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IMO 2020, a shipping regulation that may reshape global coal trade

IMO 2020, a shipping regulation that may reshape global coal trade
January 10, 2018

It is not uncommon for people in various commodity sectors to believe that their markets exist in some kind of a happy bubble, where only the obvious supply and demand forces or targeted regulations can make or ruin their day. This often applies to the world of coal too.

Shipping is a perfect example of a factor which is sometimes overlooked. This is evident from industry events these days, where shipping is often either way down the agenda or off it completely.

The issue here is not ignorance, of course. When it comes to seaborne coal cargoes, any trader worth his salt would still look at the freight element as it affects the CIF price and delivery time.

The real problem is that freight rates have been depressed and often lacking volatility for years due to an oversupply of vessels.

With freight rates low, existing arbitrages settled safely and shipping while always there naturally was no longer perceived to be a crucial factor in opening or closing trade routes.

However, times are changing. In addition to freight already being on a path for recovery due to rising demand, there is an upcoming disruptive regulation from the International Maritime Organization that could upset the apple cart.

The global sulfur cap of 0.5% on marine fuels that that will come into effect on January 1, 2020 is already seen as a perfect storm by the oil and shipping industries as it may cause extreme volatility in bunker prices.

The most likely outcome is a sharp rise in costs for shipowners, and — as in any business — these costs will be passed on to the customer. For anyone involved in seaborne coal trade, this would mean dealing with a dramatic, long-term increase in freight rates.

No easy way out

The new sulfur cap of 0.5% is a sharp drop from the current limit of 3.5% and in simple terms it means that come January 2020, all vessels around the globe will have to burn cleaner and more expensive fuels or take other costly measures to comply.

One way that shipowners could go is using special fuel oil blends, which would fall below the 0.5% cap. However, experts are doubtful that the global refining industry will be able to supply these in sufficient volume and variety in time for 2020.

Otherwise the industry could go straight to burning marine gasoil which many expect will be the most popular option, at least at first.

However, while MGO is compliant and more readily available, it also much more expensive than conventional IFO 380 bunker fuel.

Of course, there are a few alternatives available to shipowners, such as LNG bunkering or exhaust control systems, also known as scrubbers, but both have serious drawbacks.

For example, it takes $3 million-$6 million to install a scrubber on a dry bulk vessel, with costs depending on the size of the ship and the type of the scrubber.

Retrofitting a 5-10 year old ship, given current vessels prices, would therefore be prohibitively expensive.

It is even harder to justify LNG as the global bunkering solution as the infrastructure required to support it is not there yet and the upfront costs for retrofitting ships are even higher.

Who will pick up the bill?

Whichever way the industry moves, one thing is certain — it won’t be cheap. Estimates of how much the extra costs for shipping would be vary widely, ranging from modest a $5 billion to $70 billion a year, which clearly shows how much uncertainty surrounds the whole issue.

This is not just a problem for the shipping industry. Given the sorry state of the freight market, shipowners will not be willing or able to absorb such massive extra costs themselves and will have to pass on the lion’s share to their customers.

This would be people who trade the actual commodity, and the extra bunker fuel bill could be quite substantial, especially on long-haul voyages.

Let us look at a specific example — the coal arbitrage from Colombia to North East Asia. Obviously Columbia is not the biggest player when it comes to this region. Australia and Russia are as they are much closer to the buyers.

However, in both 2016 and 2017, Colombia successfully took a considerable bite out of their market share, selling over 3 million mt a year of bituminous thermal coal to NE Asia.

The graph below compares Australian and Colombian coal prices, including Panamax freight to NE Asia. For the sake of simplicity it is assumed that freight rates on both routes were constant throughout the year.

It is quite clear that there have been pockets of arbitrage from Colombia throughout the year, when the delivered price of their product was more competitive than Australian coal.

This was made possible by the lack of volatility in the depressed dry bulk freight market, and relatively low bunker prices, which allowed a distant supplier to be competitive.

The picture is likely to be very different on in 2020 once the new IMO sulfur cap comes into force.

Showing the money

If MGO does indeed become the go-to fuel for global shipping, the extra bunker expenses may skyrocket, making long-haul freight too expensive and an arbitrage like Colombia to NE Asia unworkable.

To put numbers in perspective, extra costs for one Panamax voyage on this route at current MGO prices, comparing with standard fuel oil would exceed $230,000.

According to some estimates, the overwhelming demand for MGO come 2020 could propel its prices two to three times higher.

Considering the rising trend in oil prices, the extra bill per voyage could easily come to half a million dollars, making the whole arbitrage of 3 million mt costing over $21 million more in just fuel expenses.

Since bunker expenses make up 70-80% of voyage expenses, the freight may easily double, especially on longer routes.

However, as can be seen from the graph below, even with a modest 50% increase in freight, there would be almost no occasions when the Colombia-NE Asia arb would be workable.

Certainly, depending on which side of the fence you are sitting, it might be a good or a bad thing.

In general, the further the seller is from the buyer, the more they will be exposed to the negative effects of rising bunker prices. At the same time their short-haul competitors might have a good reason to smile.

You’re not alone

It won’t be just coal that will feel the impact of the new regulations. The dry bulk market as a whole will be affected because the same tonnage is often used across various dry bulk commodities.

For example, if the long-haul grain arbitrage from the Black Sea to the East were to suffer, a drop in ton-mile demand may ease the freight burden for US coal exports.

In time, of course, both the oil and shipping industries will readjust to the new realities and both prices and trade routes will stabilize again.

However, before that happens, the coal industry should start keeping a beady eye on what is happening with bunkers and shipping to avoid nasty surprises on their balance sheets in the new decade.

This blog post was first published on the Coaltrans Blog.