If oil traders and consumers are worried about the impact of new maritime fuel regulations from the start of next year, they have not yet started to mark up prices for low-sulphur middle distillate fuels.
Under new rules agreed by the International Maritime Organization (IMO), ships will be forced to switch to using low-sulphur fuels rather than high-sulphur residual fuel oil, or fit scrubbers to remove sulphur dioxide emissions.
Refiners have been gearing up to increase the production of IMO-compliant shipping fuels, and many ship owners have installed or plan to fit scrubber units to enable them to continue using cheaper residual fuel oil.
There is considerable uncertainty about exactly how vessel owners will comply with the new regulations and how much extra low-sulphur fuel the refiners will manage to produce.
But the forthcoming regulations are expected to increase consumption of middle distillates and cause that segment of the oil market to tighten significantly.
Ships will be competing for the same low-sulphur middle distillates used as diesel, jet fuel and heating oil by road hauliers, railroads, airlines and farmers as well as many homes, offices and factories.
As a result, some analysts are forecasting a severe shortage of middle distillates, causing prices to spike, while others see a more limited impact.
The effect of the IMO regulations even merited its own section in the U.S. government’s annual “Economic Report of the President” prepared by the Council of Economic Advisors (CEA) and published earlier this month.
“Global bunker fuel represents about 5 percent of total oil demand” and the reported warned “fuel switching by ships in 2020 may cause significant disruptions in specific product markets.”
The CEA predicted a shortage of 200,000-600,000 barrels per day in compliant fuels which “will likely trigger higher prices, though estimates of price shocks to fuels including diesel, gasoline and jet fuel vary substantially”.
So far, the forthcoming switch has had little impact on either hedge fund positioning or prices in the middle distillates markets.
Hedge funds and other money managers have been net buyers of 65 million barrels of European gasoil futures and options since the start of the year.
Portfolio managers have an overall bullish position of 67 million barrels, up from 2 million at the start of the year but still far below the record 126 million they held in September before oil prices slumped.
In U.S. low-sulphur diesel oil futures and options, funds hold a net bullish position of less than 4 million barrels, far below the 63 million they held at the start of October.
Prices for European gasoil delivered in January 2020, the first month of the new regulations, and throughout the year, show no sign of an anticipated shortage.
Gasoil is trading at a premium of around $18 per barrel to Brent, down from nearer $20 at the end of the third quarter, and essentially unchanged since this time last year.
“Senior traders at some of the largest commodity houses indicate this lack of speculative positioning around IMO 2020 feels like a false war for now,” the Financial Times said.
“Traders remain scared to make a move before they get greater clarity over how the market shakes out,” it added, describing the market as paralysed (“New shipping rules leave oil traders strangely paralysed”, FT, March 21).
The impact of the IMO regulations is likely to depend critically on how fast the global economy is growing at the start of 2020.
Consumption of middle distillates such as gasoil, diesel and jet fuel, used mostly in freight transport, manufacturing and mining, is closely correlated with the business cycle.
If the global economy is growing strongly at the start of next year, the IMO regulations will tighten a market that is already short of supply, potential sending prices much higher.
If the global economy is growing slowly, or even in recession, there will be more slack in the distillates market, making fuel switching easier, and muting the price impact.
In this context, recent economic and freight data has pointed to a sharp slowdown in global growth and trade since the middle of 2018.
The progressive inversion of the U.S. Treasury yield curve suggests there is now a probability of 30 percent or more that the U.S. economy will be in recession by March 2020.
The risk of recession is the highest since 2008, according to yield-curve models developed by the Federal Reserve Bank of New York.
Other parts of the global economy, especially those most exposed to international trade and transport, have slowed even more sharply than the United States over the last 6-9 months.
Until the recession risk is resolved, it is difficult to estimate the impact of IMO regulations on distillate availability with any precision.
A more accurate picture should become available during the third quarter, and certainly by the fourth quarter, when the outlook for the business cycle and trade at the start of 2020 should be clearer.
This timeline is consistent with analysis of the market impact performed by the U.S. Energy Information Administration (EIA) and published on Wednesday.
“Shifts in petroleum product pricing may begin as early as mid-to-late 2019,” according to the EIA, which is the independent statistical arm of the U.S. Department of Energy.
“EIA anticipates that the effects on petroleum prices will be most acute in 2020, and the effects on prices will be moderate after that.”
The agency is forecasting a sharp rise in diesel and jet fuel prices relative to crude, but with the main impact felt in 2020 (“The Effects of Changes to Marine Fuel Sulfur Limits in 2020 on Energy Markets”, EIA, March 27).
But as the agency notes, “the effects of implementing the IMO 2020 regulations are highly uncertain” with many policy and technical complications and potential responses by market participants.
Until some of the economic and other uncertainties have been reduced, hedge fund positions and price effects may remain limited, leaving the market stuck in a phoney war for now.