In response to heightening environmental concerns and growing harmful emissions from ships, the International Maritime Organisation (IMO) has ruled that from January 2020 ships will have to use fuel with a maximum of 0.5 per cent sulphur content, down from the current 3.5 per cent.
To abide by this, ship owners have three options.
First, they can simply switch high-sulphur fuels to low-sulphur fuels or marine gas oil at higher costs.
Second, owners can install exhaust gas cleaning systems, or “scrubbers”, on their ships.
Third, ships can run on liquefied natural gas.
Although the rule is not binding, many large ship owners in the 174 member nations have already started taking measures in line with the IMO rules.
And their new action to buy either costly fuel oil or eco-friendly vessels will create new markets for South Korean oil refiners and shipbuilders.
Initially, ship owners are likely to opt for buying low-sulphur fuel oil, according to industry analysts, including Samsung Securities.
This is because installing exhaust gas cleaning systems or purchasing new LNG-fuelled ships requires more money and time.
To install scrubbers, it costs around $3 million to $5 million per vessel and takes around three to eight months.
The world’s largest ship operator Maersk and other big firms, including China Ocean Shipping Co and French company CMA CGM, decided to respond to the new rules with low-sulphur fuel oil in the meantime.
In Korea, more than 70 per cent of ship owners are also likely to turn to the costly fuel oil for the time being, according to the Korea Shipowners’ Association.
Opportunity for oil refiners
Ship owners’ option to choose low-sulphur fuel oil or marine gas oil is expected to be an opportunity for local oil refiners – SK Innovation, S-Oil, Hyundai Oilbank and GS Caltex.
The eco-friendly oil is more lucrative than high-sulphur fuel oil, which is currently used by vessels.
In response to the stronger environmental regulations, the four firms have already started investing in desulphurisation, a chemical process for the removal of sulphur from a material.
SK Energy, an affiliate of SK Innovation, is injecting around one trillion won ($823 million) in the construction of vacuum residue desulphurisation.
When completed next year, it will be capable of producing 40,000 barrels of low-sulphur fuel oil per day.
Combined with the capacity of another arm, SK trading international, SK Innovation will be able to produce a combined 130,000 barrels of low-sulphur fuel oil per day next year.
Three other firms are also equipped with similar facilities in response to the IMO rules, although they do not precisely target fuel for vessels.
S-Oil spent five trillion won on building a residue upgrading complex and olefin downstream complex, or RUC and ODC, which started commercial operations in November last year.
The portion of high-sulphur fuel oil is expected to be cut by half.
Hyundai Oilbank has injected 800 billion won since last year to upgrade its facilities to produce more low-sulphur gas oil.
GS Caltex also has facilities that can convert 274,000 barrels of high-sulphur fuel oil to light oil per day.
The four companies, which posted poor earnings due partly to weak refining margins in the second quarter, are expected to benefit from the IMO 2020 regulations in the latter half.
According to London-based shipping service firm Clarksons Research, high-sulphur fuel oil accounted for 72 per cent of a combined 270 million tonnes of shipping fuels used last year.
More than half of global and Korean ship owners are predicted to convert to low-sulphur fuel oil next year to meet the IMO rules, said the Korea Shipowners’ Association.
New market for shipbuilders
Although oil refiners will be beneficiaries of the rules in the short run, ship owners will eventually purchase eco-friendly vessels in the future to meet ever-tightening environmental regulations, industry watchers said.
This paints a rosier outlook for Korean shipbuilders, which saw their orders markedly fall in the first half of this year amid growing uncertainties in the global market, including the US-China trade war and the deteriorating relationship between the US and Iran.
The worldwide shipbuilding orders from January to June fell by 42 per cent to 10.2 million compensated gross tonnage, according to Clarksons Research.
In the future, however, the IMO regulations are expected to create new markets.
The world’s second and third largest ship owners, Mitsui OSK and CMA CGM, are set to adopt LNG-fuelled ships in the long term, although Mitsui OSK will install scrubbers and CMA CGM will use low-sulphur fuel oil in the short run.
Currently, the global LNG carrier market is dominated by Korean firms. They obtained 21 LNG carrier orders out of 27 orders placed worldwide in the first half of this year, according to Clarksons.
The nation’s three largest shipbuilders have already seen a steady rise in LNG-fuelled ship orders in recent years in response to growing environmental regulations.
Korea Shipbuilding & Offshore Engineering, formerly known as Hyundai Heavy Industries, has won 30 orders of LNG-fuelled vessels since 2016. It obtained 23 orders in 2018 and 2019 after having seven orders in 2016 and 2017.
“Eco-friendly regulations create a new market and new technologies, which are more lucrative and high-value, in the shipbuilding market. The trend of eco-friendly and smart vessels will appear to continue for a while,” said a KSOE official.
Another large firm, Daewoo Shipbuilding & Marine Engineering, has won 17 orders of LNG-fuelled ships over the past two years after five orders in the previous two years. Samsung Heavy Industries has won 10 orders over the past four years.
Beyond LNG-fuelled vessels, new demand for eco-friendly vessels will rise in the distant future.
In 2050, IMO plans to rule that the total annual greenhouse gas emissions from ships should be reduced by at least 50 per cent compared to 2008.
This will require ship owners to purchase hydrogen-powered or electric vessels, which emit less air pollution than LNG-fuelled ships.
In the second quarter, S-Oil posted an operating loss of 90 billion won. SK Innovation and Hyundai Oilbank also saw operating profit fall by 41 and 50 per cent, respectively, while GS Caltex saw its operating profit plummet 77 per cent year on year.
SK Innovation said it expected to see improved refining margins as demand for low-sulphur fuel oil for testing is on the rise as the IMO 2020 deadline draws near.
Three other firms made a similar prediction in their earnings statements.
What the IMO regulations will bring to the industries, however, may not be very promising.
“Uncertainty still exists,” said Yang Jong-seo, a researcher at Export-Import Bank of Korea’s global research centre specialising in the shipbuilding and marine sector.
In the long term, ship owners will have to determine whether they should buy LNG-fuelled, hydrogen or electric vessels – to meet ever-tightening environmental regulations.
This means shipbuilders in Korea face the task of preparing for every type of vessel without enough research and development budget compared to Chinese rivals fully backed by the government, according to Yang.
“The IMO regulations can be an opportunity but, at the same time, the risk current players face as leaders and followers can be reversed in a flash,” the researcher said.
As for oil refiners too, some analysts, including Lee Eung-joo, a researcher at Shinhan Investment, are not overly optimistic about the IMO regulation-led benefits because ship owners will initially respond to the rule with costly fuel but will find other alternatives, including scrubbers and LNG-fuelled vessels in the long run. The Korea Herald