Preparations ahead of the IMO 2020 low-sulfur mandate have taken considerable attention within the industry this year. In essence, many beneficial cargo owners (BCOs) didn’t even know about IMO 2020 until carriers announced their new low-sulfur bunker adjustment factor (BAF) structure at the end of 2018. Given that the coming regulations had been known for several years prior, it is clear that no material action was taken until the last possible moment.
With this backdrop, it is therefore prudent to look beyond the deadline of January 1, 2020 and look at what IMO 2020 is likely to result in not just in the very short term, but also in the coming years. This is also relevant as there are many important aspects of the mandate that have been left by the wayside in the rush to meet the more immediate Jan. 1 deadline.
First, it is important to recognize why the IMO 2020 rules were made in the first place. Numerous conversations with all types of industry stakeholders during 2019 has clearly shown there is a misconception about the reason. There is a widespread belief that IMO 2020 is somehow linked to the wider issue of greenhouse gas emissions and global warming. This is simply incorrect. IMO 2020 only pertains to sulfur that does not act as a greenhouse gas. This type of emission reduction does nothing to alleviate global warming concerns.
The reason for IMO 2020 is much simpler. Elevated levels of sulfur emitted into the air simply kill people through a higher incidence of cardiovascular illness and lung cancer. The baseline is that introduction of the new sulfur emission rules will prevent more than 100,000 premature deaths annually. Understanding the core reason is typically a good starting point for understanding the urgency and steadfastness with which calls for extension of the deadline has been rejected.
But looking toward 2021, 2022, and beyond, several additional elements warrant closer inspection — the impact of scrubbers, who will end up paying the bill, and the preparedness of other actors in relation to enforcement.
Scrubber popularity on the rise
By now it is clear that carriers are vigorously pursuing the installation of scrubbers. At a price differential of some $200 to $250/ton, the payback time is on the order of just 12 to 18 months. A continuation of this spread would ensure continued scrubber installations in the next couple of years. But this brings up an aspect likely to become an issue in 2021. At that point, a very substantial portion of the vessels operating in the Asia-Europe trade will be equipped with scrubbers. Furthermore, many will be getting to the point where the capital costs have been covered. Hence, for contract negotiations in 2021 and even more so in 2022, we should expect a severe reduction in the associated BAF levels on this particular trade. Not that they will drop to zero, as the scrubbers certainly have costs associated with maintenance and also because they do increase overall fuel consumption 1 to 3%. But it is clear that the price competition in Asia-Europe in 2021-22 will be strongly dominated by carriers who, by that time, have had their capital costs for scrubbers earned back.
This also implies that the usual “arms race rules” apply. As soon as a critical mass of vessels are getting scrubbers installed in a trade lane, everyone has to follow suit — or lose in the predictable competition on costs that will ensue one to two years later. As such, this is likely to become a main issue in the Asia-Europe negotiation at the end of 2020 for 2021 and for the trans-Pacific rate negotiations in spring 2021 for contracts ranging into 2022.
That brings us to the aspect of who is going to foot the bill. Bottom line is that the rules will result in added costs of $10 to 15 billion versus the baseline of no new rules — with the operational cost aspect declining somewhat in a couple of years due to the aforementioned scrubber effect. The carriers cannot absorb such costs, hence this has to be passed on to the cargo owners — either as increased rates/surcharges or, in the case of generally declining oil prices, as less of a rate decline than what would otherwise have been the case.
Conversely, several large BCOs have stated at public conferences that this will not, as such, result in increased prices toward the consumers. And given that ocean freight costs are typically a tiny fraction of the consumer retail prices, such a position is also logical.
Hence, over the coming years, we will see increased pressure on the stakeholders located in between the carriers and the major BCOs in order to recoup the added costs. This will, therefore, intensify the cost pressure on ports, terminals, and intermediary logistics providers.
Much criticism has been levied on the carriers for not preparing for the transition earlier. However, in this context it should also be kept in mind that oil companies were also not exactly quick to ramp up production and distribution of appropriate low-sulfur bunker fuel. Any short-term disruptions to supply chains in early 2020 should therefore not solely be blamed on the carriers as they are not the ones producing and distributing the fuel.
Furthermore, the national authorities who are entrusted with enforcement of the rules remain quite opaque in terms of how practically they will execute this task — and, more worryingly, what the level of fines for violations are. Given the substantial financial impact, the risk is that disproportionately small fines will encourage deliberate violations.
When the low-sulfur rules were introduced in North Europe in 2015, it essentially took the authorities about a year before effective enforcement was in place, including appropriate penalty schemes
This brings us back to the shippers. Whereas it is not the role of shippers to act as an enforcement agency vis-à-vis IMO 2020, they do potentially have a role to play nonetheless. In an environment wherein not all national authorities are capable of, or willing to, enforce the rules — or a low level of fines makes it opportune to violate the rules — shippers can simply choose to shift part of their cargo away from carriers which are seen to deliberately flaunt the rules. This might prove to be an important impetus in setting the scene for a stable, well-regulated, and well-enforced environment in 2021.
Finally, beyond 2022, there is the issue of liquefied natural gas (LNG)-powered vessels. In 2020-2022, the impact of such vessels is very marginal simply because there are very few of them. From a pure sulfur perspective, these resolve the issue perfectly and an uptake in orders of LNG vessels might very well be seen. If that begins to happen in earnest, the commercial impact on the markets will be felt in 2023-2025 when a new generation of vessels are phased in.
Contact Lars Jensen at Lars.Jensen@SeaIntelligence-consulting.com.