An Energy Shock from the High Seas -- Heard on the Street

By Spencer Jakab Features Dow Jones Newswires

Circle January 2020 on your calendar for what could be a major disruption to the energy market and a jolt to the global economy.

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The origin of the problem isn't some oil cartel's machinations, a looming war or even a technological shift -- it is a bureaucratic body that few people have heard of: the International Maritime Organization. Just 30 months from now the cargo vessels that are the lifeblood of global trade will be required to cut the sulfur content in their fuel from 3.5% to 0.5%.

Ships move more than 10 billion tons of cargo a year and do it far more efficiently than road or rail, but it comes at a high cost in terms of overall pollution because ships use fuel oil, which is just about the cheapest, dirtiest stuff to come out of refineries. About 9% of all sulfur dioxide emitted globally comes from ships, contributing to acid rain and many premature deaths annually. Even the new cap is 500 times the sulfur content of most road diesel.

But the sudden cut may have a significant global impact. "The shipping industry sees this as a shipping problem, and it isn't," said Martin Tallett, president of refining specialist EnSys Energy, which has studied the issue for years.

While standards have changed for many fuels, the rapid nature of the switch means that, if shippers fully comply, there could be price spikes. Ships that currently use cheap high sulfur fuel oil will have to switch to some other source higher up in the product slate that comes out of refineries. Even with significant investment, refiners may not be ready and ships may have to burn more expensive marine diesel.

"Marine diesel affects land diesel which affects jet fuel which affects gasoline," explains Mr. Tallett. That could cause the prices of those fuels to go up by 10% to 20%.

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The only solution may be to simply refine more oil, which means increasing overall demand, to get enough low-sulfur fuel out of the world's refineries. The International Energy Agency worried about the impact in a February report, yet it assumes many ships will install marine scrubbers to clean the dirty fuel and that refiners will add units to reduce sulfur content -- both expensive propositions.

The drain on U.S. motorists alone would be $1 billion a year for each cent per gallon increase. Furthermore, goods would get more expensive, particularly those transported by ship. Even oil prices might rise by about $1 a barrel because of the extra cost to ship it using the cleaner fuel.

Is the threat real? While energy traders mainly focus on the next several months, derivative prices indicate it is. For example, crude futures expiring in July 2020 are just 1% more expensive than those expiring in July 2017. By contrast, Rotterdam high sulfur fuel oil is 16% cheaper and New York ultralow sulfur diesel is 10% more expensive.

Watch this space.

Write to Spencer Jakab at spencer.jakab@wsj.com

(END) Dow Jones Newswires

June 06, 2017 14:59 ET (18:59 GMT)