GLOBAL AIRLINES GET THAT SINKING FEELING UNDER PLANS TO CLEAN UP MARITIME FUEL
Bid to curb the environmental damage done by the shipping industry could have an impact up in the skies as well
From the window of a jet plane, it can be hard to see ships crawling across the seas. Yet what is 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, according to Bloomberg.
From January 1, 2020, ships around the world will need to consume fuels containing less sulphur under the 2016 rules set out by the International Maritime Organisation, part of the United Nations.
The move is intended to protect the environment in shipping lanes, since engine fuel creates sulphur oxides responsible for acid rain. Pollution from ships has been estimated to cause 130,000 premature deaths from respiratory illnesses worldwide each year, and is particularly bad along the Arabian Gulf, Red Sea, India, Java and East Asia. By contrast, the North Sea and the coasts of North America already apply stricter rules.
Cowboy shippers may not follow the regulations immediately as enforcement and penalties are unclear. But leading shipping and cruise lines and major ports will comply. They have four choices. First, they can use fuel oil processed to reduce its sulphur content, but this will be expensive and in scarce supply. Second, they can burn marine diesel, which also has lower sulphur but is costly.
Third, they can fit scrubbers which wash the exhaust with seawater to turn the sulphur oxides into harmless calcium sulphate. But scrubbers are expensive, priced around $3 million to $5m each, and shipyards cannot fit enough of them by the 2020 deadline. Or fourth, they can adapt ships to burn liquefied natural gas, a clean fuel. But converting an existing ship to use LNG is expensive and the required tanks reduce the vessel’s cargo capacity. LNG is not available at all ports, though the major ones such as Rotterdam, Singapore and Shanghai are installing LNG bunkering facilities. However, Fujairah, the world’s second-largest bunker port, is still without LNG.
While the regulators’ target was to lower sulphur emissions from ship fuel, it is 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 is serious disagreement about whether the result will be a glut or a shortage.
“These rules are going to impact airlines,” said Mark MacLean, managing director at Commodities Trading Corporation, which advises on hedging strategies. “The impact 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. Oil refineries are likely to face an initial demand surge from shippers for diesel-type products. 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.
How it plays out in practice hinges on the way refineries make jet fuel and – critically – how much flexibility they will have to adjust their output once the new rules come into force. Jet fuel is made in one simple refining process – 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 sulphur specifications, according to Jan-Jacob Verschoor, a director at Oil Analytics and a chemical engineer by training. Refineries will also have some flexibility to maximise diesel production to the detriment of jet fuel output, more than negating any ramp-up in overall crude processing, he says.
So far, most airlines seem relaxed about the situation. Of 26 carriers monitored by Bloomberg in Europe, the United States and Asia, only Southwest Airlines has reported hedged fuel prices into the next decade. The company has 38 per cent of 2020 buying covered, up from 36 per cent a year ago for 2019. It is 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.
Prices for jet fuel for mid2020 have risen by more than 40 per cent 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 are already having on the market, says London-based Mr MacLean. The ICE gas oil crack, or premium to Brent, for June 2020 has gained about 60 per cent since last July.
The fallout from the shipping rule change is an important quandary for airlines already suffering from a more than 50 per cent increase in crude prices over the past year.
The surge in crude price may force some weaker operators out of business, Ryanair chief executive Michael O’Leary said last month. Willie Walsh, chief executive of British Airways parent IAG, said last week that the price of fuel “is having an impact because it’s much higher than we expected”.
New rules are intended to protect the environment in shipping lanes, since engine fuel fumes are responsible for acid rain