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When we introduced our IMO 2020 modeling last September, we concluded n
that this historically large shift in marine sulfur regulation was “Challenging but Solvable“. Six months later, our updated and expanded modeling suggests that both the shipping and refining industries are on track to meet this challenge.
On the demand side, scrubber orders have remained robust, consistent with our n
above-consensus expectations. While we are slightly reducing our scrubber installation forecast, we don’t expect their appeal to be derailed by the growing opposition to open loop scrubbers.
On the supply side, the combination of refinery secondary unit additions and n
strong shale growth in the face of losses in medium/heavy production has already tightened the high-sulfur fuel oil market. Looking forward, the set of available adjustments by refiners remains large - in fact broader than we first modeled - from shifts in slate and coker/FCC utilization to residue stream segregation.
Net, while the IMO regulation will still have an impact on forward margins and n
cracks, our new 2020 equilibrium points to slightly smaller dislocations than previously, even after accounting for delays in new refinery capacity additions and smaller vessels being scrubbed. While we are also downgrading our global GDP growth forecasts (following revisions by our economists), easing the pull on distillates, we are increasing our 2020 expected compliance level to 85%.
At our $60/bbl Brent forecast for next year, we now forecast more upside to n
forward gasoline cracks than previously. We are less constructive on distillate cracks, with a forecast close to market forwards. Finally, our HSFO cracks remain slightly below market forwards for 2020, but narrow thereafter. In all cases, higher oil prices than we forecast would lead to wider cracks.
While solvable, we acknowledge the potential volatility in fuel prices that is likely n
to accompany such a large shift, especially from this fall through to next spring. From a risk management perspective, we recommend refiners lock in above-average 2020 distillate cracks while scrubbed vessels owners lock in 2021+ discounted HSFO prices to protect their investments should the refinery adjustment process continue to surprise positively.
Damien Courvalin +1(212)902-3307 | [email protected] Goldman Sachs & Co. LLC
Callum Bruce +1(212)902-3053 | [email protected] Goldman Sachs & Co. LLC
Justine Fisher +1(212)357-6711 | [email protected] Goldman Sachs & Co. LLC
Jeffrey Currie +1(212)357-6801 | [email protected] Goldman Sachs & Co. LLC
Oil
IMO 2020 - On track
21 February 2019 | 4:22AM EST
Investors should consider this report as only a single factor in making their investment decision. For Reg AC certification and other important disclosures, see the Disclosure Appendix, or go to www.gs.com/research/hedge.html.
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Executive summary
To estimate an equilibrium outcome for global fuel markets under IMO 2020, we introduced last September a framework leveraging (1) a scrubber incentive installation curve for both ship owners and scrubber manufacturers, as well as (2) an equilibrium model for refining which simultaneously balanced the global distillate, gasoline, low-sulfur and high-sulfur fuel oil markets. This allowed us to determine the likely path of bridging this gap lower in marine sulfur emissions.
We update this model in today’s report. On the demand side, we incorporate the latest data on scrubber orders and implement a fast steaming model for scrubbed vessels. On the supply side, we expand our refinery equilibrium model to better account for shifts in crude slate, inventories and FCC utilization. Finally, we update our three exogenous inputs, lowering our 2020 Brent price assumption to our forecast of $60/bbl, lowering our global GDP growth forecast following revisions by our economists, and increasing our assumed IMO compliance rate to 85% in 2020 (+5%).
Exhibit 1 shows our previous and updated shipping and refining cost curves. These curves reflect the economic incentives of shippers to consume HSFO and refiners to destroy HSFO1 and intersect at our modeled equilibrium. Specifically:
Our scrubber cost curve represents the compliant volume of HSFO consumed by 1.scrubbed vessels, showing the pace at which scrubbers’ consumption of HSFO increases as the distillate-HSFO price spread widens. It reflects scrubbers already announced to be completed by mid-2020, as well as the incentive to add more scrubbers by then, and for each subsequent year. It reflects our payback calculation of scrubber installation, accounting for cost inflation and vessel size as well as the incentive to fast steam.
Our refining cost curve represents the amount of HSFO destroyed/upgraded by 2.refining as a function of the distillate to HSFO price spread. This is the output of an equilibrium model that balances the global gasoline, distillate, LSFO and HSFO markets taking into account: (1) new refining capacity additions (the cheapest sunk-cost solution) and the variable cost solutions of (2) local changes in crude slate, (3) redirection and optimization of existing crude flows, (4) utilization shifts for global refineries, cokers and FCCs, (5) yield shifts between gasoline and diesel, (6) segregation of residue streams, and (7) stock changes. Non-compliance is also assumed to be part of this curve.
This cost curve also reflects three exogenous factors: (1) global GDP growth, as it 3.changes the demand for gasoline, on-road diesel, and freight volumes, (2) oil prices, as they impact both demand (through elasticities) and all crack calculations since refiners respond to % rather than $/bbl crack incentives, and (3) compliance level which creates non-compliant HSFO demand.
1 The horizontal dimension is the size of the international HSFO bunker market in million barrels per day and the vertical is the distillate to HSFO price spread in $/bbl which drives the incentives to adjust.
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The update of our IMO 2020 model confirms the two strongest - and out of consensus - conclusions from our September report. First, that the pace of scrubber announcements remains high and on track to exceed consensus expectations, with the recent debate around open loop scrubbers unlikely to derail this outcome in our view. Second, that the range of refinery solutions is large, in fact now even greater than we initially estimated, with the industry increasingly well-equipped and prepared to meet the IMO challenges.
Nonetheless, two headwinds are partially offsetting these efficient responses to IMO 2020. First, some of the new refinery additions that will help meet the shift in petroleum products demand are running late relative to our initial expectations. Second, the mix of scrubbed vessels features smaller ships than we had expected. This leads to less compliant HSFO demand from scrubbed ships, although our new modeling of fast steaming by scrubbed ships helps make up for some of this shortfall.
Net, at our $60/bbl Brent forecast for next year, we now forecast more upside to 2020 gasoline cracks than previously ($8.50/bbl vs. market forwards at $4/bbl, Exhibit 2). We are instead now less constructive on distillate cracks, with a forecast close to market forwards ($18.50/bbl vs. market forwards at $19/bbl), in part due to weaker expected economic growth. In addition, our HSFO cracks remain slightly below market forwards (-$20/bbl vs. market forwards at -$17.50/bbl). In all cases, higher oil prices, GDP growth and compliance than we assume would lead to wider cracks. Finally, we now forecast a 2020 Brent-Dubai average calendar spread of $3.75/bbl.
Exhibit 1: Our new 2020 IMO equilibrium model Comparison of old and new IMO 2020 equilibria and current European 2020 average LSGO-HSFO spread. Y-axis is Distillate-HSFO spread ($/bbl), X-axis is the HSFO market (mb/d)
0
10
20
30
40
50
60
70
80
0 0.5 1 1.5 2 2.5 3
Old Refining
Old Scrubber
Current cal 2020 NWE0.1%s GO vs 3.5%HSFO spreadNew Refining
New Scrubber
Source: Goldman Sachs Global Investment Research, ICE
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The solutions to achieve the IMO 2020 sulfur cap are admittedly complex and the effectiveness of the policies to enforce it uncertain with still ongoing discussions of a potential waiver mechanism (likely through May). We therefore acknowledge the potential volatility in fuel prices that is likely to accompany such a historically large shift, especially in the early transition from this fall through to next spring, as shippers likely initially shift their consumption to the established low-sulfur marine gasoil rather than new untested low-sulfur compliant bunker fuel blends.
Beyond these initial frictions, however, our updated modeling continues to show that the answer to the IMO 2020 question is closer than most think. In particular, we continue to expect that the IMO 2020 challenge will be resolved by 2023, resulting in normalized cracks and differentials, although new emission regulations are likely to follow. In particular, one key takeaway from our refinery update is the potential for even greater flexibility than we are currently able to quantify in both reducing HSFO supply and creating low sulfur compliant bunker fuel through the segregation of both straight-run and secondary unit residual streams. This comforts us in our conclusion that the risk of HSFO having to discount itself sharply for sustainable periods of time to clear against coal or gas in power remains low.
Exhibit 2: We are most bullish gasoline, modestly bearish HSFO, and in line with the forwards for distillate cracks Realized and forward cracks for HSFO, Gasoline, and Distillate (0.1% LSGO). Dashed lines are our calendar year average forecasts
Exhibit 3: Higher oil prices than we expect would increase the cost of reaching the IMO equilibrium... IMO 2020 equilibria under various Brent oil price assumptions. $60/bbl is our base case
-25
-20
-15
-10
-5
0
5
10
15
20
25
Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22
Gasoline HSFO 0.1% LSGO0
10
20
30
40
50
60
70
80
0 0.5 1 1.5 2 2.5 3
50 Brent
60 Brent
70 Brent
Scrubber 2020
Source: Goldman Sachs Global Investment Research, ICE, Platts
Source: Goldman Sachs Global Investment Research
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Based on our updated equilibrium and our view that the shipping and refining industry are progressing towards solving the IMO challenge, albeit with potential volatility in cracks in 1H20, we recommend two risk management strategies and two investment ideas:
For refiners, to lock in above 5-year average distillate cracks in 2020 and consider n
hedging 2Q20 HSFO cracks to protect against downside volatility when enforcement and hence compliance start to pick up.
Conversely, for ship owners installing scrubbers, we recommend leaving 2020 n
HSFO exposure unhedged to be able to monetize any price weakness during early adoption. However, given our view that the change in bunker fuel is likely to be relatively efficient in coming years, we recommend locking in still-discounted 2021-2023 HSFO prices and cracks.
While most IMO discussions focus on distillate, our modeling suggests gasoline n
offers better potential returns for investors, with the large expected turnarounds season in the fall providing the first catalyst for this move. This bullish gasoline view and our mildly bearish 2020 HSFO view (relative to forwards) also point to a wider Brent-Dubai spread than the forwards next year, even if we expect Dubai to continue to outperform in coming months.
Exhibit 4: ... the cost of IMO 2020 is also very dependent on the economic growth outlook IMO 2020 equilibria under various global GDP growth assumptions. 3.5% is our base case 2018-2020 average
Exhibit 5: We expect IMO 2020 to be resolved by 2023 (at 1.15 mb/d of scrubbed fuel), with normalized cracks beyond then Evolution of scrubber and refining curves and associated IMO equilibria (2020-2022)
0
10
20
30
40
50
60
70
80
0 0.5 1 1.5 2 2.5 3
5% GDP
3.5% GDP(Base case)
2% GDP
Scrubber 2020
0
10
20
30
40
50
60
70
80
0.0 0.5 1.0 1.5 2.0 2.5 3.0
Scrubber 2020 2020 Refining
Scrubber 2021 2021 Refining
Scrubber 2022 2022 Refining
Source: Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research
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In the rest of this report, we discuss in a Q&A format the updates we are making to our IMO framework. We first discuss shipping, focusing on the recent pace of scrubber installation (page 7) and our updated forecast (page 10), the open-loop scrubber debate (page 8) as well as introducing a fast steaming incentive (page 11). We then turn to refining, taking stock of the current tightness in HSFO (page 12), digging deeper on the ongoing shifts in global crude slate (page 16), and updating our assessment of refiners’ IMO 2020 tool kit: new capacities (page 15), cokers/FCC utilization (pages 17, 23) and residue stream segregation (page 18). Finally, we look at the key price sensitivities of our equilibrium (and of solving IMO 2020 more broadly), focusing on Brent price levels (pages 19-20), light/heavy crude differentials (page 19), policy/compliance risks (page 21) and finally hedging (page 21).
Exhibit 6: Our model utilizes numerous solutions to meet the IMO challenge of 2020 Solution decomposition of the HSFO market in 2020 according to our model. Note all changes are cumulative vs. 2017
0
0.5
1
1.5
2
2.5
3
3.5
Source: Goldman Sachs Global Investment Research
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Shipping - still on track for strong scrubber installation
Q: How has the pace of scrubber installation evolved?
A: The orderbook has already grown to over 2,100 scrubbers The scrubber orderbook has continued to grow at a fast pace since we published our last update in October:
From October through late January, the total scrubber orderbook grew at a monthly n
run rate of 201, about on par with the roughly 200 per month rate we saw in each of September and October last year (we were not tracking the scrubber order rate prior to then).
Total orders for scrubber-fitted vessels stood at 2,110 in late January versus 1,507 in n
late October (a 40% increase). Total orders for individual scrubbers (some vessels have more than one scrubber) stood at 2,489 in late January versus 1,836 in late October (a 36% increase).
Total orders for scrubber-fitted vessels for delivery/retrofit before July, 2020 (we use n
mid-2020 scrubber installations to determine our average scrubbed HSFO consumption for the year) were 1,851 in late January versus 1,422 in late October (a 30% increase).
Most of the additional orders were from private companies. While scrubber announcements by public companies have slowed, the strong momentum of orders is now sustained by private shippers. Such private orders could in fact still be understated,
Exhibit 7: GS base case crack forecasts post IMO 2020 NW Europe product cracks vs. Brent, USD/bbl. Distillate is proxied by 0.1% low-sulphur gasoil
Exhibit 8: Growth and compliance are the most important exogenous factors Product cracks under alternative scenarios (USD/bbl)
2020 2021 2022
GS -20.0 -13.0 -11.0
Fwd -17.5 -14.5 -11.0
GS 18.5 16.3 17.3
Fwd 18.5 18.3 18.3
GS 8.5 8.5 9.3
Fwd 4.0 3.3 3.0
GS 13.5 12.4 13.6
Fwd 13.8 14.0 14.4
GS 38.5 29.3 28.3
Fwd 36.0 32.8 29.3
HSF
OD
istil
late
Gas
olin
eLS
FOD
-HSF
O
Gasoline Diesel HSFO
8.5 18.5 -20.0
5% -18.0 13.5 22.5
2% -22.0 3.0 12.5
100% -26.5 9.0 20.0
70% -12.0 8.0 16.0
70 -20.0 8.0 18.0
50 -17.0 9.0 17.0
Gro
wth
Com
plia
nce
Bre
nt p
rice
Base Case (3.5% growth, 85% compliance, 60 Brent)
Source: Goldman Sachs Global Investment Research, ICE
Source: Goldman Sachs Global Investment Research
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as fleets (such as sovereign-owned fleets) may be installing scrubbers but not publicly announcing them.
While scrubber orders have continued to increase, they have not skewed as much
towards larger vessels as we had initially expected. From October through January, 62% of new scrubber orders were for larger vessels (consuming 50mt or more of fuel per sailing day, such as VLCCs, Suezmaxes, Capesize vessels and 8,000 TEU+ container ships). However, the total orderbook remains only 54% larger vessels, which is notably lower than our initial assumption from September that the vast majority of scrubbed ships would be larger ships.
While the economics of scrubbers are most compelling for large vessels with high fuel consumption and long voyage times, we see three possible reasons behind this broader adoption: (1) fleet diversification, where shipowners may want to diversify their price risk within or between different vessel types in their fleets, (2) economies of scale from ordering scrubbers for smaller ships if shipowners receive bulk order discounts or if the vessels are sister ships, which reduces engineering costs, or (3) different payback hurdle assumptions and expected fuel price spreads than we have given the still wide range of forecasts. Please see the Appendix for further information on new scrubber orders.
On the cost side, we have not seen much inflation, as new Asia-based producers (mainly Chinese) appear to have ample capacity and to be taking share from the established Scandinavian players, as we expected. This growth in available supply has kept pricing in check and in fact below our previous expected rate of inflation, which we are reducing going forward.
Q: Is the ban on open-loop scrubbers a threat to our forecasts?
A: Not a significant one, in our view Over the past couple of months, the issue of sulfur waste disposal methods between open-loop and closed-loop scrubbers has come to the forefront in shipping. As a reminder, scrubbers extract sulfur particles from a vessel’s emissions by spraying the exhaust gas stream with water, which captures the particles and pulls them back down out of the air. Open-loop scrubbers dispose of the sulfur (and other elements extracted
Exhibit 9: 62% of incremental scrubber orders from October through January were for larger ships (50mt/day or more of HSFO)
Exhibit 10: The orderbook still currently stands at only 54% large vessels (50mt/day or more of HSFO)
Vessels consuming
50t+/day at sea, 62%
Vessels consuming
<50t/day at sea, 38%
Incremental orders, October through January
Vessels consuming
50t+/day at sea, 54% Vessels
consuming <50t/day at sea,
46%
January 2019 orderbook for delivery through 6/2020
Source: Clarkson’s, Goldman Sachs Global Investment Research, Company data
Source: Clarkson’s, Goldman Sachs Global Investment Research, Company data
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from exhaust gas) and water in the ocean, while closed-loop scrubbers store the extracted sulfur and water and dispose of them on land. Hybrid scrubbers can do both.
Most notably of late, Singapore and the Port of Fujairah have banned the use of open-loop scrubbers and China has banned the use of open-loop scrubbers in some coastal waters. These actions, as well as commentary from some companies and organizations in shipping, have led to concerns about whether open-loop scrubbers might be banned in more places in the future, and therefore whether they are still an attractive investment. It is important to note, however, that these are not bans on vessels with open-loop scrubbers installed, they are simply bans on the use of those scrubbers within these ports/coastal waters. Please see the Appendix for more information on the open-loop versus closed-loop scrubbers.
The IMO’s subcommittee on Pollution Prevention and Response (PPR) is meeting this week. However, to our knowledge, the PPR subcommittee is evaluating guidelines for the proper disposal of scrubber effluent rather than an outright ban on open-loop scrubbers. We expect potential future open-loop scrubber bans to come from member states acting individually rather than from the IMO. This is a reminder that states still have autonomy with respect to the enforcement of IMO regulations. This could affect compliance and the use of waivers under the new rules.
It is our sense that the debate over open-loop scrubbers is unlikely to affect the economics of scrubbers materially for several reasons, with the pace of scrubber orders in fact remaining strong over the past month.
Many shipping companies we have spoken to were already planning to use 1.
MGO or LSFO in their auxiliary engines in coastal waters and at port, while
installing scrubbers only on their main engines that will be in use on the high
seas. As a result, their estimations of scrubber economics and payback periods likely already exclude the use of HSFO at port, and their vessels will be equipped to manage in coastal waters where scrubbers are banned. If we hypothetically assume zero HSFO consumption by any vessels at port, it would only reduce our scrubbed HSFO consumption forecast by 5% (as most voyage time is on the high seas).
Many shipping companies have ordered hybrid, hybrid-ready or closed-loop 2.
systems. Per the May 2018 data from the Exhaust Gas Cleaning Systems Association, 63% of scrubber orders were for open-loop scrubbers at that time. We unfortunately have not found updated data from the EGCSA, and while Clarkson’s has identified some orders with closed-loop, open-loop or hybrid technology, a little under half of the scrubbers in its orderbook do not have a disposal technology identified at all. Even so, clearly not all scrubber systems will be affected by open-loop bans, and recent orders or yet-to-install orders are likely to favor hybrid, hybrid-ready, or closed-loop scrubbers given the current pushback on open-loop scrubbers.
The additional cost of changing from an open-loop to a hybrid system affects, 3.
but does not destroy, the attractive economics of scrubbers. Based on our conversations with industry participants, the additional cost of a hybrid scrubber system is likely around $500,000, possibly topping out at $1 million for the largest
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ships. This is in the context of total open-loop scrubber costs in the $1-4 million range. The higher costs for hybrid and closed-loop are primarily engineering and installation costs. We calculate that, for a VLCC, this should extend the payback period for a scrubber by 3-6 months, but we do not think this eliminates the attractive economics of scrubbers for larger ships (though switching to a hybrid system would have larger negative impacts on the economics of scrubbers for smaller ships). Overall, we think the HSFO-LSFO spread is likely to be the most significant driver of whether a scrubber investment generates a significantly positive return.
Q: What is our updated forecast for scrubber installations?
A: Orders are on pace to reach 3,000+ by mid-2020, but we no longer think the market will need that many scrubbers to reach an equilibrium Our forecast for the number of scrubbers installed for each year is derived from the HSFO scrubber cost curve that we introduced in our initial IMO report. Specifically, our mapping of vessel type to their HSFO consumption and scrubber payback incentive allows us to convert the equilibrium HSFO shipping demand into a number of scrubbers installed. Taking into account the nature of scrubbers announcements over the past six months, we are updating this mapping as follows:
We have re-categorized our vessel categories since gaining access to the n
Clarkson’s scrubber orderbook data. This has allowed us to further break down scrubber orders by vessel type and to take a more granular approach to fuel consumption.
We have accounted for the presence of smaller vessels installing scrubbers. n
Our original analysis assumed that the largest vessels would invest first since the economics make most sense for them, however there continues to be a significant proportion of small vessels in the orderbook. Moving forward we weight our previous cost curve by a smaller proportion of larger ships than we originally anticipated to account for these installations, steepening the cost curve.
We have reduced the amount of cost inflation. Rather than the market finding a n
balance through higher prices, it is finding a balance through higher supply.
We have added fast-steaming to our cost curve, which reflects higher HSFO n
consumption at higher speeds (more on this later). This effectively reduces the required number of scrubbers to reach a given amount of scrubbed HSFO consumption.
On our updated scrubber (and refining) cost curves, we now estimate that 2,700 scrubbers are likely to be installed by mid-2020, down from 3,125 scrubbers previously. Given that our modeling is based on a supply-demand equilibrium of the HSFO market, this lower scrubber number reflects the greater ability for refiners to reduce HSFO supply than previously modeled, as well as the impact of fast steaming. This forecast remains above most forecasts and reflects (1) attractive economics at current and forecast HSFO-distillate spreads and (2) our view that, with new manufacturers entering the market, there are not significant scrubber manufacturing constraints.
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Run rate still on track for 3,000+ installations by mid-2020, but the pace likely to
slow. As we noted above, the total scrubber order run rate has been around 200/month since we started tracking it in September. From October to January in particular, the total scrubber orderbook increased by 603 (monthly run rate of 201), of which 429 (monthly run rate of 143) are for delivery/retrofit before July 2020. At this rate, we are on track to see 3,000+ installations by mid-2020. However, with our new scrubber cost, fast steaming, and refining assumptions, we forecast that the market will need fewer than 3,000 scrubbers to find an equilibrium. We therefore expect the monthly order run rate to slow through 2H19 as the IMO 2020 deadline approaches and the window of time to monetize scrubbers shrinks, especially if our modeling of refiners’ ability to reduce HSFO plays out and the payback period is slightly extended by ordering hybrid or closed-loop scrubbers.
Q: How much HSFO will scrubbed ships absorb?
A: We lower our forecast from 1.05 mb/d to 900 kb/d We previously expected 3,125 scrubbers (on average) in 2020 to consume 1.05 mb/d of HSFO. As mentioned above, the scrubber orderbook has skewed more towards smaller vessels than we had expected, which reduces the HSFO consumption for a given number of scrubbed ships.
However, our previous scrubbed HSFO consumption forecast assumed current vessel speeds. With this report, we expand our analysis to include “fast-steaming” by a subset of scrubbed ships. While speeding up consumes more fuel, low HSFO costs relative to MGO/LSFO should create an opportunity for scrubbed ships to speed up and thereby increase utilization (i.e., the number of laden days they are paid for), and therefore profitability. Fuel costs per sailing day would be higher, but the addition of profitable laden days and a reduction of ballast days would still incentivize speeding up.
We have performed a more granular analysis of vessel speed, and we conclude that roughly 150 kb/d of additional HSFO will be consumed by fast-steaming scrubbed vessels. We calculate fast steaming by allowing scrubbed vessels to increase their
Exhibit 11: At the current order pace, we would hit over 3,400 scrubbers by December 2019
Exhibit 12: We allow fast steaming (B) of scrubbed ships to the extent it offsets slow steaming (A) by LSFO/MGO consuming ships, keeping freight rates constant Indicative diagram of how we calculate fast steaming in equilibrium
500
1000
1500
2000
2500
3000
3500
4000
Expected order path at October 2018
Orders assuming we stay at the recent rate for deliveries by June 2020(143/month)
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300
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32 34 36 38 40
Inde
xed
mar
gina
l rev
enue
/cos
t
Vessel Speed Freight ($/journey, index) Old cost New (HSFO) New (LSFO)
f(LSFO-HSFO spread)
A B Flat marginal revenue
Upward sloping marginal costs
Source: Clarkson’s, Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research
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speeds with non-scrubbed ship utilization declining in response, while keeping the overall supply of sailing days - and hence freight rates - constant to balance the market. Implicit in this is the assumption that non-scrubbed ships will slow down to reduce their consumption of higher-cost low-sulfur fuel. The decision for scrubbed ships to speed up is a function of the distillate/HSFO spread, as we illustrate in Exhibit 12. This should increase scrubbed HSFO consumption, offsetting some of the negative impact of smaller ships in the orderbook.
Net, we reduce our scrubbed HSFO forecast to 900kb/d from 1.05mb/d to reflect the trend of smaller ships in the scrubber orderbook, somewhat offset by our expectations for fast-steaming by scrubbed ships.
Refining - a wide array of solutions
Q: Why have HSFO prices strengthened so much recently?
A: The refining market is already preparing for IMO 2020 The rally in high-sulfur fuel oil prices that started in 2018 has reached new highs in 2019 (Exhibit 13). HSFO cracks in the US/Asia/Europe are $9, $0, -$4/bbl, respectively, compared with recent historical ranges of -$20 to $0/bbl. This strength has come as a surprise given the expected demand destruction from IMO 2020 and consensus bearish views on HSFO cracks from late 2019 onwards. We think this reflects the market already preparing to balance for IMO 2020 (another illustration of our long held view that, in commodity markets: “long-term surpluses create near-term shortages”) as well as recent large shifts in the global crude slate.
Refiners globally have been investing over decades to reduce the yield of this residual product that has traditionally priced at large discounts to crude and faced persistent demand destruction in the power sector. As a consequence, fuel oil stocks have been
Exhibit 13: Fuel oil cracks have strengthened significantly since early 2018 Fuel oil cracks and forwards (USD/bbl) vs Brent for EU, Dubai for Asia, and WTI for USGC
Exhibit 14: Fuel oil’s recent price surge seems to have lagged bullish fundamentals in place since early 2017 HSFO timespreads (1m v 12m, %, rhs) vs OECD HSFO in days of forward demand cover vs their 5y average (%, lhs)
-25
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-15
-10
-5
0
5
10
15
Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Jan-22
EU Asia USGC
-20%
-15%
-10%
-5%
0%
5%
10%
15%-20%
-10%
0%
10%
20%
30%
40%
50%
Jan-
10M
ay-1
0S
ep-1
0Ja
n-11
May
-11
Sep
-11
Jan-
12M
ay-1
2S
ep-1
2Ja
n-13
May
-13
Sep
-13
Jan-
14M
ay-1
4S
ep-1
4Ja
n-15
May
-15
Sep
-15
Jan-
16M
ay-1
6S
ep-1
6Ja
n-17
May
-17
Sep
-17
Jan-
18M
ay-1
8S
ep-1
8
%vs 5ya in DoFDC 1m v 1y timespread
Source: Goldman Sachs Global Investment Research, Platts, CME, DME
Source: Goldman Sachs Global Investment Research, IEA, ICE, Platts
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falling at a dramatic pace since 2008, with a notable acceleration since 2016 (Exhibits 15-16), despite the stabilization (at lower levels) of global demand.
Specifically, India and China, two of the main regions adding/modernizing refineries, have reduced their fuel oil yields (Exhibits 18-19). Kuwait’s exports experienced a level shift lower since 2017, also due to domestic refinery upgrading. Finally, Russia - the largest producer and net exporter of fuel oil - has undertaken a large refinery modernization program to limit exports of fuel oil and other high-sulfur vacuum residuals. Russia’s increased domestic sales at the expense of export sales could be related to recent mandates for domestic refiners to prioritize the domestic market, which has historically suffered from an open export arbitrage (Exhibit 20).
Exhibit 15: Fuel oil stocks have tightened in developed and emerging markets since 2008 and significantly so in the last three years Fuel stocks (mb) for OECD and basket of 30 emerging markets
Exhibit 16: Global demand has essentially stopped declining Global fuel oil consumption and YoY growth rate (mb/d)
30
35
40
45
50
55
60
65
70
100
110
120
130
140
150
160
170
180
190
200
Jan-
02A
ug-0
2M
ar-0
3O
ct-0
3M
ay-0
4D
ec-0
4Ju
l-05
Feb-
06S
ep-0
6A
pr-0
7N
ov-0
7Ju
n-08
Jan-
09A
ug-0
9M
ar-1
0O
ct-1
0M
ay-1
1D
ec-1
1Ju
l-12
Feb-
13S
ep-1
3A
pr-1
4N
ov-1
4Ju
n-15
Jan-
16A
ug-1
6M
ar-1
7O
ct-1
7M
ay-1
8OECD Stocks (lhs) EM Stocks (rhs)
-1.5
-1
-0.5
0
0.5
1
1.5
0
2
4
6
8
10
12
14
16
18
1972
1974
1976
1978
1980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
Demand (lhs) YoY change (rhs)
Source: IEA, JODI, Goldman Sachs Global Investment Research, Petrologistics
Source: Goldman Sachs Global Investment Research, IEA, EIA, JODI, National Sources, Customs
Exhibit 17: OECD fuel yields have now bottomed out after decades of decline yet EM yields continue to fall OECD fuel oil yield
Exhibit 18: India has sequentially decreased its fuel oil yield even in recent years India fuel oil refinery yield
7%
8%
9%
10%
11%
12%
13%
14%
15%
Jan-
05Ju
l-05
Jan-
06Ju
l-06
Jan-
07Ju
l-07
Jan-
08Ju
l-08
Jan-
09Ju
l-09
Jan-
10Ju
l-10
Jan-
11Ju
l-11
Jan-
12Ju
l-12
Jan-
13Ju
l-13
Jan-
14Ju
l-14
Jan-
15Ju
l-15
Jan-
16Ju
l-16
Jan-
17Ju
l-17
Jan-
18Ju
l-18
OECD FO Yield
0%
2%
4%
6%
8%
10%
12%
Apr
-11
Aug
-11
Dec
-11
Apr
-12
Aug
-12
Dec
-12
Apr
-13
Aug
-13
Dec
-13
Apr
-14
Aug
-14
Dec
-14
Apr
-15
Aug
-15
Dec
-15
Apr
-16
Aug
-16
Dec
-16
Apr
-17
Aug
-17
Dec
-17
Apr
-18
Aug
-18
India FO Yield Annual average
Source: IEA, Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research, PPAC
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The decline in fuel oil supply has also been helped by a regional shift in refining utilization. Countries with low refining complexity but medium/heavy local crude production such as Mexico and Venezuela have seen steady declines in their refinery runs due to political, economic, and technical challenges. This has been offset by higher utilization in countries of high complexity such as the United States, India, and the relatively complex Chinese teapot refiners for a net impact of further reducing global fuel oil yields (Exhibit 21).
Lastly, the global crude slate has become significantly lighter over the last decade, leading to lower fuel oil supply. The surge of naphtha-rich US shale production is in stark contrast to the dire production performance and outlook for heavy crude grades. The former looks likely to grow by 4.5 mb/d between 2016 and 2019 with most of this growth concentrated in grades well above 40 degrees API that produce little to no fuel oil (Exhibit 22). Meanwhile, Venezuela, Iran, Mexico and Australian heavy crude oil have all faced significant declines due to a combination of poor economics, US sanctions, and years of under-investment. While we expect shale production growth to slow in 2019, this is more than offset by the OPEC cuts which mostly remove medium crudes from global supply. We analyze the consequences of this development for our IMO equilibria in more detail below.
Exhibit 19: Refinery modernizations and additions in China have recently caused fuel oil yields there to decline too, increasing its pull on the seaborne market China refinery fuel oil yield (lhs) and FO imports (kb/d, rhs)
Exhibit 20: A mandate to focus on its domestic market has seen refiners boost domestic sales and stockpiling this year at the expense of exports YoY change in Russian refinery fuel oil balance (kb/d)
0
100
200
300
400
500
600
700
2.5%
3.0%
3.5%
4.0%
4.5%
5.0%
Jan-
13A
pr-1
3Ju
l-13
Oct
-13
Jan-
14A
pr-1
4Ju
l-14
Oct
-14
Jan-
15A
pr-1
5Ju
l-15
Oct
-15
Jan-
16A
pr-1
6Ju
l-16
Oct
-16
Jan-
17A
pr-1
7Ju
l-17
Oct
-17
Jan-
18A
pr-1
8Ju
l-18
Oct
-18
China FO Yield % FO Imports (kb/d)
-600
-500
-400
-300
-200
-100
0
100
200
Jan-
15
Mar
-15
May
-15
Jul-1
5
Sep
-15
Nov
-15
Jan-
16
Mar
-16
May
-16
Jul-1
6
Sep
-16
Nov
-16
Jan-
17
Mar
-17
May
-17
Jul-1
7
Sep
-17
Nov
-17
Jan-
18
Mar
-18
May
-18
Jul-1
8
Sep
-18
Nov
-18
Domestic Sales Exports Stock changes (MoM)
Source: Goldman Sachs Global Investment Research, NBS
Source: Goldman Sachs Global Investment Research, Petrologistics
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Q: How have we changed our forward view?
A: Six key changes to our IMO refining model point to more available solutions With this report, we update our IMO refining model in six key ways which reflect both updates to our inputs as well as new identified solutions to reduce HSFO supply and increase LSFO availability.
1. We revise downward our outlook on refinery additions through 2020. The net impact on product supply is that between 2017-2020, we end up with cumulatively 180 kb/d less gasoline supply, 340 kb/d less distillate supply and 160 kb/d more HSFO (Exhibits 23-26). There has been significant slippage on the timelines of some of China’s refinery additions and on Kuwait’s Al-Zour refinery that push their impact back towards late 2020. Additionally, some of the additions in Russia have been identified as being replacement units as opposed to incremental capacity.
Importantly, some new capacity additions help: Last November, the (500 kb/d) St Croix refinery in the US Virgin Islands announced it was looking to partially restart 200 kb/d of its capacity in time to capture some of the margin benefits expected in 2020. In addition, a few smaller additional units have been identified in our database, and some debottlenecking investments have been made at some refinery complexes that should increase throughput and product output significantly. The announcement of such a debottlenecking at the Jubail refinery in Saudi Arabia is a recent example. However, such debottlenecking projects are rarely captured in available data or newsflow and we are wary of understating the capacity additions that they will enable over the next couple of years. Although smaller in capital intensity, these debottlenecking projects are nevertheless sunk costs that will act as margin-insensitive capacity additions as opposed to margin-sensitive increases in utilization.
Exhibit 21: The refining system has effectively become more complex due to the relative decline of simple systems in Latam Refining utilization by region
Exhibit 22: Most oil production growth recently has been 40 API and above while the heaviest grades have declined YoY change in production by API gravity (mb/d)
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2011 2012 2013 2014 2015 2016 2017 2018 2019
EU US China SOE China Independents Mexico Venezuela
-3
-2
-1
0
1
2
3
4
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
API<20 API20-30 API-30-35 API35-40 API40+
Source: Goldman Sachs Global Investment Research, EIA, IEA, NBS, ICIS, SCI, Bloomberg, IIR, ANP, Reuters
Source: Goldman Sachs Global Investment Research, Woodmac, EIA
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2. We better take into account the lightening of the global crude slate in our
optimization process. As mentioned above, the dramatic lightening in the global crude slate reduces global HSFO and diesel supply. We estimate that between 2017 and 2020 the impact of our global oil supply forecast will be to reduce HSFO and diesel supply by -300 and -330 kb/d while increasing the output of gasoline by 500 kb/d. This reduction in global FO availability makes it easier to resolve the fuel oil overhang in 2020. The impact is all the more important that US production has significantly surprised to the upside since our September update.
3. We have also adjusted our slate optimization process to account for more
stringent constraints on import and export capabilities of some regions. Importantly, it isn’t US export capacity which we see constraining this process, but rather logistical limitations in some of the potential destination markets instead. For instance, the Middle East is unlikely to start processing foreign crude in its refining system while Latin America faces logistical constraints since the region has historically
Exhibit 23: Although we have revised downwards our refinery additions, many clean product producing secondary units are expected to be added over the next three years... YoY Secondary unit net capacity additions (mb/d)
Exhibit 24: ...resulting in higher supply of distillates, gasoline, and LSFO at the expense of HSFO YoY changes in clean product refinery output (mb/d)
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
2017 2018 2019 2020 2021 2022 2023 2024 2025
COK FCC HDC RHC RDS
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
1.2
2017 2018 2019 2020 2021 2022 2023 2024 2025
LPG Gasoline/Naphtha Distillates CBFO HSFO
Source: Goldman Sachs Global Investment Research, IIR, Bloomberg, Argus, Platts, Reuters
Source: Goldman Sachs Global Investment Research, IIR
Exhibit 25: Some of the 2019 additions have been delayed into 2020 but there has also been some pulling forward of 2021 additions Differences in YoY changes in clean product refinery output from September-18 publication (mb/d)
Exhibit 26: A lot of the CDU additions come at the end of 2019 and start of 2020 providing upside risks to 2020 distillate cracks if they are further delayed QoQ CDU additions (mb/d)
-0.6
-0.5
-0.4
-0.3
-0.2
-0.1
0.0
0.1
0.2
0.3
0.4
2017 2018 2019 2020 2021 2022 2023 2024 2025
LPG Gasoline/Naphtha Distillates CBFO HSFO
0.0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q4Q1Q2Q3Q
2016 2017 2018 2019 2020 2021 2022 2023
CDU
Source: Goldman Sachs Global Investment Research, IIR
Source: Goldman Sachs Global Investment Research, IIR, Bloomberg, Reuters
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been a net exporter. Optimizing the global slate to maximize refining margins at the relative product cracks we see in 2020 (relative to 2017 prices) should result in 70 kb/d more distillate and 30 kb/d less gasoline production while destroying 180 kb/d of HSFO and producing 130 kb/d more of LSFO (Exhibits 27-28).
4. We now allow vacuum gasoil (VGO) to be diverted from FCCs and into the
low-sulfur bunker pool. Vacuum gasoil (VGO) is the feedstock of FCCs, units designed to maximize gasoline yields. In equilibrium, we expect high LSFO prices (following strong demand for compliant low-sulfur bunker fuel) to reduce FCC margins and encourage the diversion of VGO from the creation of gasoline and distillates to the LSFO bunker blending pool instead. In our 2020 equilibrium, we see this mechanism contributing towards a 2 p.p. decline in global FCC utilisation rates. This in turn produces 280 kb/d more LSFO (LSVGO) at the expense of 170 kb/d and 80 kb/d of gasoline and distillates, respectively. The key appeal of this source of compliant low-sulfur bunker fuel is that VGO – as a straight-run product – tends to have better stability and compatibility properties than cracked products such as the lighter diesel-like fuels such as MGO. In addition, there already exists a 0.6-0.7% sulfur VGO market in Europe and other refining hubs. More information is available in the Appendix.
5. We allow for some imbalance in the product markets via inventory
builds/draws. Previously, our equilibrium model forced every market to balance. However, more realistically, the market will allow for large builds of fuel oil, while drawing on the clean products, to ease the intra and inter-temporal imbalances. This allows less severe product price differentials as inventories help smooth imbalances rather than having to source all the required product today. We calculate the relationship between each product’s 1m-2y timespreads and their inventory levels (in days of demand cover vs. 5-year average) and allow their stocks to build or draw as a function of their timespreads which are calculated endogenously in the model. In equilibrium, in our 2020 base case, HSFO stocks are able to build over 100 kb/d that year which is helped by currently high spare storage capacity for dirty products/crude.
6. Lastly, we reduce our demand assumptions. Part of this change was due to our economists lowering their global growth forecasts, however we lowered our gasoline
Exhibit 27: Optimizing trade flows with constraints to maximize refining margins can achieve incremental gains in adjusting to IMO 2020 Improvement in product output from optimizing the global refining system to maximize refining margins using 2020 product differentials vs. 2017 prices
Exhibit 28: Logistical constraints outside of North America limit the extent to which such gains can be achieved Change in slate when optimizing with 2020 product price differentials vs. optimizing with 2017 prices, subject to constraints (kb/d)
Product kb/dLPG 4
Gasoline/Naphtha -31Distillate 66HSFO -179LSFO 127Coke 17
Asia Latam North America Europe Middle
East Africa
20 H -176 -300 376 0 100 020 L 0 0 0 -210 0 21030 H -500 300 324 -32 -100 830 L -448 55 0 391 -4 635 H 431 -72 159 -379 -28 -11235 L -84 33 0 24 27 -140 H 468 -81 -281 -30 -11 -6540 L -100 43 0 26 37 -6
40+ H 500 -40 -578 184 -36 -2940+ L -92 61 0 27 16 -12
Source: Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research
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demand assumption above and beyond this. This is because we had modeled gasoline and naphtha demand as a basket just as we treat their supply. However, the forward demand path for naphtha is significantly weaker going forward than has been the case historically. New petrochemical plants have instead tended to be NGL feedstock-based due to the better economics and the establishment of seaborne trade routes and US export capacity. The growth of Chinese propane dehydrogenation plants which import distant US LPG rather than local naphtha is a prime example. We therefore assume minimal naphtha demand growth going forward for this gasoline-naphtha basket.
Q: Are there other solutions available to refiners?
A: Yes, especially in the segregation of low-sulfur streams as a source of compliant bunker fuel We believe that refiners likely have additional solutions to both reduce HSFO supply and increase LSFO availability through segregation. We had previously identified the availability of low-sulfur straight-run vacuum residue that could be directly used as compliant low-sulfur bunker fuel, which we had conservatively estimated at 600 kb/d (Exhibit 30). Our conversations with refiners also suggest the potential segregation of low-sulphur residual streams from secondary refinery units. For example, fluid catalytic cracking (FCC) units produce a residual stream called slurry (or decant) oil that is typically low in sulfur and diverted into the bunker market and combined with much dirtier (more sulfurous) streams.
Even if not traded, the opportunity cost of these residues will be their value as a low-sulfur bunker fuel rather than as part of the high-sulfur bunker pools they are typically dumped into. Although historical sulfur spreads have not provided enough of an incentive for segregation of these small streams to make economic sense, this will change in 2020. As we noted previously, despite the 3.5% current cap on the sulfur content of fuel oil, the actual average sulfur content is just 2.7%wt. This suggests that some relatively low-sulfur streams are currently being blended with the very dirtiest of residuals in what likely amounts to a bar-bell blend composition by sulfur content.
While the lack of available data on these intra-refinery processes – both in terms of volumes and prices – make them very difficult to model, the potential volumes could be significant. Looking across our database of the refining system available in 2020, we select a sub-sample of refineries which have FCC units, but no hydrocrackers or cokers, as these units are typical candidates for absorbing and upgrading FCC slurry. We additionally assume only refineries with capacity above 50 kb/d have the opportunity of making segregation economic. Next, assuming an 80% utilization rate of these units, a typical decant yield of 7%, and that 20% of refineries are not close enough to the coast to cover transportation, we arrive at an estimate of 240 kb/d of possible low-sulfur secondary residual volumes which could be segregated. If we remove the restriction that the refinery requires a coker, and was in a position to divert these LS streams away from further downstream upgrading (also freeing up room to process high-sulfur residues), then this estimate rises to 450 kb/d (Exhibit 28).
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The impact of such an increase in LSFO supply/decrease in HSFO supply would be significant. Assuming a 300 kb/d potential segregation of low-sulphur residual streams from secondary refinery units would reduce our equilibrium distillate cracks by $2/bbl.
Pricing - still many moving parts
Q: Why don’t you view IMO 2020 as bullish prices?
A: Our IMO solution does not require new demand in power, only impacting relative crude prices At our equilibrium solution, we do not believe that the surplus in HSFO in 2020 will be sufficiently large to lead to a price discount that would be sufficiently large to incentivize the shift of power burn away from coal and gas towards HSFO. As a result, our global oil demand growth forecast is not impacted by IMO 2020 (one small supportive factor will be the increase in freight volumes needed to accommodate the greater flows in crude and products to optimize slate and supply compliant low-sulfur bunker fuels). Rather, we think the key impact that IMO will have is on the relative pricing of crudes and product prices rather than to lift all oil prices, with the largest negative price impact on heavier and more sulfuric crudes.
Q: How far will Dubai have to discount itself to Brent?
A: After rallying further in coming months, Dubai should average at a $3.75/bbl discount to Brent in 2020 Given the 2020 equilibrium cracks in our base case model, we expect the Brent-Dubai price spread to widen in 2020 due to stronger gasoline and weaker HSFO cracks vs. current forwards (with our modeling showing that distillate cracks are not statistically significant in this spread). We now forecast an annual average differential of $3.75/bbl in 2020, above current forwards (Exhibit 31). Near-term, however, we expect Dubai to
Exhibit 29: Significant quantities of low-sulfur streams exist within refineries that either get blended into HSFO or fed into cokers which could be segregated Estimated quantity of low-sulfur secondary unit residual streams that could be used for low-sulfur bunker (kb/d)
Exhibit 30: This is on top of the 600 kb/d of low-sulphur straight-run vacuum resid estimated to exist in our last report Density function and cumulative density of global vacuum residuum supply by sulphur content
0
50
100
150
200
250
300
350
400
450
500
Min segregatable secondary LS streams Max segregatable secondary LS streams
0
500
1,000
1,500
2,000
2,500
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
Pro
duct
ion
Den
sity
Cum
ulat
ive
Pro
duct
ion
(kb/
d)
Sulphur Content
Cumulative LHS) Density (RHS)
Source: Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research, Wood Mackenzie
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outperform Brent further in coming months, to up to a $1/bbl premium, given recent heavy crude supply losses in Iran, Venezuela, and Saudi (Safaniya).
Q: Why do oil price levels matter for your IMO equilibrium?
A: Because refiners respond to % cracks while scrubber payback is driven by $/bbl differentials Petroleum product cracks and price differentials matter more to refiner as a percentage of the oil price than on an absolute $/bbl basis. Consequently, there are clear, strong relationships between crude flat prices and cracks/differentials (Exhibit 33). We therefore model refinery utilization on percent margins, which historically tends to match up with the data better than using $/bbl margins (Exhibit 34). Similar statements can be made when talking about secondary unit utilizations, yield switching models, and more. Ultimately, this reflects refiners allocating capital based on rates of return rather than NPVs.
While the refining side of our equilibrium responds to incentives in % terms, the scrubber side of the equilibrium responds to spreads. Since installation costs are fixed in $, scrubber breakeven simply depends on the $/bbl differential between distillates/LSFO and HSFO. Thus, our equilibrium is not independent of the oil price as seen in Exhibits 3 and 8, with a higher distillate-HSFO spread (and cost of the policy on society) at higher oil prices.
Exhibit 31: We expect Brent-Dubai differential to widen again as fuel oil eventually reprices lower while gasoline recovers Brent-Dubai (USD/bbl) and forwards vs. GS model shown with 2020 forecast based on our equilibrium cracks
Exhibit 32: We model Brent-Dubai on a model of HSFO and gasoline cracks as well as Brent flat price Model output
-1
0
1
2
3
4
5
6
7
8
Brent-Dubai Model Forwards 2020 Forecast
Parameter Coeff t-stat3
Intercept -215% -4.6Brent flat price 1% 3.5
FO Crack -35% -7.0(FO Crack)^2 -1% -4.3
RB Crack 3% 1.7
Standard ErrorAdj R-sq2
1 Sample Jan-2008-Feb-20192 The model explains this % of the variation in the dependent variable over sample3 High t-stat. coefficients confirm that each parameter is useful in estimating demand
Brent-Dubai1,
95%60%
Source: Goldman Sachs Global Investment Research, ICE, DME
Source: Goldman Sachs Global Investment Research, ICE, DME
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Q: Why do you think the cost of implementing IMO 2020 matters for compliance?
A: Because too onerous a shift would lead to a policy push back We are raising our compliance estimate from 80% to 85% although we still don’t expect full compliance given the lack of enforcement mechanism in 1Q20 and the disincentive of EM shippers to comply (see our September report for further details). Ultimately, full compliance initially would sharply increase the cost of this policy, acting as a tax on the global economy through elevated levels of distillate and gasoline prices. Such a social cost could potentially lead to its enforcement being adjusted, in our view.
While the statutes of the IMO make it difficult for a country to unilaterally change the regulation, it is not inconceivable that the prospect of a significant negative growth shock to the global economy would be a sufficient catalyst to amend its implementation, although this is not our base case. The US administration has already shown a great focus on keeping a lid on prices, with 2020 a presidential election year. Such high costs could also lead to weaker compliance - in the face of rising oil prices last year, the Philippines resumed imports of higher-sulfur diesel after a two-year hiatus, with Indonesia buying lower quality gasoline than in 2017.
Q: What should refiners and scrubbed vessel be hedging?
A: Refiners should lock in above-average 2020 distillate cracks while scrubbers should lock in discounted 2021+ HSFO prices Based on our updated equilibrium and our view that the shipping and refining industry are progressing towards solving the IMO challenge, albeit with potential volatility in cracks in 1H20, we recommend two risk management strategies:
For refiners, to lock in above 5-year average distillate cracks in 2020 and consider n
hedging 2Q20 HSFO cracks to protect against downside volatility when enforcement and hence compliance starts to pick up.
Exhibit 33: Product cracks have a clear relationship with crude flat prices HSFO and HO cracks (x-axis) vs. Brent flat price (y-axis)
Exhibit 34: Margins and cracks matter more in percent than levels just as IRRs are sometimes more important than NPVs Cross sectional median of 22 countries (detrended) refining utilization vs. refining margins in levels ($/bbl) and %Brent
0
20
40
60
80
100
120
140
-30 -20 -10 0 10 20 30
HO crack HSFO Crack
0
1
2
3
4
5
6
7
8
9
-10%
-5%
0%
5%
10%
15%
20%
Median Detrended Util (lhs) % margin (lhs) USD Margin (rhs)
Source: Goldman Sachs Global Investment Research, ICE, Platts
Source: Goldman Sachs Global Investment Research, Platts, CME, IEA
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Conversely, for ship owners installing scrubbers, we recommend leaving 2020 n
HSFO exposure unhedged to be able to monetize any price weakness during early adoption. Given our view that the change in bunker fuel is likely to be relatively efficient in coming years, we however recommend locking in still discounted 2021-2023 HSFO prices.
Appendix
New scrubber orders We saw the largest increases for tanker and Capesize scrubber orders between October and the end of January. In Exhibit 34, we show that we’ve adjusted our analysis of the orderbook to exclude not only vessels for delivery after June 2020, but also to exclude scrubber retrofits scheduled for after May 2020. In the October orderbook, the vast majority of retrofits were due to occur before June 2020, so we assumed that all retrofitted vessels would be operating on the water by mid-2020. Now, as the orderbook has grown, companies have reported (and Clarkson’s has recorded) some retrofits due to take place after May 2020. In order to be as precise as possible on how many scrubbed ships will be consuming HSFO by the middle of 2020, we have excluded those vessels with retrofits after May 2020 (allowing for a month to complete the retrofit). We note that retrofit dates are only available for some orders, and for those without specific retrofit dates we assume a retrofit by mid-year.
Exhibit 35: We saw the largest increases for tanker and Capesize scrubber orders between October and the end of January
Total less delivered after Number consuming Total less newbuilds delivered less retrofit Number consuming Change betweenNumber 6/2020 (all newbuilds) HSFO by 6/2020 Number after 6/2020 after May, 2020 HSFO by 6/2020 October and January
300k DWT+ VLCC 126 2 124 178 10 3 165 41125-200k DWT Suezmax 39 39 107 2 10 95 5685-125k DWT Aframax 20 2 18 67 2 3 62 4485-125k DWT LR2 56 56 80 2 78 2255-85k DWT LR1 22 22 17 17 -540-55k DWT MR 84 2 82 169 33 1 135 53sub-40k DWT Handysize Tanker 29 29 37 1 36 7
TOTAL TANKER 376 370 655 588200k DWT+ VLOC 52 15 37 54 15 39 2
100-175k DWT Capesize 129 5 124 223 8 14 201 7780-100k DWT Kamsarmax 100 100 104 4 8 92 -860-80k DWT Ultramax 91 91 130 9 12 109 1850-60k DWT Supramax 41 3 38 47 3 44 640-50k DWT Handymax Bulker 8 8 8 8 0sub-40k DWT Handysize Bulker 47 47 51 3 48 1
TOTAL BULKER 468 445 617 54119,000k+ TEU 19k+ TEU 34 7 27 34 6 28 1
15,000-19,000 TEU Very Large Container 14 8 6 19 9 10 412,000-14,999 TEU Large Post Panamax 50 18 32 73 19 3 51 198,000-11,999 TEU Small Post Panamax 61 5 56 103 5 23 75 196,000-7,999 TEU Large Panamax 16 16 21 21 53,000-5,999 TEU Small Panamax 15 15 31 3 28 13
TOTAL LARGE CONTAINER 190 152 281 21310k DWT+ Large Cruise 65 4 61 69 5 64 3
5,000-9,999k DWT Mid Cruise 67 4 63 67 5 62 -1sub-5k DWT Small Cruise 4 4 4 4 0
TOTAL CRUISE 136 128 140 13020k+ DWT Large Ro-Ro/Ro-Pax 28 28 33 33 5
10-20k DWT Mid Ro-Ro/Ro-Pax 58 9 49 54 1 53 4sub-10k DWT Small Ro-Ro/Ro-Pax 44 44 44 44 0
TOTAL RO-RO/RO-PAX 130 121 131 13015k+ DWT Large Car Carrier 9 9 23 2 21 12
sub-15k DWT Small Car Carrier 6 6 7 7 1TOTAL CAR CARRIER 15 15 30 28
sub-3k TEU/Other small ships Feeder/Other 131 1 130 172 31 141 11Ferry 14 14 17 1 16 2LNG 4 4 2 1 1 -3LPG 43 43 65 2 63 20
TOTAL SHIPS 1,507 85 1,422 2,110 1,851
Jan-19Oct-18
Source: Clarkson’s, data compiled by Goldman Sachs Global Investment Research
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The open-loop scrubber debate We do not take a view on the environmental impact of scrubbers, but the two sides of the debate are:
In opposition to open-loop scrubbers. Opponents say that even though there n
have been no conclusive studies on the impact of marine scrubbers on ocean acidification and marine wildlife, the risks are too great to dispose of sulfur in the ocean before such studies are completed. They note that transferring pollution from the air to the sea merely shifts the threat to marine life from humans, and that the intentional deposition of sulfur from vessels into the ocean creates a more highly-concentrated threat than if sulfur were to naturally fall out of the atmosphere. They also say that while it is true that there is sulfur in the ocean already (in the form of sulfate), the other elements that are captured in the scrubber effluent and disposed of in the ocean with open-loop scrubbers (i.e., vanadium, nickel, polycyclic aromatic hydrocarbons) could be harmful to marine life as well. The economic argument against open-loop scrubbers is that if enough countries ban their use then their payback periods will be longer because owners will be able to use them less often.
In support of open-loop scrubbers. Supporters note that there have been no n
conclusive studies showing that the disposal of scrubber waste in the ocean is harmful. They highlight that the ocean already contains sulfur (in the form of sulfate), and that the incremental amount contributed by marine scrubbers would be negligible versus what is already in there. They also say that the particulates currently emitted ultimately fall back down into the ocean anyway (just in a very low concentration), and that the deposition of captured particulates in the open ocean by scrubbers will still not be concentrated enough to be harmful. Finally, even if countries ban their use in coastal waters, open-loop scrubbers could still be used on the high seas, which is where the bulk of fuel consumption from a vessel’s main engine takes place.
VGO diversion from FCCs VGO has been identified as one of the better refinery streams for creating low-sulfur bunker fuels. FCCs typically have hydrotreaters fronting the units to clean the input to protect the sensitive catalysts used in the cracking process. This desulfurized feed can therefore naturally be diverted away to provide a low-sulfur bunker fuel alternative. FCC utilization also has a clear relationship to FCC margins as can be seen in Exhibit 35. Therefore, we allow FCC utilization to be determined by FCC margins in our model which in turn are determined by the product cracks solved endogenously in the optimization process. We proxy VGO on a forward basis (for the optimization) by LSFO prices as these two prices should converge in a world where VGO is actively being marketed in the marine pool. This convergence process can be seen already in Exhibit 36 with VGO and LSGO prices inching closer to each other as the 1-Jan-20 deadline approaches.
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Supply and demand bridges for gasoline and distillate between 2017 and 2020
Other disclosure Clarkson Research Services Limited (CRSL)
Clarkson Research Services Limited (CRSL) have not reviewed the context of any of the statistics or information contained in the commentaries and all statistics and information were obtained by Goldman Sachs & Co. from standard CRSL published sources. Furthermore, CRSL have not carried out any form of due diligence exercise on the information, as would be the case with finance raising documentation such as Initial Public Offerings (IPOs) or Bond Placements. Therefore reliance on the statistics and information contained within the commentaries will be for the risk of the party relying on the information and CRSL does not accept any liability whatsoever for relying on the
Exhibit 36: FCC utilization fits a simple model on FCC margins very well Model of FCC utilization on FCC margins and monthly dummy
Exhibit 37: VGO prices should converge on LSFO prices in 2020 as they have been doing already Price differential of low-sulphur (1%) fuel oil and vacuum gasoil (USD/bbl)
70%
75%
80%
85%
90%
95%
Mar
-99
Nov
-99
Jul-0
0M
ar-0
1N
ov-0
1Ju
l-02
Mar
-03
Nov
-03
Jul-0
4M
ar-0
5N
ov-0
5Ju
l-06
Mar
-07
Nov
-07
Jul-0
8M
ar-0
9N
ov-0
9Ju
l-10
Mar
-11
Nov
-11
Jul-1
2M
ar-1
3N
ov-1
3Ju
l-14
Mar
-15
Nov
-15
Jul-1
6M
ar-1
7N
ov-1
7Ju
l-18
FCC utilisation Model
-30
-25
-20
-15
-10
-5
0
Jan-
14
Apr
-14
Jul-1
4
Oct
-14
Jan-
15
Apr-1
5
Jul-1
5
Oct
-15
Jan-
16
Apr
-16
Jul-1
6
Oct
-16
Jan-
17
Apr
-17
Jul-1
7
Oct
-17
Jan-
18
Apr
-18
Jul-1
8
Oct
-18
Jan-
19
LSFO-VGO
Source: Goldman Sachs Global Investment Research, IEA, Platts
Source: Goldman Sachs Global Investment Research, Platts
Exhibit 38: Gasoline faces some structural oversupply headwinds but the requirements of IMO tighten balances Global gasoline waterfall chart, cumulative changes 2017 to 2020 (mb/d)
Exhibit 39: Many solutions contribute to fill the IMO 2020 distillate short position without extreme cracks Global distillate waterfall chart, cumulative changes 2017 to 2020 (mb/d), orange is IMO demand
0
0.5
1
1.5
2
2.5
3
0
0.5
1
1.5
2
2.5
3
Source: Goldman Sachs Global Investment Research
Source: Goldman Sachs Global Investment Research
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statistics or information. Insofar as the statistical and graphical market information comes from CRSL, CRSL points out that such information is drawn from the CRSL database and other sources. CRSL has advised that: (i) some information in CRSL’s database is derived from estimates or subjective judgments; and (ii) the information in the database of other maritime data collection agencies may differ from the information in CRSL’s database; and (iii) whilst CRSL has taken reasonable care in the compilation of that statistical and graphical information and believes it to be accurate and correct, data compilation is subject to limited audit and validation procedures and may accordingly contain errors; and (iv) CRSL, its agents, officers and employees do not accept liability for any loss suffered in consequence of reliance on such information or in any other manner; and (v) the provision of such information does not obviate any need to make appropriate further enquiries; and (vi) the provision of such information is not an endorsement of any commercial policies and/or any conclusions by CRSL; and (vii) shipping is a variable and cyclical business and any forecasting concerning it cannot be very accurate.
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Disclosure Appendix
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