On New Year’s Day, the IMO 2020 regulation will take effect and vessel owners, shippers, refiners and the rest of us will take our first plunge into the uncharted waters of a new environmental realm.
On New Year’s Day, ocean vessels will get slammed with new global regulations, which could provoke disruptions and will likely boost freight rates substantially. Containers being shipped from Asia to the US and Europe could see a $200 or more jump in cost.
“If freight rates don’t go up to match this cost increase, carriers will go out of business,” said Lars Jensen, who heads SeaIntelligence Consulting. “There is absolutely no way the carriers can absorb this cost.”
Vessel owners and shippers alike are struggling to figure out what they will mean to an already uncertain marketplace. “Who’s going to pay for it and how is really an open question,” said Jim Blaeser, a director in the transportation and infrastructure practice at the consultancy AlixPartners.
Changes in Fuel
Because the new regulations take effect on midnight January 1, ship operators must begin to make the necessary fuel changes in November and December.
IMO 2020 mandates a 0.5% cap on the sulphur content of bunker fuel, a major reduction from the 3.5% cap now allowed. That means vessels can no longer burn higher sulphur fuel unless the exhaust systems are equipped with expensive scrubbers.
Fines for non-compliance remain up in the air and depend on individual country jurisdiction. (In the US, the Coast Guard will be responsible.) Singapore, for example, has threatened to imprison ship captains who are in gross violation, and fine others S$10,000 ($7,400.) In addition, a non-compliant ship could be prohibited from discharging cargo or forfeit its insurance coverage.
Major container lines won’t risk non-compliance. Any violation would cause a major hit to “brand value,” Jensen believes, especially since those lines transport so much of the goods for major retailers, who wouldn’t countenance breaking the law.
On the other hand, small carriers between secondary or tertiary ports in Asia, Africa and Latin America may well take their chances, since enforcement won’t be as strict. Estimates are between 80% and 90% of vessels will be compliant next year.
According to data from the International Energy Agency (IEA), global shipping in 2017 consumed 3.8 million barrels a day of fuel oil. (Other estimates project that total is perhaps 20% higher.) Of this, just 600,000 barrels a day was marine gas oil, which is compliant under the new regulations. The rest is termed intermediate or marine diesel.
Already, the lower sulfur fuel costs substantially more. As of mid-April, marine diesel hovered at around $420 per metric tonne in Rotterdam and $460 pmt in the US. Marine gas, by contrast, cost around $603 pmt in Rotterdam and $660 pmt in New York.
What the price will become January 1 is anyone’s bet, although some futures contracts indicate a $200 pmt spread between the two types of fuel. Refiners have tried to calm fears of an acute shortage of sulfur-compliant fuel. However, the sudden increase in demand could well prompt a spike in prices, not to mention a collapse in the price of marine diesel. If so, “that spread becomes even more dramatic and exacerbates the issue,” said Blaeser, the lead author of a recent study on global container shipping this year.
BAF and Baffling Behavior
AlixPartners estimates that the bunker adjustment factor rate on eastbound transpacific sailings of large carriers must increase by $150 per forty-foot equivalent unit to just continue operating margins at pre-IMO 2020 levels. The hike in Asia-European sailings is even more dramatic — $270 per FEU.
Those two routes, the consultancy said, would result in an increase of about $3 billion a year and account for about 30% of the global container trade, in terms of mileage. So, based on data supplied by 14 of the biggest carriers, AlixPartners estimated the additional costs to the industry will be about $10 billion a year.
Jensen estimates the additional costs will be about $12 billion a year.
Either estimate adds maybe 2.5% to the total container shipping revenue of approximately $200 billion to $220 billion. But look at it another way: The profits of the main container carriers in a seven-year period ended 2017 totaled just $8 billion, said Jensen. “They’d have to basically triple their profitability to cover this new cost,” Blaeser added.
That profit picture demonstrates just how undisciplined the shipping industry has been, allowing margins to diminish over time. As Jensen points out, oil prices collapsed in 2014 and vessel owners and operators couldn’t pocket any of the savings.
So, what will happen next year? Jensen, for one, anticipates what he terms an “orderly transition,” with fuel surcharges being levied on Day 1. “That is very likely,” he said.
If not, “the carriers will almost overnight become colossally loss making, which means that the carriers can sustain this for a very, very short period,” Jensen warned. “What you will then most likely see is a repeat of what we saw in the aftermath of the financial crisis where the carriers will do the only sensible thing that is to cancel a lot of their savings and idle the vessels.”
Shippers have no choice but to shoulder the price hikes, analysts believe. “The overall impression I get from all the shippers I‘ve spoken to is that conceptually they see the necessity of this and that there‘s not much pushback,” said Jensen.
That doesn’t mean negotiations will necessarily go smoothly. For one, all-in pricing — where carriers offer one price, which includes fuel, freight and any surcharges — will become less attractive; Maersk and Hapag Lloyd have already announced they will end the practice. “Many carriers are starting to come out and say, ‘you know what. we’re not going to offer an all-in rate, because the risk is just too high there‘s too much uncertainty in the market right now,’” said Blaeser.
His firm, he added, always recommends to shipper clients that they unbundle fuel and surcharges from the actual freight costs, but that many shippers prefer one price.
Second is the issue of front-haul carriage versus back haul. Will it be distributed evenly or weighted, since the front haul carries most of the goods?
Alternatives
The attraction of alternative fixes also remains unknown. Scrubbers are one, with two types of systems being offered: open-loop and closed-loop. Open loop, a simpler technology, accounts for about 80% of all scrubbers now in operation, explained Ian Adams, executive director of the Clean Shipping Alliance 2020, a group of carriers that advocates scrubber use. This technology uses seawater in the scrubber towers to neutralize the sulfur, as seawater acts as a natural alkaline agent. Closed loop by contrast uses other chemicals to neutralize the sulfur.
Estimates put the number of installed scrubbers by the beginning of next year at just 3,000, or about 5% of the total vessels in operation. For one, the equipment is expensive — costs run anywhere from $2 to $10 million. Secondly, scrubber manufacturers just don’t have the capacity to outfit a significant percentage of ships as each scrubber is custom built. Third, outfitting a ship with a scrubber requires yard time of three to five weeks.
“Container operators have been slow on the uptake and now they‘re just starting to take them and they‘re also doing it almost in a sort of trial way,” said Adams. “They’re doing two or three ships and seeing how it works out for them.”
The benefits are there. Large ships can recover costs within a year and those will be more likely to outfit their exhaust systems with scrubbers.
“There’s an extraordinary economic advantage there until the market swings,” Blaeser said, citing the likelihood that eventually, refiners will produce much more low sulfur fuel, causing the price differential between low and high sulfur fuel to lessen.
The attraction of LNG powered vessels should increase as well with the new regulations in place. Again, large vessels are the more likely targets. CMA ordered five LNG-powered mega-ships. Hapag Lloyd is now retrofitting a 15,000 TEU vessel to use LNG. The fleet giant has 16 more ships that are LNG-ready and can be retrofitted as well. However, the number of LNG-powered ships “isn’t something that truly moves the needle,” said Jensen, who points out that the life cycle of the largest conventionally-powered container carriers is just beginning.
