* Short-term price spike possible from end of 2014
* Limited take up of scrubbers and LNG expected
* Refining margins clobbered by lower LSFO demand
By Claire Milhench
LONDON, March 4 New fuel rules for ships
entering low sulphur zones around northwest Europe and North
America next year could trigger a price spike in European
gasoil, whilst refiners will struggle to offload unwanted fuel
From January 2015, ships entering "Emission Control Areas"
(ECAs) in the Baltic, North Sea and English Channel and around
the North American coast, will have to switch from low sulphur
fuel oil (LSFO) with 1 percent sulphur content to 0.1 percent
gasoil, in a crackdown on marine pollution.
Industry experts believe shipowners will opt for gasoil
rather than using exhaust filter systems known as scrubbers or
alternative fuels such as liquefied natural gas (LNG), because
of high investment costs, long payback times, and the lack of
suitable port infrastructure.
Gasoil currently trades at around a $300 premium to
LSFO on a flat price basis.
"Most ships will move to marine gasoil in 2015," said David
Wech, an analyst at JBC Energy. He sees demand for gasoil
growing by 135,000 barrels per day (bpd) in northwest Europe and
105,000 bpd in the United States. Demand for fuel oil will fall
by 120,000 bpd and 90,000 bpd respectively.
This could prompt a short-term price spike in gasoil,
similar to that in August 2012 when North America's ECA first
came into effect, mandating a switch to 1 percent LSFO. Although
this was flagged well in advance there was a run on European
LSFO from June, peaking in mid-September.
"When spec changes have taken place in the past there have
been spikes, but there is more spare capacity in the system
now," said Jonathan Leitch, head of oil product short-term
analysis at consultancy Wood Mackenzie.
"So there's a potential for price spikes to be
shorter-lived. We might see a run up in November/December ahead
of the switch, and in the first couple of months."
Crucially, North America is switching to 0.1 percent at the
same time as northwest Europe, which could lead to a temporary
reduction in middle distillates export volumes - exports that
Europe relies on to help make up its shortfalls.
"It's moving them more back into equilibrium as it's
encouraging more domestic middle distillates consumption," said
Iain Mowatt, an oil analyst at Wood Mackenzie.
WoodMac calculates that some 220,000 bpd will switch from
LSFO to gasoil in northwest Europe, which Leitch argued could be
found from new refining capacity in the Middle East.
But traders are not convinced cheap gasoil will be so easy
to find as ship owners will have to compete with existing gasoil
buyers in North Africa and West Africa. This will push up prices
before the market adjusts to the new demand.
One trader pointed out that European refiners have upgraded
units to produce more diesel and less gasoil. This could prompt
some blending of high value diesel into the mix if gasoil prices
rise enough to make it worthwhile.
"If you look at gasoil I don't think there is enough supply,
but there is plenty of diesel. So we might see diesel ending up
in the 0.1 percent," another trader agreed.
As late as 2013 some expected a broad take up of scrubbers
or LNG, but this is now considered unrealistic for 2015 with
adoption put at less than one percent of the global fleet.
Scrubbers were not an unmitigated success in sea trials and
still need to prove themselves. The installation expense is also
deterring shipowners, with only a few exceptions such as
Carnival Cruise Lines, which is spending more than $180
million to install scrubber technology on 32 ships.
"For most ships it isn't cost-effective to put in
scrubbers," said WoodMac's Mowatt. "Even those ships that will
spend 100 percent of their time in the ECA are a bit reluctant
to fit scrubbers as they are still at the demonstration phase,
and in some ships it isn't easy to retrofit them."
A handful of shipowners are opting for LNG, with Brittany
Ferries commissioning a 270 million euro LNG cruise-ferry from
shipbuilder STX France for service in spring 2017.
But LNG only suits ships with regular ports of call because
of the infrastructure required. The EU is trying to ensure this
will be ready post-2020, when further sulphur restrictions are
implemented globally. Even so, Brittany Ferries said its new
ship would have a dual fuel engine, so it can still use gasoil
One sticking point is how easy it will be for authorities to
enforce the new rules. North America is expected to do a more
consistent job than EU member states, although Mowatt thought
the Netherlands would try hard.
Antoine Kedzierski, policy officer at Transport &
Environment, a campaign group for greener transport policies,
said that the lack of a proper enforcement mechanism was a big
issue in Europe. "Quality shipowners that invest to comply with
the (EU) Directive will potentially suffer a competitive
disadvantage compared with the laggards who may just bet on the
low chance of being controlled," he said.
UNWANTED FUEL OIL
For European refineries still producing large amounts of low
value fuel oil, margins are likely to deteriorate further as
they struggle to offload the unwanted product.
LSFO's premium to high sulphur fuel oil (HSFO), known as the
hilo, will compress as demand for LSFO falls. "The spread will
fall markedly in late December/early January with LSFO possibly
pricing very close to HSFO in a few instances," JBC Energy's
It's also far from certain that Asia - once seen as an
outlet for European LSFO - will absorb the surplus barrels.
"It's bearish on the market as overall there's going to be
excess fuel oil," said one North Asian trader. "Another downside
factor is the Japanese government's push for nuclear power
plants to restart." He pointed out that fuel oil was already the
last choice for Asian power stations, with natural gas and coal
preferred for electricity generation.
But what refiners lose on the fuel oil may be partly offset
by what they gain on the gasoil. This could give some European
plants, which are under extreme pressure from U.S. exports, a
"The switch may offer a boost to European refiners in 2015
and 2016 but that will be short-lived as Russia ramps up 10 ppm
(diesel) production," a trader said.