the more stringent sulfur specifications, according to Jan-Jacob Verschoor, a director at Oil Analytics and a chemical engineer by training who previously worked at Royal Dutch Shell Plc. Refineries will also have some flexibility to maximize diesel production to the detriment of jet fuel output, more than negating any ramp-up in overall crude processing, he said.

Airlines Un-Hedged

So far, most airlines seem relaxed about the situation. Of 26 carriers monitored by Bloomberg in Europe, the U.S. and Asia, only Southwest Airlines Co. has reported hedged fuel prices into the next decade. The company has 38 percent of 2020 buying covered, up from 36 percent a year ago for 2019. It’s already hedging all the way into 2022.

“New developments like IMO 2020 regulations are certainly one of the many items we monitor on an ongoing basis to determine their impact on the energy markets, and ultimately the price of jet fuel, and we incorporate such information into our robust planning processes,” Southwest said by email in response to questions about its hedges.

Big Question

Prices for jet fuel for mid-2020 have risen by more than 40 percent since the middle of last year, tracing gains in both crude and diesel. Rising profit margins for diesel, one of the fuels that airlines reference when hedging their costs, are a sign of the impact the new shipping rules already are having on the market, London-based Maclean said. The ICE gasoil crack, or premium to Brent, for June 2020 has gained about 60 percent since last July.

The fallout from the shipping rule change is an important quandary for airlines already suffering from a more than 50 percent increase in crude prices over the past year.

The crude-price surge may force some weaker operators out of business, Ryanair Holdings Plc Chief Executive Officer Michael O’Leary said last month. Willie Walsh, CEO of British Airways parent IAG SA, said last week that the price of fuel “is having an impact because it’s much higher than we expected.” Rising fuel costs were a factor that prompted the International Air Transport Association to cut its profit target for global aviation.

While those higher crude prices may be preoccupying airline executives for now, the looming changes for shipping are starting to register.

Robert Isom, president of American Airlines Group Inc., said in a call last month that his company too is looking at the issue without having a clear strategy yet. At a recent industry conference, the CEOs of Kenya Airways Plc and LOT Polish Airlines SA said they were aware of the issue and that, if anything, it may lower costs as more jet fuel gets produced. Virgin Australia’s CEO also said it would likely influence pricing.

“Our fuel guys are going through everything to understand what the impact could be on us,” Isom said. “So, we are in the process of working through that. I don’t have an answer on that yet at all.”