November 2017

Trends and Resources

Business Trends: Preparing for a sea change in global refining

The global oil refining industry has been buffeted by many events in recent years.

Follette, C., Ruiz-Cabrero, J., Boston Consulting Group

The global oil refining industry has been buffeted by many events in recent years. These events include China’s pursuit of energy self-sufficiency, the crude oil price advantage for US refiners and the popularity of diesel as a replacement for gasoline. However, the implications of these events for refiners are likely to pale in comparison with the effects of the new sulfur regulations adopted by the International Maritime Organization (IMO).

Beginning in 2020, the new IMO regulations will reduce the limit of sulfur content in marine fuel from 3.5% to 0.5%. In turn, this decrease in sulfur content will reduce airborne emissions from ships. The new sulfur regulation could change the drivers of profitability in the refining industry for many years.

As we approach 2020, the implementation of the regulations will cause an oversupply of high-sulfur fuel oil (HSFO), which will severely disrupt industry dynamics. This disruption may extend through 2025, or even longer, as most industry players delay making the investments needed to reignite demand for HSFO and normalize prices.

Widespread disruption

Approximately 90% of the marine fuel sold has a sulfur content of 3.5%. This percentage equates to 3 MMbpd–4 MMbpd of HSFO, or nearly half of global HSFO production. By requiring ships to use marine fuel with no more than 0.5% sulfur, the IMO ruling will eliminate part of that demand. This decrease in consumption could cause a glut of nearly 2 MMbpd of HSFO. In turn, this could prompt an industry-wide disruption in two main areas: product pricing and refinery profitability.

FIG. 1. Switchable demand and competition will set the price for HSFO. Source: BCG analysis.
FIG. 1. Switchable demand and competition will set the price for HSFO. Source: BCG analysis.

Due to tight supply of heavy residue streams for nonswitchable end uses (e.g., conversion in a refinery to higher-value products), HSFO pricing has been above average. Should a 2-MMbpd oversupply of HSFO enter the market, it would cause marginal supply of HSFO to shift to a lower-value, switchable end use that competes with other fuel options, like natural gas, coal or petroleum coke (FIG. 1).

At the same time, the price of 0.5% sulfur fuel oil and distillates, which can be used to create compliant fuel oil blends, will increase. The authors expect the situation to be similar to the introduction of low-sulfur regulations for on-road vehicles by the US Environmental Protection Agency (EPA) in 2006. Approximately 1 yr before the ruling took effect, the price spread between low-sulfur and high-sulfur diesel dramatically widened to more than $11 at its peak.

A shift in the HSFO pricing mechanism from its higher-value to its lower-value substitution use could have a significant knock-on effect on the price differential between light and heavy refined products. The authors expect a significant spike in the differential.

Natural winners and losers

Within the global refining industry, there will be natural winners and losers, depending on refiners’ capabilities and product mix.

Complex refineries with hydrocracking and residue desulfurization units that enable maximization of compliant fuel oil and distillates production will be able to navigate the disruption. Many of these complex refineries are in Asia and the Middle East. Additionally, refiners with coker units, such as those on the US Gulf Coast (USGC), will fare well, as will refiners with access to crude with very low sulfur.

However, simple refineries that produce mostly HSFO (such as the high-sulfur hydroskimming and topping refineries in Russia) and those with products having low distillate yields (such as fluid catalytic cracking (FCC) refinery configurations, based in parts of Northwest Europe and on the US East Coast, that maximize gasoline yields) will find it very difficult to maintain profitability in the new environment.

The location of refineries may also affect profitability. Historically, HSFO prices have been lower in Northwest Europe than in the USGC and Singapore, which are larger hubs for marine refueling and home to more residue conversion facilities, creating higher demand. For distillates, however, the USGC has a price advantage over other regions, owing to the relatively lower demand. Therefore, shippers may prefer to source distillate fuel from the US, benefiting US refiners at the expense of European ones.

The sulfur content of crude oil also varies widely by region. For example, low-sulfur crudes are located primarily in West Africa and in the US, whereas other areas, such as the Middle East, have high-sulfur crudes. The IMO ruling will cause the price spread between low-sulfur, sweet crudes and high-sulfur, sour crudes to widen. These differences in crude oil prices will be directly reflected in refinery profitability.

Assessing compliance options

Under the IMO’s ruling, it is the responsibility of the shipowner—and the shippers that charter from them—to ensure that vessels are compliant. Although a degree of noncompliance is to be expected, particularly in the beginning, most will comply since the IMO is planning stringent measures to ensure that this happens. Several compliance options are available, some of which would enable the continued use of HSFO as a marine fuel.


As part of the regulations, the IMO is permitting ships to meet its emissions standards by using scrubbers. These systems are fitted onto a ship’s exhaust to remove sulfur oxide from effluent gas by mixing it with alkaline water (H2O).

Installing a scrubber takes approximately six months, but retrofitting a vessel can cost shipowners between $2 MM and $3 MM. When buying a ship, the inclusion of a scrubber in the specifications boosts the price by $1 MM–$2 MM. Unfortunately, the IMO ruling comes at a time when the shipping sector is financially weak due to low fleet utilization, anaemic charter rates and a widespread cash crunch. Therefore, the scrubber option presents a challenge for shipowners.

For shippers, scrubbers are an attractive option. Shippers operating vessels fitted with scrubbers would be able to continue using HSFO, which will be less expensive than compliant fuel. The savings would not only offset the higher day rates that shipowners would likely charge to recover their investment, but also cover the additional cost of handling effluent sour H2O from a closed-loop system. It is uncertain as to whether there will be any restriction on sour H2O discharge, even in highly alkaline ocean waters.

At present, scrubbers are installed on less than 1% of ships worldwide, and industry analysts predict that adoption is unlikely to exceed 25% by 2020. Given this forecast and the financial challenges, the authors anticipate that many shipowners will hold off on making significant investments in scrubber equipment, especially for older ships in the fleet.

Liquefied natural gas (LNG)

The use of LNG as marine fuel has several benefits. When compared with HSFO, LNG has lower emissions and, depending on commodity prices and regions, could have a lower cost per distance traveled. However, this option would require significant investment not only by shipowners, but also by some port authorities. Vessel engines would need to be converted so that they could burn LNG, and LNG terminals would need to be built or expanded.

Shipowners could increase day rates to recoup their investment, but that strategy could have its own challenges. In addition to a weak shipping economy, such ships may represent an opportunity cost to shippers—LNG tanks take up much more space than those for other bunker fuels, leaving less room for cargo. Furthermore, leasing such ships will not be an option for shippers that use smaller ports without LNG terminals.

Since LNG adoption neither destroys nor allows the consumption of HSFO, it would prolong the surplus of HSFO and the disruption period. However, these implementation obstacles make it a less probable choice, particularly to counter the disruption that could start as we approach 2020.

Distillates as fuel

Middle distillates that serve as road fuel provided a key solution in 2015 when the IMO imposed a low-sulfur limit for emissions control areas (low-emissions zones along the coasts of North America and in Western Europe). Some studies have suggested that distillates could be shipowners’ and shippers’ first choice, but the authors disagree for two reasons:

  1. The IMO regulation applies to all open waters. Relying solely on distillates as fuel would normally be very costly for shippers, and the increase in demand will push the price even higher.
  2. The use of distillates would require a capital expenditure (CAPEX) by shipowners to make fuel oil-based engines compatible with lower-viscosity distillates.

Distillates may be used as fuel by some shipowners and shippers seeking to comply with the IMO ruling, but distillates are unlikely to be the sole or primary option in the long run.

While shipowners could press ahead with the investments needed to enable vessels to use scrubbers or LNG, the authors expect that—lacking any compelling options—they will wait to see whether refiners will adopt alternative solutions at scale before taking action themselves.

Given the likely inaction from shipowners, refiners have several opportunities to limit their downside—or even emerge as winners—during the disruption period. The authors expect the following trends to emerge as refiners adjust to the new industry dynamic.

Creating compliant fuel blends

FIG. 2. Non-distillate refining routes may have better margins. Source: BCG analysis.
FIG. 2. Non-distillate refining routes may have better margins. Source: BCG analysis.

Typically, using distillates is the most expensive way to produce compliant fuel. As a result, such fuel will become the marginal supply source that sets the price of compliant fuels. Refiners that use intermediate residue streams, such as hydrotreated vacuum gasoil, will benefit by realizing a higher price at a lower cost than refiners that use distillates (FIG. 2).

Investing in residue desulfurization

The investment case for desulfurization units is attractive for refiners. Fuel oil with a sulfur content of 0.5%, which can be used as a compliant fuel, will be priced at a significant premium by 2020. Some refiners may choose to invest in cokers and hydrocrackers. However, the CAPEX for residue desulfurization units is slightly lower, and they offer more flexibility. When price differentials are wide between light refined products and heavy refined products, desulfurization units can produce more distillates to maximize profits. Conversely, when price differentials are narrow, these units can function as fuel oil hydrotreaters, producing compliant fuel.

Despite the benefits, drawbacks exist. Although the capital outlay for a desulfurization unit is lower than it is for a coker or hydrocracker, it can cost approximately $900 MM. In addition, refining returns are volatile, and the time required to bring these units online can be up to 5 yr. To be ready by 2020, projects should be underway now.

However, refiners could make smaller investments in auxiliary units, such as sulfur and amine gas treating units. Since these units increase a refiner’s capacity to remove sulfur from its products, they require less capital and can be brought online more quickly, making them highly profitable during the disruption period.

Partnering with shipowners

Innovative partnerships between refiners and shipowners are likely to emerge. For example, refiners and shipowners may forge offtake agreements whereby refiners co-invest in scrubbers, secure the purchase of their HSFO and mitigate the shipowner’s investment. Similar agreements are already being explored. For example, a Finnish marine equipment manufacturer offered shipowners the option of repaying the cost of scrubber equipment by means of a premium paid on top of the HSFO price.

Optimizing the asset portfolio

Smart refiners will optimize their asset portfolio in anticipation of, and during, the disruption period. They will divest poorly performing and non-integrated assets, or, in the absence of buyers, decommission and convert assets into storage terminals. Refiners that produce a high proportion of HSFO or a low proportion of distillates will increase their efficiency and boost margins through asset optimization.

The IMO ruling is set to cause significant disruption in the global refining industry. However, by examining the implications of the low-sulfur regulations ahead of 2020, undertaking scenario analyses and taking appropriate action, refiners can increase their chances of mitigating threats and maximizing profits. HP

The Authors

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