Uncertainty continues to surround the forthcoming IMO 2020 sulfur cap, even with a mere five and a half months to go before the January 1, 2020, start of the regulation.
What will the makeup of marine fuel demand be after the sulfur cap goes into effect? Will compatibility concerns limit market appeal for low sulfur fuel oil (LSFO)? Will the author of this blog post get any meaningful shuteye between now and January 1, or will sulfur cap anxiety continue to disturb his slumber? These are just some of the questions on the minds of industry stakeholders.
We sought to answer one of these questions at our recently-held ClipperView market outlook events, held biannually in New York, Houston, Geneva, Singapore and London. (The shuteye question has already been answered: No). Namely, in order to produce IMO-compliant LSFO, will refiners be incentivized to redirect feedstocks away from fluid catalytic cracking (FCC) units and towards the bunker blending pool?
For those less ingrained in refinery operations, an FCC unit upgrades intermediate vacuum gasoil (VGO) and other refinery feedstocks into coveted light products that, among other uses, can be blended to make gasoline. Depending on its quality, the VGO can be diverted to pretreatment units before entering the bunker blending pool to produce LSFO. LSFO is one of the key fuels that shipowners will be turning to in order to adhere to the IMO 2020 regulation.
The economic return for diverting the VGO into the bunker pool would need to exceed the return a refiner obtains from running the VGO through their FCC unit in order for this diversion to occur. This incentive has traditionally not existed. After all, refiners spend hundreds of millions of dollars on FCC units for the promise of boosting the economic return of their refining complexes.
But there is nothing traditional about IMO 2020.
ClipperData applied futures prices to the product yield of a barrel of crude, both when the FCC is operating and when the unit is shut off, in order to determine what the market is currently signaling for feedstock redirection in the buildup to IMO 2020. Historically, the market has signaled it was indeed profitable to run an FCC unit, as the increase in light product output resulted in favorable returns. But looking ahead to Q4 2019, the opposite appears to be true:
Futures markets are currently signaling that it will be more profitable to divert VGO away from FCC units and towards the bunker pool starting in October. The reasons are rooted in both the light and heavy side of the barrel. Global economic indicators have proved increasingly troublesome in recent months, which have depressed gasoline futures. Because a refinery produces more gasoline components when running its FCC, lower gasoline futures prices in Q4 have made running an FCC less profitable. At the same time, futures prices for LSFO have spiked in recent weeks as the LSFO market becomes increasingly liquid. As such, markets are signaling that refiners should produce as much LSFO as possible, deterring use of the FCC because it is the less profitable option.
Does this mean refineries across the globe will rush to shutter their FCC units to maximize LSFO production? Most likely not. There are significant question marks surrounding the spec issues of using VGO in the bunker pool that may limit demand for LSFO bunker blends. At the same time, VGO redirection also drastically reduces the amount of gasoline a refinery produces. ClipperData ran several scenarios on how VGO diversion in the US could impact gasoline inventories:
Even a 20 percent decline in FCC processing across the United States would result in a 19 percent reduction in US gasoline inventories from October-December. Such FCC outages would likely boost gasoline prices and the profitability of running an FCC. Still, the market is signaling changing refining economics are on the horizon, which will likely result in at least some refiners redirecting their VGO streams away from FCC units and towards the bunker blending pool.