For beneficial cargo owners (BCOs) beginning the process of negotiating annual ocean carrier contracts, the worldwide cap on sulfur content in bunker fuel set to take effect on Jan. 1, 2020, is looming as the largest issue they will face in getting these agreements in place.
There is no current forecast that doesn’t anticipate a substantial increase in fuel costs for those ships that must use low-sulfur fuel as of the implementation date of the International Maritime Organization-imposed rule. Ships can either burn low-sulfur fuel or be installed with so-called scrubbers that remove sulfur from the exhaust. Shipowners have been rushing this year to install scrubbers, having realized that low-sulfur fuel will likely cost substantially more than traditional bunkers as of 2020, but much of the fleet will be forced to burn low-sulfur fuel at a substantial premium to current high-sulfur prices.
According to Drewry, “the level of uncertainty today as to the total cost impact is so large that nobody is able to provide a confident forecast of the cost of compliance; the only certainty is that the extra cost will run into billions of dollars globally come 2020.”
For the period from 2020 to 2022, the sulfur cap “will result in a hugely disruptive period for the refining and shipping industries,” according to the IHS Markit energy team, which predicts a “scramble period” of up to a few years when a new equilibrium of supply and demand will be determined by refiners and shipowners. This could result in the price of low-sulfur bunker fuel hovering around $680 per ton in 2020, up more than 30 percent versus the current price of high-sulfur bunkers, through other analysts have put the differential as high as 55 percent or higher.
“Our view is that the price of [high-sulfur fuel oil] will move among various pricing bands during the first three years before a sizable share of the large vessel fleet installs scrubbers and an onset of refining conversion capacity additions bring the market back to a new ‘norm,” IHS Markit wrote in a recent report.
Low-sulfur fuel mandate – an existential moment for ocean carriers
The likelihood of significantly increased fuel costs has carriers girding themselves for an existential moment, where failure to recoup the additional fuel costs could threaten mountainous losses or even bankruptcy. Their view was summed up earlier this year by MOL President Junichiro Ikeda, who told the Financial Times, “We’re all going to go bust” if carriers can’t recover the added costs from customers.
One senior carrier executive told JOC.com that there would be “no negotiation” on bunker fuel surcharges beginning as early as 2019 annual contracts that won’t even extend into 2020, let alone trans-Pacific contracts signed as of May 1, 2019, that will extend well into 2020. That may well be so, but the track record is less promising. Carriers have little history of successfully passing along prior bunker fuel cost increases to customers, as the 2018 run-up in bunker prices has amply demonstrated.
And despite efforts to create transparent fuel surcharge formulas, the legacy of prior, less than fully transparent formulas is that customers suspect the carriers’ goal is revenue creation versus cost recovery. “There is a need for carriers to address the transparency concerns expressed by their customers,” Drewry said recently.
The danger for BCOs is less that they will be forced to pay higher costs for ocean transportation but rather that the carriers will fail to recoup a substantial portion of the additional cost and be forced to take drastic measures like reducing capacity to drive rate levels up and recoup the added costs that way instead.
The state of the market next spring will go a long way to determine the extent to which carriers will negotiate on fuel cost surcharges. The impact of the US-China trade war and early-2019 decisions by ocean carriers on limiting capacity will play key roles in determining the relative strength of the market in the run-up to the May 1 deadline for most trans-Pacific eastbound contracts. As will carriers’ desire to support key favored customers as they have done in similar situations in the past. “Each carrier will have a group of customers that they ‘protect;’ it's in their DNA,” said industry veteran Gary Ferrulli.
If, when face to face with losses in 2020 the carriers were to withdraw significant capacity as the Jan. 1 date approaches, the scenario would likely resemble 2010 when, reeling from losses from the financial crisis, carriers mothballed capacity, drove rates through the roof, and restored profitability while leaving a trail of angry and disillusioned BCOs. Shippers need to be asking themselves how well they will be situated with carriers if that scenario were to unfold again in early 2020.
How good are your carrier relationships at their headquarters? When was the last time not when they visited you, but when you visited them? Are you seen as a “good customer” by delivering on minimum quantity commitments, accurately and consistently forecasting volumes, and not walking away from commitments when lower spot rates can be found out in the market?
Are you careful not to sign on to rock-bottom rates in contracts that could come back and haunt you if and when spot rates were to go up, forcing carriers to choose between your cargo and higher-priced business they can load from the spot market?