A sulfur cap on global shipping will go into effect in January 2020, an effort by the International Maritime Organization (IMO) to reduce emissions in the marine sector. While that target will directly disrupt shippers and refineries, the implementation of IMO 2020 will provide a one-off spur for oil demand while harming heavy crude producers in the process, OPEC said in its “World Oil Outlook 2040” report released on Sept. 23.

The rule limits the sulfur content in all bunker fuels from 3.5% to 0.5% in January 2020. While the regulation will hit the refining industry, OPEC said that it expects the rule to “likely affect overall demand levels, especially in the one to two years following its implementation.”

“In order to produce sufficient volumes of middle distillates, the global refining system is expected to increase runs by around 0.4 million barrels per day (MMbbl/d) in 2020 [additional to the case if no IMO regulations were adopted],” OPEC said in the report.

(Image Source: OPEC)

Outlined in the report, analysts expect oil demand to decelerate from 1.6 MMbbl/d in 2018 to 1.4 MMbbl/d in 2019. But, instead of a continued growth deceleration heading into 2020, OPEC projects that oil demand will bounce back to 1.7 MMbbl/d in 2020 as a result of market adjustments to the IMO regulation.

The temporary boost will cause post-2020 global demand levels to revert to 900,000 bbl/d in 2021 and 800,000 bbl/d in 2022 and 2023, the report showed. According to OPEC, the oil demand increase will be a direct consequence of two issues: the volumetric processing gain from switching fuel oil to diesel and, more significantly, the refining industry’s reluctance to invest in expanding capacity to meet the fuel standards. Because of the cap more refinery runs to produce lower sulfur fuel oil will be necessary.

Though OPEC expects the spur to be short-lived, it said the sulfur cap has the potential to tighten markets significantly within that short timeframe.

Expressing that same concern at PESA’s recent market outlook luncheon, Marshall Adkins, analyst at Raymond James, said the rule would “eliminate the fracking oil that we’re currently consuming globally and shipping” and essentially reduce the supply of usable crude by 1.5 MMbbl/d once implemented.

“You can’t just whack supply by 1.5 million a day in one year in a market as tight as ours right now and not see prices spike,” Adkins said.

Moreover, though refiners will obviously face challenges with the new rule, OPEC sees heavy crude producers in danger as well.

“A strained refining market would also inevitably bring impacts on crude oil, as well as product differentials. Low-sulfur crudes can be expected to command a premium, while discounts for heavy sour grades would likely widen, potentially severely,” OPEC stated in the report.

With the extra production of roughly 400,000 bbl/d in 2020, more than 200,000 bbl/d will be surplus high-sulfur oil forcing a price discount. Those geared towards heavy and sour crudes will experience high margins, OPEC said, while light sweet crude producers will see margins improve despite an increased premium.

“Because of these regulations, from 2020, refiners can expect demand for high-sulfur fuel oil to fall, demand for low-sulfur fuel oil to increase and a corresponding price differential between the two to open up,” Royal Dutch Shell said in its “Key Steps for Refiners Ahead of IMO 2020” report last year.

“Fortunately, the [low-sulfur to high-sulfur] price differential is likely to close partially over time as scrubber technology improves and conversion facilities are built. Consequently, there will still be a market for HSFO [high-sulfur fuel oil] and refiners do not necessarily need to eliminate their HSFO exposure, but they would be well advised to reduce it to retain their competitiveness,” the Shell report said.

Important to note is that the rule does have an exception to the sulfur limit for tankers that have scrubbing facilities onboard. Still, the regulation is set to meet a high probability of non-compliance since there aren’t many scrubbers on vessels due to its high cost and the disinterest to expand from refiners.

But, OPEC expects compliance to grow from an initial 75% to 90% in 2023 once more onboard scrubbers are adopted.

“OPEC’s reference case assumes that installing scrubbing facilities will take off only from 2019, shortly before the IMO decision comes into force and once the financial incentive—in the form of a widening HSFO discount to compliant LSFO and gasoil—materializes.”

Mary Holcomb can be reached at mholcomb@hartenergy.com.