Traders face high freight costs under new shipping fuel rules

The United Nations (UN) has warned of global higher freight rates and additional costs as carriers comply with the IMO 2020 regulation on Sulphur that will come into force on January 1,2020.

In its report on Review of Maritime Transport, 2018 United Nation Conference on Trade and Development (UNCTAD) says the implementation will bring new challenges in the shipping industry, particularly in container shipping, prompting the UN agency to come up with several options for carriers.

January, 1 2020 marks the full implementation of the IMO 2020 regulations reducing the content of sulphur in fuel oil from 3.5 percent applied since 2012, to 0.5 percent in 2020.

This will significantly reduce the amount of sulphur oxides emanating from ships, improve air quality in port cities and coastal areas and meet global climate change objectives.

“Bringing emission levels to under 0.5 per cent mass/mass will mark the beginning of a new era that will bring about fresh challenges and require a radical change by the shipping industry. For carriers to comply with the new IMO 2020 regulation, three main options are currently available,” said the report.

The most direct option, according to UNCTAD, is for carriers to switch to low-sulphur fuels such as low-sulphur residual fuel oil, very-low-sulphur fuel oil, or low-sulphur distillates such as marine gas oil.

“This would inevitably entail additional costs and higher freight rates, given that the price of high-sulphur fuel is lower than that of low-sulphur fuels, as the latter are more costly to produce. The price of low-sulphur fuel stood at about Sh60,000- Sh70,000 per metric tonne in March and April 2019, while that of the traditional bunker fuel oil was about Sh40,000–Sh45,000 per metric tonne and the price differential between high-sulphur bunkers and marine gas oil was about Sh17,000 and Sh32,000, respectively, per metric tonne,” said the report.

The second option is carriers could continue to use cheaper high-sulphur fuel oil and install scrubbing equipment to remove sulphur from the ship engines’ exhaust system.

“However, installing these scrubbers will come at a cost. Various sources have estimated that installing scrubbers can cost between Sh200 million and Sh1 billion. They are also made by a limited number of manufacturers around the world that may not be able to meet all demand. Hence, as mentioned previously, this would influence the carriers to turn to scrapping, in particular for older vessels of smaller tonnage, with more ships likely to be scrapped towards the end of 2019,” said UNCTAD.

Another concern for ships fitted with scrubbers would be the availability of high-sulphur fuel oil to meet the demand and the impact on price if refiners move to significantly restrict the sale of such fuel oil.

The third option for ships, according to the report, would be the use of cleaner alternative fuels such as liquefied natural gas or methanol. However, it is estimated that liquefied natural gas production could cover only 10 percent of the required shipping fuel by 2040. In addition, ships fitted with liquefied natural gas tanks will require more physical space on board, taking up almost 3 percent of a vessel’s TEU slots.

“As a result, this will reduce the number of containers that can be carried. Also, due to the expected large increase in demand for liquefied natural gas fuels, it has been reported that the price of liquefied natural gas may increase as much as 50 percent. As for other alternative sources of fuel, such as biofuels and hydrogen, they are mostly sin the research and development stages,” said the report.

“Therefore, compliance with the IMO 2020 regulation will bring new challenges in the shipping industry, particularly in container shipping. Key issues for consideration may include higher costs and price volatility, as well as reduced capacity and increased transit time.”

UN has, however, warned that these additional costs may have an impact on the price to be paid by the end user as carriers will attempt to pass on increased costs to shippers through various forms, including new bunker surcharge formulas.

“It is argued that if these costs are not passed on to shippers, profit margins in the container shipping industry would be reduced and may lead to bankruptcies of the most financially vulnerable carriers,” the report said.

UNCTAD added that this may also prompt further consolidation in the container shipping industry.

“In recent years, carriers have been struggling to find ways to cover their losses and have applied various bunker charge programmes to mitigate these costs. For example, in 2018, carriers turned to a cost-recovery programme applying emergency bunker surcharges and passed the costs on to shippers.

Shippers may be at risk of receiving a new set of emergency bunker surcharges that is projected to be between 15 and 20 per cent higher once the regulations enter into force.

Six global container lines – Maersk Line, Mediterranean Shipping Company, CMA CGM/American President Lines, Hapag-Lloyd, Orient Overseas Container Line and Ocean Network Express (ONE) – had already outlined a new price mechanism for the bunker adjustment factor (also known as marine fuel recovery or the bunker recovery charge) that would replace the old formulas on January,1 2020 to cover fuel costs, as prices are expected to surge because of tighter environmental standards from 2020,” the report said.