The October 2016 decision by the International Maritime Organization to implement strict sulphur emissions from 2020 will transform the shipping industry and bunker fuel markets in the longer term, though it signals uncertainty and some big swings in price relationships for crude oil and refined products as we near 2020. In this paper, we look at the forthcoming transition and some implications for refiners.
For more than a decade now, the Marine Environment Protection Committee (MEPC) of the International Maritime Organization (IMO), a United Nations entity, has been planning an orderly reduction in the global level of sulphur and nitrogen emissions from marine sources. Early mandates saw emissions sharply lowered in some environmentally sensitive regions, known as Emissions Control Areas (ECAs). However, the majority of global waters have continued operating with a level of stack emissions equivalent to burning 3.5 percent sulphur residue bunker fuel (HSFO) with no emissions abatement.
MEPC policy implemented in 2008 defined a pathway to lower global sulphur emissions to a level of 0.5 percent sulphur equivalence, but the implementation date was not determined at that time. Rather, a decision was to be taken in 2018 as to whether it should take place in 2020 or 2025. Given the long time-line for capital investment, the IMO brought forward this decision to 2016 and in late October, it determined that the market was technically able to achieve the 0.5 percent standard from 2020.
The MEPC decision was based on a technical study commissioned in 2015 that determined it was feasible to supply the market with enough low sulphur material for the industry to make this transition by 2020. The terms of reference of this study did not consider the cost of making this transition – only the technical feasibility of supply. Given that we are now only three years away from this major transformation of bunker fuel markets, time is short to make any major strategic changes. Refiners now need to be balancing their near-term operational needs in the run-up to 2020 with medium term capital planning based on the market response in the 2020 – 2025 period.
Last week the US Energy Information Administration (EIA) released its latest Short Term Energy and Summer Fuels Outlook, which shows 2016 gasoline demand growing 130,000 bpd after having grown by a massive 240,000 bpd in 2015. Driven by a spike in new car sales, especially SUVs, and very low pump prices (which have fallen by more than a dollar per gallon in the past year), US consumers have boosted their demand for gasoline to record levels, finally erasing the steep drop that occurred in the aftermath of the global financial crisis which started in 2007. This is part of a broader trend that saw global gasoline demand rise by more than 700,000 bpd in 2015.
Gasoline demand growth is only half the story in the US. We are also watching the evolution of demand for premium gasoline, which has expanded sharply since oil prices started to drop in mid-2014. Our sense is that American drivers feel more able to splash out on premium gasoline when the pump price is as low as it has been in recent months. Some new cars also require premium grades of gasoline. Tracking US consumption and price data, we can see that this strength has translated into a premium for octane barrels in the US, as refiners adjust their operations in response to rising demand. Globally, gasoline prices are very strong at present, reversing a long-term trend that has seen diesel premiums exceed those of gasoline for more than a decade.
Refiners globally have been scrambling to respond to this gasoline flip-flop. You can read our latest White Paper on the subject here.
I’ve spent the past week in India, visiting with many of India’s refiners and presenting at the Refining & Petrochemicals session of the 7th Oil & Gas World Expo in Mumbai. This was my third trip to India in as many years, and each time the signs become clearer that India is about to take off.
Low oil prices have been a boon for the Indian economy, providing a $100 billion annual savings in imported oil costs – money that instead recirculates within the domestic economy. The government is driving ahead with market-oriented reforms, reducing or eliminating subsidies and funding major infrastructure investments. Sales of new cars are at record levels, having grown 12 percent in 2015-16 and expected to grow the same again in 2016-17. There is a buzz of progress in the air.
When I travel around India, I look for signs of growth and progress: new business openings, slum redevelopments, cranes on the increasingly crowded skyline, traffic jams– not all of the signs are positive!
A new scheme to reform LPG subsidies caught my attention. Rather than selling LPG at below-market prices, everyone pays the market price and receives a one-off monthly rebate from from the state through Direct Benefit Transfer (DBT), triggered by their purchase of LPG. But once they’ve had their subsidy, that’s all they get. The new system circumvents abuses.
What’s impressive about this is the scale of the effort needed to make it work. Over 180 million households have been registered and fiscalised, with some kind of banking facility to make this possible. Also impressive is the “Give It Up” scheme to encourage wealthier Indians to forgo the subsidy, which has already collected nearly 8 million pledges.
The Modi government’s latest budget is directing major investment into the agricultural sector. It is seeking sensible taxes on fuels and new car purchases to fund infrastructure growth and environmental improvement. India’s economy is expected to grow by 7.6 percent in 2016, having grown by 7.3 percent in 2015. In the aftermath of the budget, the SENSEX stock market index is up over 7 percent since the beginning of March.
We’ve taken a closer look at India’s oil & gas sector and some of the challenges facing the industry as the country powers ahead. Download and read our white paper, India – Making the Most of Low Oil Prices, and let us know what you think.
With oil prices dropping below $30/bbl, the depth and duration of the current low price environment is taking a major toll on OPEC members. Despite adjusting their budgets and cutting popular benefits like fuel subsidies, member states are running significant deficits, and the lack of cash flow is starting to drag their economies into recession.
Whilst this may look like a financial ‘own goal' to some, it also represents a huge opportunity for OPEC national oil companies (NOCs) - and others - to recast themselves on more commercial lines. Using this opportunity to trim costs, to integrate and to streamline operations will leave these companies far more competitive and 'match fit' once prices do resume a more sustainable trajectory. This will benefit not only the NOCs but also their biggest shareholders – the national governments.
News that Saudi Aramco is looking at a possible IPO certainly got the attention of the markets. Floating a stake in arguably the world’s biggest company would be a huge move and could release a massive amount of cash to the Saudi government. But before Aramco could be floated – especially on major stock markets – it would require a lot of sunlight on the company’s operations. Saudi Arabia has traditionally been quite secretive about the performance of Aramco, which is not only responsible for most of the state’s income, but also sustains the House of Saud, which is large, diverse and said to be talking about its future direction, its leaders and their plans for reform.
Our goal here isn’t to dissect the politics of the Kingdom or to speculate on the possibility of such an IPO, but rather to note the real potential of re-aligning OPEC NOCs along more conventional and transparent business lines. Transforming NOCs into market-focused entities will not be easy. It means setting aside the politics, bureaucracy, patronage networks and “business as usual” mentality that frames many such companies. Realising the real value of NOCs requires their costs to be controlled, supply and investment decisions taken with reference to market rates of return and their workforces structured and upskilled for the challenges of tomorrow. Just getting in shape for an IPO would provide new direction and vigour for the NOCs, with clarity on social, financial and environmental objectives – the so-called “triple bottom line” that are the real benefits NOCs bring to their stakeholder governments and populations.
Oil prices have started 2016 with a deep dive, with front month Brent crude oil losing around $4/bbl this week, or around 10 percent of its value, despite rising political tensions between Iran and Saudi Arabia. At the time of writing, the price of Brent is just over $34/bbl, a level last seen in 2004. Clearly the market is focused more on the sustained level of oversupply and fears of an economic slowdown spurred by the Chinese stock market meltdown than on sparks flying between the two OPEC powerhouses. With global stock levels rising by over 500 million barrels last year and continuing to rise despite unsustainably low current prices, crude oil traders are nervous and short positions have increased to recent record levels, pointing to lower price expectations in the months ahead.
Much attention has been focused on the US shale oil sector, which has been defying predictions of collapse for more than a year now. While output has slipped in recent months, supply is still abundant, production in some quarters is still rising and oil continues to move to markets in the US Midcontinent – at least for now. A successful stock market placement by Pioneer Natural Resources this week, raising $1.4 billion dollars to sustain an expansive capital investment programme and boost output, is a vote of confidence in the sector despite lingering concerns for the viability of some smaller players. A key question remains as to whether US tight oil producers will have a soft landing, with production slipping only modestly, or a much harder time with output perhaps falling by another 1 million bpd. On current evidence, the former seems more likely, which is a challenge to producers elsewhere.
The current price environment is bad news for the oil majors, who have already hacked away at their capital spending programmes with a view to sustaining dividend payments and turning net cash positive by 2017. The biggest impact here will be on longer-term growth of conventional production, and potentially on the oilfield service companies hired to develop new resources. If 2015 was tough, 2016 will be tougher, with an even sharper focus on cost control. A test of oil prices in the $30/bbl range will drive producers to stress test their new projects at hurdle prices far lower than in the recent past. Having squeezed costs over the past two years, non-OPEC upstream will become much more cost competitive, which heralds an extended era of sustained lower marginal cost crude oil.
Meanwhile, refiners continue to benefit from cheaper energy and strong consumer demand, especially for gasoline. The mild winter in the Eastern US and parts of Northwest Europe has weakened demand for distillates, which are accumulating in storage in Europe, but strong gasoline cracks are driving refiners to sustain output and delay maintenance with a view to “getting while the getting’s good”. This is a key opportunity for refiners to invest in operational efficiencies to be better prepared to weather then next downturn when it comes. Margins remain stronger today than before the oil price crashed, though refiners will be wary of an economic slowdown which would curb demand growth for refined products.
KBC Energy Economics sees oil demand growing by 1.5 million bpd in 2016 and 1.9 million bpd in 2017, but these figures are dependent on sustained economic recovery in Europe and growth resuming throughout North America, Asia and the Middle East. Growing demand should serve to tighten up the oil market by late 2016, with price recovery following on. KBC sees prices remaining in the low $30/bbl range in Q1 before rising through the rest of the year to finish around $57/bbl at year end. Refining margins are likely to remain robust at least through the ‘driving season’ in the Northern Hemisphere summer.