The year that defied predictions
26th February 2016 18:19 GMT

As the start of last year approached, the market readied itself for two game-changing developments: the reduction of sulfur limits in emission control areas (ECA) from 1.0% to 0.1% and the ramifications of the collapse of leading global supplier OW Bunker at the end of the previous year.

Both were expected to bring tough challenges and drive major changes in 2015.

In addition, ongoing oversupply in most shipping segments meant rates, and hence the financial health of many bunker buyers, were under severe pressure. 2015 looked to be a year in which so much could go wrong, not least for smaller, financially weak companies in bunker supply and shipping.

THE EMISSIONS FACTOR

Let’s start with the anticipated ECA consequences.

Expectations were that the surge in demand for compliant marine gasoil (MGO) would lead to product shortages and huge price increases. Droves of ship operators would cheat to save money, and nobody would be caught because of lax enforcement. Short sea operators within ECAs would lose their competitive edge over other modes of transport and lose customers. Ships would shudder to a halt due to thermal shock in the busy English Channel as they switched from hot, highly viscous heavy fuel oil (HFO) to a cool, low viscosity MGO, or engines would be starved of fuel because of filter clogging or leaks on the fuel line.

But that isn’t what happened at all. In fact, the switch to the 0.1% sulfur went much more smoothly than anticipated.

Supply did not seem to be an issue and compliant fuel was much more affordable than companies had budgeted for. By the start of 2015, MGO prices were on a par with where HFO rices had been in mid-2014, and prices stayed low throughout 2015. On the enforcement side, several countries significantly increased fuel spot checks in 2015, typically finding less than 5% of ships to be in breach of the limit. True, some loss-ofpropulsion incidents were reported in the US, but no accidents were reported as a result. Of course, it is possible that fuel switch related engine problems were underreported, but overall it wasn’t the catastrophic issue that was predicted.

Meanwhile, short sea operators within ECAs appear to have weathered the storm and at least two North European ferry firms reported record results during 2015 due to higher freight volumes and revenues. One stated that investments in scrubbers and fleet efficiency played a part in its strong financial performance. The incentive to make those investments, however, weakened as the outlay for MGO fell.

The differential between HFO and MGO remains significant, but has increased the payback time for scrubber installations.

Current low oil prices may have put a break on a shift to LNG, as price advantages have been eroded and the market has been put off by the huge investment required, both for ships to run on LNG, and for the supporting supply infrastructure.

As we arrived at 2016, oil and hence fuel prices had fallen even further and few think they will recover much this year. However, lower fuel costs have now been budgeted for and if prices unexpectedly rally, the market may be adversely impacted.

As for ECA enforcement, it will be tightened in 2016 as EU member states now have mandatory requirements for checking ships for compliance. This is a huge change as in the past only about one in 1,000 ships visiting ports inside ECAs in Europe were subjected to fuel sulfur checks. Now EU countries inside ECAs are required to check the sulfur content in fuels on 40 out of every 1,000 ships. In the US, the inspection regime is less clear but US authorities have a history for coming down hard on any attempts at falsifying records, meaning operators calling at US ports should think hard about cheating.

There are other environment moves to watch this year as well. The Paris climate talks at the end of 2015 were expected to produce a global framework to limit CO2 from shipping. It was not to be, however, due to conflicts of interest regarding political principles. Pressure to regulate CO2 emissions will undoubtedly continue at the IMO during 2016, initially focused on matching the EU’s monitoring, reporting and verification (MRV) regime. While this won’t impact the bunker industry directly, it will increase focus on accurately measuring fuel consumption, and by association how much was supplied to the ship. The long term signal is to reduce fossil fuel use to cut CO2.

THE OW EFFECT

Moving onto 2015’s second game-changer, who could have predicted that Brent crude prices would more than halve from a peak of $115 in mid-June 2014 to below $50 by mid-January 2015. This unexpected sharp fall was a major factor in bringing down one of the world’s largest bunker fuel trader OW, as its
risk management strategy, or oil price speculation, backfired, causing losses totaling $175.5 million in late 2014.

The fallout from OW Bunker’s collapse was felt throughout 2015, but as yet it hasn’t led to the anticipated change in market behavior or structure. For a short while, suppliers and traders saw margins boosted as buyers were desperate for suppliers that could fill the sudden vacuum left by OW, which had won a huge market share by being very competitive. That didn’t last, and the vacuum was quickly filled.

It was thought bunker companies would undergo considerable consolidation, as owners would hold back from dealing with underfunded smaller players. More bankruptcies were a distinct possibility.

OW assets, or at least the people that worked for OW, were snapped up by companies keen to exploit their contacts and gain market share. It did lead to some consolidation as bigger players bought whole units of OW, helping them set up new supply locations and/or trading units. A year on, however, a number of former OW employees had moved on as they found they didn’t fit in with the company culture at their new employers.

The anticipated weeding out of smaller players didn’t occur – mainly because selling fuel on credit became more affordable due to low prices. With low prices, existing credit lines could accommodate twice the fuel volume. This allowed them to compete for more stems and clients. In fact, 2015 was a year when the big, listed suppliers and traders reported an increase in volumes – partly attributable to the disappearance of OW – but reduced profitability because they accepted wafer-thin margins by competing hard for the business.

Of course, many companies are now warier of who they are dealing with and want to know that their counterparty is financially sound. But there are also tales of suppliers offering credit terms bordering on reckless to companies with poor payment records.

For one large bunker company, failure to collect monies due is thought to have contributed to its undoing in 2015. US-based Bunkers International and its affiliated companies filed for Chapter 11 bankruptcy protection in August 2015, after its primary lender cut off its funding. It had an estimated $40 million worth of debts, which may well have put further strain on some of the bunkering companies already owed money by OW.

The upshot of all this is that major lenders are likely to tighten the screws on bunker players that are perceived to be living dangerously. If and when the time comes when shipping companies pay very late, or not at all, suppliers’ ability to meet the terms of their own credit agreements could begin to unravel.

HOW LOW CAN WE GO?

On the shipping side, freight rates were weak in most segments at the start of 2015, a hangover from over-ordering of newbuilds in previous years, causing oversupply just as demand for shipping stagnated. Many were expecting multiple shipping bankruptcies during 2015 due to persistent low freight rates. In the dry bulk sector, 2015 was particularly bad as Chinese imports of iron ore and coal slumped. The Baltic Dry Index (BDI) plumbed new record lows on a daily basis and had fallen below 400 by mid-January 2016.

The number of casualties in 2015 has been low, as operators have been propped up by lower operating costs. The price of Brent crude fell by two-thirds over the 18 months to the end of 2015 to below $40/b, and even fell below $30/b in early 2016 as crude oil futures hit their lowest since 2003. Some analysts predict substantial price volatility between $20 and $40 per barrel during the first half of 2016.

The question is what impact that pricing level will have on bunker suppliers and buyers? Will it be low enough to keep dry bulk operators afloat? The pains already endured by dry bulk lines during 2015 will have eroded their viability; January 2016 saw average daily earnings for panamaxes drop to $2,600, which, even at current bunker prices, is a less than half operating cost. That is clearly not sustainable.

Low oil prices are a mixed blessing: on the one hand, they might help bunker buyers survive at a time when they are being hammered by weak freight rates, but on the other hand they are keeping old, inefficient tonnage on the water. This doesn’t help the environment or the market, as oversupply persists. It
does allow a more diverse supply side as credit becomes more affordable, but pressure on margins continues as competition remains fierce. And if everyone is competing on price, what happens to quality – both of the fuel, the service, credit discipline and the professionalism of the industry overall?

A low oil price carries within it the seeds of its own destruction. Some of the world’s production is unsustainable at less than $50-60/b, but the fight for market share has kept much of that production going. Some of the US shale oil producers, for example, have continued to pump to service debt, but there were dozens of bankruptcies in 2015 and more expected in 2016. This could rein in production, but it will take a while for the market to rebalance from the current glut.


*The above was written in mid-January 2016 for the 'Commentary' in the February 2016 issue of the Bunker Bulletin, the Platts Bunkerworld magazine


Unni Einemo,
26th February 2016 18:19 GMT

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