Potentially one of the most economically disruptive regulations the maritime sector has seen in recent years, IMO 2020 came into force from 1 January 2020. Whilst significantly reducing the amounts of sulphur oxides emitted from ships and bringing major environmental and health benefits, it has lead to ship owners facing difficult decisions, which have huge implications for their organisations. In this article we look at IMO2020 and the events leading up to it, the effects of sulphur oxides on humans and the environment, and the demand for low sulphur fuels together with the alternatives.
“IMO 2020: the global regulation effective 1 January 2020 from the International Maritime Organisation to cap the sulphur content in marine fuels at 0.50%, globally.”
What is IMO 2020?
The previous limit for sulphur content in marine fuel was 3.50% (when outside of Emission Control Areas – see below) and so 0.50% m/m (mass by mass, or weight by weight) represents a reduction of over 80% against current levels.
For many years the IMO has been attempting to reduce the harmful environmental effects of shipping. According to a Goldman-Sachs study, burning standard bunker fuel (Heavy Fuel Oil or HFO) accounts for almost 90% of sulphur oxide (SOx) emissions globally, with the largest 15 vessels producing more sulphur than the combined total of all the world’s automobiles.
The impact of this regulation will be significant, with the shipping sector consuming over 3.5m barrels of bunker-fuel oil per day in 2018. Because of that, the impact on the pricing and availability of compliant fuels, and hence the economics of the whole sector, has the potential to be cause considerable disruption.
Emission Control Areas
In order to establish stricter controls, Emission Control Areas under regulations 13 and 14 of MARPOL Annex VI were introduced in designated sea areas off the Pacific and Atlantic Coasts of the United States and Canada; the Gulf of Mexico and Caribbean sea area; around the islands of Hawaii; and the Baltic Sea and the North Sea, extending into the English Channel.
From January 2015 ships trading in these ECAs have had to use fuel with a sulphur content of no more than 0.10% (with limited exceptions, such as for securing the safety of a ship).
In Europe, following numerous EU Directives, Member States from 2015 have had to ensure that ships in the Baltic, North Sea and English Channel (i.e. the SOxECAs, SOx-Emission Control Areas) use fuel with a sulphur content no greater than 0.10%. With IMO 2020, from 1 January 2020 they have had to ensure that ships, other than those operating in these SOx-ECAs, satisfy the no more than 0.50% sulphur content requirement.
China introduced its own regulations to control sulphur emissions, effective from 1 January 2019, by creating its own domestic emission control areas. Within its territorial sea, vessels have had to use fuel with a sulphur content not exceeding 0.50%. From 1 January 2020, vessels entering inland ECAs (i.e. the Yangtze and Xi Jiang Rivers) must now use fuel with a sulphur content not exceeding 0.10%, extended to Hainan Coastal waters from 1 January 2022.
What damage do sulphur oxides (SOx) do?
The heavy fuel oil used in shipping contained more than 2,700 times more sulphur than the fuel used for road transport. Burning it causes Sulphur Di Oxide (SO2) to be emitted as well as contributing to the formation of secondary particulate matter that is particularly harmful to humans and the environment. In Europe this air pollution was estimated to cause around 50,000 premature deaths each year. SO2 emissions cause, amongst other things, acid rain that affects water supplies and soil, and is one of the causes of biodiversity damage.
Inhaled particulates penetrate the lower airways in humans and can enter the bloodstream. Exposure has been shown to cause higher incidences of asthma, pneumonia, chronic obstructive pulmonary disease (COPD), heart disease, and strokes.
When compounds like SO2 and NO/NO2 are released into the air they can rise high into the atmosphere where a reaction takes place between water, oxygen and other chemicals to form more acidic pollutants, what we know as “acid rain”. Being acidic it then has harmful effects on plants, aquatic animals and infrastructure. Adversely affected are forests, freshwater and soils, killing insects and aquatic life forms. Acid rain also causes damage to steel structures, stone buildings and paint to peel.
In addition to this “wet deposition”, acidic particles can also land on surfaces as “dry deposition”. These particles are then washed off a surface when it rains, with the acidic water flowing into the ground, again harming plants and wildlife, including insects and fish.
MARPOL Annex VI
Annex VI to the International Convention for the Prevention of Pollution from Ships (MARPOL, MARine POLlution) was adopted in 1997 in an effort to address air pollution caused by shipping. The Annex seeks to control emissions from ships that including sulphur oxides (SOx), nitrogen oxides (NOx), ozone depleting substances (ODS), volatile organic compounds (VOC) and shipboard incineration. The Annex came into force in May 2005, with a significant strengthening adopted in October 2008. Since 2010 there have been further amendments, introducing further ECAs. Parties to Annex VI decided in October 2016 to implement the 2020 reductions, i.e. 3.50% sulphur content down to 0.50%, from 1 January 2020. The 2020 date was first set in 2008 but required the IMO to review whether it should be delayed until 2025, the review being completed in time for the October 2016 decision, in other words for 2020 to be the implementation date, and not 2025.
What are the alternatives?
The regulations can be complied with by using low-sulphur bunker fuel. Some vessels are however choosing marine gas oil (with a sulphur content of 0.10%) instead of high sulphur fuel oil, it having negligible sulphur oxide emissions, and methanol for some short services.
One of the most publicised alternatives is for a ship to use exhaust gas cleaning systems or “scrubbers” which clean the emissions from higher sulphur content fuel before being released into the atmosphere.
Alternatives such as batteries or hydrogen powered fuel cells may gain some traction if future pricing changes allow, both in terms of the cost of such equipment and that of the alternative, existing solutions.
Marine scrubbers are an environmentally friendly way to remove sulphur oxides from the exhaust gas of ship engines and to protect air and water quality.
Scrubbers work by passing the exhaust gases through water causing a reaction that produces sulphuric acid. On its own this acid is highly corrosive, however with sea water being alkaline, mixing the two together, in the appropriate volumes (the alkalinity of seawater varies depending on the location), neutralises the resultant mix that can then be discharged into the sea after any sludge has been removed. As they take up a fair amount of space they can be installed in the funnel casing and sometimes replace part of the conventional exhaust system.
There is also a recently introduced membrane option, where instead of passing through water, the gases are separated using a nano porous ceramic membrane that consists of tubes suspended in the exhaust stream. An absorbent solution is passed through the tubes with the SOx being dissolved in it.
Monitoring and certification ensures that scrubbers being used meet the requirements of the IMO regulations.
A ship owner has had to make a major commercial decision when considering how to comply with the regulations effective from 1 January 2020. Do they risk the uncertainty of market forces that will determine the price of low sulphur bunker fuel or do they fit expensive scrubbers? Making that decision requires investigation of many factors: the operating profile of individual vessels, the economics of the bunker fuel sector, as well as the technical, operational, financial and commercial circumstances of each owner. Scrubbers are increasingly being fitted to new vessels, but the majority now in operation have been retro-fitted. This means losing days at sea during fitting in addition to the cost of the equipment. The capital cost of scrubbers is currently high from $0.5m up to $4.5m, the cost determined by the maker and vessel size.
The commercial decision made needed to take into account the cost of the equipment and its installation, annual fuel consumption and assumptions about the price differentials between high and low-sulphur bunker fuel. When the first scrubbers were fitted in 2006 there were few manufacturers, nowadays there is more choice and more competition.
Some owners chose retrofitting scrubbers based on the assumption that increased demand for low-sulphur fuels would lead to a reduction in heavy fuel oil prices.
2019 saw a surge in scrubber fitted ships being available for charter. At the same time an increasing number of newbuilds are appearing with scrubbers fitted.
For an insight into the economics of the decision to fit scrubbers, the following charts produced by Cleaves Securities show the current (January 2020) spread between high and low sulphur bunker fuel, the cost of fitting scrubbers and the likely payback periods. At the present time bulk carriers and tankers fitted with scrubbers appear to be the clear winners.
There is some debate as to whether low sulphur fuels have a detrimental impact on engine cylinders over time. Regardless, there will always be a search for new, more efficient types of fuel. DNV GL has made predictions on the future energy mix of the world fleet based on the assumption of toughening IMO requirements, concluding that liquefied methane will have a dominant share of the fuel mix in 2050. At this stage it feels that ammonia will be the most promising carbon neutral fuel for new builds due to the lower cost of conversion, storage and the fuel itself.
When looking at possible solutions to accommodate the lower SOx regulations, owners are well advised to also look at the likely future changes in the sector with regard to other greenhouse gases (GHGs). The stated IMO vision is the reduction in total annual GHG emissions by at least 50% when comparing 2050 to 2008, “while at the same time phasing them out as soon as possible”. IMO strategy talks about “a pathway of CO2 emissions reduction consistent with the Paris Agreement temperature goals”. With this in mind, when making investment decisions, especially with respect to new builds and given the length of their useful lives, consideration should be given to zero carbon technologies and fuels. All options ought to be reviewed in order to develop a future proof strategy.
Policing, enforcement and penalties
The regulations say that no vessel can burn marine fuel with a sulphur content higher than 0.50% unless it is operating with an exhaust gas cleaning system that enables it to achieve an equivalent level of compliance. Similarly, from 1 March 2020 there is a ban on the carriage of non-compliant fuel unless a ship has scrubbers. It is not clear as yet how this will be enforced. The IMO itself has no enforcement powers, it falling to flag states to prosecute owners (making that unlikely).
Up until now enforcement has been a non-issue as the sulphur content of existing fuels is around 2.7%. Policing a confined ECA is very different to policing the open seas, and it is currently not clear how this will happen.
If an owner is found to have breached the terms of IMO 2020 it is also unclear as to what fines or penalties will be imposed – there is no fine or sanction established by the IMO (other than the statement that they should be sufficient to discourage violation), this is the responsibility of the individual State Party to MARPOL.
However, for example, Port state controls will be able to prosecute owners for having high sulphur fuel on board in territorial waters without a scrubber being used. The IMO states that bunker suppliers have certain obligations and have to sign a declaration that the fuel they supply complies with the low sulphur content, or alternatively that the purchaser has stated that an exhaust gas cleaning system is fitted – importantly, however, suppliers are under no obligation to check this.
In July 2018 the US Coast Guard noticed, during an on board examination of a tanker, that there were discrepancies in the vessel’s bunker delivery notes. There were false entries in the oil record book and some of the delivery notes had been falsified. The US Government brought charges against the operator, owner, commercial manager, master and chief engineer for directing a vessel to use non-compliant fuel. The owner and operator were fined $1.5m, with a four year probation period. The master and chief engineer were put on three year probation, being forbidden to enter US on any vessel. The vessel’s manager was fined $500,000.
Clearly, it is easier to enforce regulations in more restricted areas. The Maritime and Port Authority of Singapore have stated that captains and owners of vessels that burn over sulphurous fuel in their territorial waters could face up to two years in prison from the start of 2020.
Pressure to reduce emissions is also brought to bear in other ways on the shipping sector. An example is the “Poseidon Principles” initiative by twelve leading banks, representing around US$100bn in shipping finance. Signatories include ABN-Amro, Citi, DNB, Danish Ship finance and Societe Generale, with Maersk, Euronav and Lloyds Register involved in the development. The Poseidon Principles are “are a framework for assessing and disclosing the climate alignment of ship finance portfolios. They create common global baselines that are consistent with and supportive of society’s goals to better enable financial institutions to align their portfolios with responsible environmental impacts”. It means that climate considerations will be taken into account by these banks when making lending decisions.
Marine fuel demand
As at November 2019, demand for 0.50% sulphur marine fuel oil has surged in most of the world’s ports. In Singapore, it accounted for more than 43% of marine fuel so far delivered in November, in China it was 37%. Suppliers have been gearing up, ready for early next year. Demand in the Mediterranean has been slower however, where it seems thus far 20-25% has been the norm.
With sizeable increases in demand, some analysts are expecting to see significant price increases for low sulphur fuel oil, especially as existing refinery capacity falls short, the effect on prices being especially acute next year. In Singapore on 22 November 2019, marine gas oil and low sulphur fuel were 47% and 42% more expensive that HS380 respectively. In Fujairah they were 64% and 44%, in Rotterdam 56% and 45%, Gibraltar 51% and 39% respectively.
There has been speculation that US refiners that operate plants that remove sulphur are positioned to profit significantly from selling IMO 2020 fuels. Reuters reported Maersk and MSC as saying they could face annual extra costs of more than $2bn each. They were also told by a number of logistics company executives that any “IMO related costs”, such as fuel and ship upgrades, would be passed on to customers.
With regard to supply, at the start of December 2019 Hellenic Shipping News reported that “stocks of gasoil and other middle distillates have remained comfortable and there has been little pressure on refining capacity to make them. The predicted marine fuel crisis has failed to materialise”. It seems that the trade war between China and the US, together with a slowdown in global manufacturing and trade have meant that the scale of shortages in supply that some foresaw have thus far not occurred.
In summary: IMO 2020 is an ambitious step towards reducing the harmful environmental effects caused by ship emissions. The regulations have however necessitated high risk decisions, due for example to the uncertainty surrounding future fuel prices, with increasing concerns about the allowability of scrubbers being used in and around some of the world’s busiest ports. In the short term freight rates are expected to increase, in order that costs can be covered to accommodate the necessary changes. IMO 2020 does however make real progress towards a cleaner and more sustainable maritime sector, one that respects the planet and is seen to be acknowledging the expectations of society as a whole.
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