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Will This Be Another Kick In The Teeth for Canadian Oil

Did you know that 90 percent of every good we buy gets loaded on a ship at some point?  And shipping accounts for about 4-5% of global fuel use.

Those two stats basically guarantee that there WILL be a major disruption to the oil and shipping markets in 2020–just two years from now.  How exactly everything unfolds isn’t entirely clear.

What is clear is that it will raise costs on many, many things.  Get ready for every good that you purchase becoming more expensive.  Buying a washing machine, a toy for your children/grandchildren, a plane ticket, some sugar and yes especially your gasoline.

You are now on notice, in 2020 the price of virtually everything is going to take a jump higher.

This is also going to be a major event for both the oil and gas and shipping industries.  Some companies are going to make a lot more money because of this…..some are going to experience the opposite.

I don’t even need to stop there.  Entire countries are going to feel the impact.

Here Is What Is Happening

In 2020 (that is just 18 months from now……terrifying I know!) there are new rules coming into play for the global shipping market.  That may not sound interesting but trust me it is.

Those new rules are intended to reduce the amount of pollution produced by the world’s ships.

These rules were created by the International Maritime Organization (IMO). Starting in 2020 the IMO is going to enforce a complete ban on ships that use fuel that contains a sulfur content higher than 0.5%.

The current standard is 3.5%.

A ship in violation will be hit with fines, almost certainly find that their insurance become invalid, and likely declared “unseaworthy” which would result in the ship being barred from sailing.

This isn’t a slap on the wrist or a parking ticket that can be ignored.  The shipping industry needs to abide by this and the start date is getting very near.  The analyst reports that I have read suggest that compliance will be very high.

If you were wondering why the IMO is cracking down on sulfur emissions I was able to find a few pieces of information…..and they are startling.

One report (1) indicates that just 15 of the world’s largest ships emit as much pollution as the entire global automobile fleet (almost 1 billion cars).  That sounds crazy until you realize that the low grade bunker fuel (or fuel oil) used in ships has 2,000 times the sulfur content of diesel fuel used in cars.

The ships aren’t the problem; it is the high sulfur fuel that they burn.

Combine that information with a few other eye opening facts:

  • These large container ships have 109,000 horsepower engines which weigh 2,300 tons — they burn a lot of fuel!
  • That each ship typically 24hrs a day for about 280 days a year — they almost never stop!
  • There are more than 90,000 ocean-going cargo ships — there are a lot of them!
  • 70% of all ship emissions are within 400km of land — they operate in sensitive locations

Another report, this one published in the Environmental Science and Technology concluded that the emissions from the 90,000 plus cargo ships in operation globally cause 60,000 deaths per year from lung and heart problems and create $330 billion in health care costs.

Apparently sulfur emissions are very bad.

Both The Shipping And Energy Industries Are Ill-Prepared

The enemy targeted by the regulations is the high sulfur fuel oil.  Today the global shipping fleet consumes 4 million barrels of it per day.

At least 3 million barrels per day of that demand disappears when the clock strikes midnight on December 31, 2019.

All of that demand gone overnight, literally.

Almost all of that demand for high sulfur fuel oil is going to switch to marine gasoil, which is a lower sulfur distillate fuel.

Think for a moment about the logistical implications of 3 million barrels of demand for one product disappearing and a similar 3 million barrel per day increase for another one appearing.

Pricing of the two different fuels is obviously going to be dramatically impacted.

Today marine gasoil currently trades at a premium of $250 a ton to fuel oil but the futures curve is now showing this premium ballooning to $380 per ton by 2020.

That big increase in fuel cost is going to be bad for the shipping companies.  Thomson Reuters Research estimates that the fuel cost for a VLCC (a big-boy oil tanker that carries 2 million barrels) will jump by 25%.  That is a big deal given that fuel already represents half of a ship’s daily operating cost.

In turn, the increase in cost to the shipping industry is going to get passed on down to you and me.

For some this will be good news–like, whomever is already equipped to make and sell that marine gasoil.  They will get some big-time margin expansion.

That would be refiners that are equipped with complex facilities that can exploit price differentials between heavy and light crudes.

Globally the publicly traded operators that are best prepared are believed (according to Morgan Stanley research) to Valero (VLO-NYSE), Repsol (REPYY-OTC) and India’s Reliance Industries.

The bigger question is that how does the refinery industry physically get prepared to meet an additional 3 million barrels of demand for marine gasoil in just 18 months?  Can it?

The cost to adjust a refinery so that it produces more distillates with less sulfur content is estimated to be almost $1 billion.  The smaller refineries can’t afford that and will be stuck producing fuel oil that there is no demand for.

Global Oil Price Differentials Are Going To Be Reset

The easiest way for a refinery to produce fuel that has less sulfur is to process crude oil with a lower sulfur content.

That will mean demand for lower sulfur oil will increase while demand for high sulfur oil will drop.

The result of that will be changes to how the different oil grades are priced globally.

“Sour” crudes with higher sulfur are going to see their pricing suffer — we are talking steep discounts.  Those high sulfur (sour) crudes would include what produced by Venezuela, Mexico and Ecuador.  Not exactly what any of those countries need right now.

It would also be yet another kick in the teeth for Canadian heavy oil producers who have already suffered discounts from pipeline constraints for years.  The Canadian Energy Research Institute (CERI) said last year they thought that 500,000 bopd of Canadian crude could be affected, as a large chunk of it has 2-5% sulphur.

Meanwhile pricing for the light, sweet blends like North Sea crude, Nigerian Bonny Light and North American shale oil will increase.  So keep the grade of oil being produced when you are looking at oil producers as investments.

When this hits in 2020 it could be a seismic shift in the global oil markets.

How it all plays out is very complicated but it will clearly impact anyone who wants to move virtually anything, and I’m not just talking about goods moving by ship.  The strain of limited refining capacity for lower sulfur fuels is going to increase the prices of all oil products, including diesel, jet fuel and petrol.

Because these “clean” fuel products are closely related, when demand and pricing for one surges that tends to also raise prices of the others.

I’ve got my head down looking for the best investment opportunities that are going to come out of this.  I’m sure I’m going to find a couple of beauties.

Editors Note: the new shipping regulations should increase demand–and pricing–for light oil. Get my favourite light oil stock right now–a company already increasing dividends, and growing production quickly. Click HERE to get the name and symbol.

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