Marine Fuels Outlook Under MARPOL

ANNEX VI Supplemental Marine Fuels Availability Study

0.5% Sulphur Rule in 2020 or 2025?

1

Martin Tallett David St. Amand

EnSys Energy Navigistics Consulting 1775 Massachusetts Avenue 1740 Massachusetts Avenue

Lexington, MA 02420, USA Boxborough, MA 01719

www.ensysenergy.com www.navigistics.com Telephone: 781-274-8454 Telephone: 978-266-1882

MartinTallett@EnSysEnergy.com DaveSt@Navigistics.com

25 February 2016

Background & Objective

• EnSys/Navigistics 2007/8 studies for EPA, AOPI/IPIECA and IMO

provided important inputs to MARPOL Annex VI.

• 2015 analyses provided a first pass review of 2020 outlook

• EnSys/Navigistics’ 2016 objective is to provide Supplemental input

to the IMO’s MEPC process and to stakeholders at large.

Sponsorship arranged to support our study.

Intent is to share premises with CE Delft team.

• The team’s core approach is for Navigistics to develop alternative

marine fuel demand outlooks (incrementally from the IMO’s 3rd GHG

Study) and for EnSys to apply WORLD modeling to examine a

range of 2020 global supply / demand scenarios.

2

Most Critical Issue: Switch Volume to Meet the

0.5% Sulphur Requirement • How much Residual Based Marine Fuel will need to SWITCH to Distillate Fuel in 2020?

• Two critical factors to consider:

What will be the total Marine fuel demand in 2020?

How will that demand be met?

• The IMO’s 3rd GHG Study developed a widely accepted baseline for total marine fuel demand in 2012, however;

The projections to 2020 and beyond were done when crude oil was $100/BBL.

Crude oil is now under $35/BBL – implications for economic activity, EGCS economics, and vessel speeds.

• Two primary approaches to meeting marine fuel demand:

Refining – produce fuel with 0.5% max sulphur.

Install Exhaust Gas Cleaning Systems (Scrubbers).

The answer is almost certainly a combination of the two

3

Projections of Switch Volumes Vary • The ability of the global refining industry to meet marine fuel

demand is highly dependent on the SWITCH volume.

• Recent studies have a wide divergence of opinion

4

2020 Switch Level IMO IEA IEA EnSys/Navigisti

cs

3rd GHG

Study 2015

MTOMR 2016

MTOMR 2015 Study

Scrubber

Penetration 58% 25% 28% 18%

Switch, mmtpa 24 110 100 195

Switch, mb/d 0.5 2.2 2.0 3.9

• The IEA described the impact of the 2.0 mb/d SWITCH on the global refining industry as follows (2016 MTOMR).

Global refiners will be put under enormous strain by the shifting product slate. If refiners ran at similar utilization rates to today, they would be unlikely to produce the required gasoil volumes, margins would be adversely affected by the law of diminishing returns. In order to increase gasoil output, less valuable products at the top and bottom of the barrel would be produced in tandem which would likely see cracks for these products weaken and weigh margins down.

(IEA’s MTOMR released 22 February 2016 page 39)

2015 Analyses by EnSys/Navigistics for

ICS/BIMCO and a Confidential Client

Highlighted Potential Broad Impacts of Rule

2015 WORLD modeling showed: • Global refining in 2020 should be able to handle

low SWITCH volumes but potential major strains at medium to high SWITCH levels.

• Refining is a co-product industry so strains go beyond marine fuels. Potential for strained high prices (versus crude) for diesel, jet/kerosene, also gasoline, worldwide.

• Hence ‘backlash’ potential – political (pressure to “relax” the IMO 2020 decision or widespread non-compliance?)

5

The Regulatory “Catch 22” of the Uncertainty

Regarding 2020 or 2025 • In a 2012 study for the European Commission “Analysis of market

barriers to cost effective GHG emission reductions in the maritime sector” by Maddox Consulting (Navigistics was the “technical” lead) stated (page 55):

Uncertainty over regulatory requirements –for example, will the maritime industry be forced to use distillate fuels in 2020 in order to meet the mandated SOx emission levels? This would nearly double the cost of fuel per tonne in comparison to heavy fuel oil (HFO). Alternatively, will the IMO study on low sulphur marine distillate fuels availability delay the switch until 2025? Reluctance to move towards the use of distillate fuels will remain until the uncertainty over this issue is resolved.

• It is clear that the “uncertainty” over 2020 or 2025 is leading to “inaction” on compliance decisions (e.g., whether to install an EGCS).

• If the IMO chooses 2020 – potential for broad ranging fuel supply problems beyond marine • Could this lead to “relaxing” the Global Sulphur rule by other regulatory bodies.

• If the IMO chooses 2025 – potentially just “kicking the can down the road” of compliance decision-making.

6

Primary Drivers

From the Marine Fuel Demand Perspective: • Accept the 2012 Baseline in the 3rd GHG Study and

trade growth rates.

• Vessel speeds – the IMO’s 3rd GHG was done in early 2014 when crude oil was $100/BBL and vessels were operating at slower speeds. Today crude oil is under $35/BBL. Optimal vessel speed is a tradeoff between fuel cost and charter hire.

• Scrubber penetration – The IMO’s 3rd GHG implicitly had ~60% of marine fuel consumed on ships equipped with scrubbers?

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Marine Fuels Demand Outlooks • Navigistics Outlooks – Vessel speed issue

• International seaborne trade has grown significantly since the recession while

related marine fuel consumption has stayed flat

• high fuel prices and excess shipping capacity have led to slow steaming

• 2015 Navigistics assessed the impacts on demand of partial and full return by

containerships to design speed operation. 2016 goal is to update assessment

• the drivers - recent unsustainably low freight rates and today’s lower crude / fuel prices

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• Navigistics Moderate scenario:

• partial speed up to ~20 knots

(vs. design service speed of

~24 knots)

• Navigistics High scenario:

• return to full design speed of

~24 knots

• Note the Navigistics scenarios do not

assume all vessel classes at design

speed and therefore contain an element

of conservatism

The Need to Update the Prior EGCS Analysis

• Navigistics Outlooks – Scrubber penetration forecast

• Navigistics used IHS data to 2015 plus “S curve” analysis to assess potential

scrubber penetration through 2025 • Linear regression on actual scrubber penetration used to establish shape of “S curve”

• Method predicted a market penetration of ~18 percent in 2020 although sensitive to exact

pace of adoption (c.f. 58% 2020 by IMO)

• 60% “saturation” penetration assumed by 2025 (level consistent with IMO)

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Do we believe

our “S curve?

Goal/need is to

update

EGCSA Member Input would Dramatically

Improve the Veracity of the Analysis

• Data used (from IHS used with permission)

• “Garbage In – Garbage Out” (GIGO) is a concern with this approach.

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Do you believe this data is accurate?

Goal/need is to update

Total IHS 50,000.0

Year Model Year Installations IHS Fleet Size Market

Penetration Log

formula

2010 1 1 1 0.0020% 10.3089

2011 2 4 5 0.0100% 8.6993

2012 3 12 17 0.0340% 7.4752

2013 4 27 44 0.0880% 6.5233

2014 5 65 109 0.2180% 5.6140

2015 6 137 246 0.4920% 4.7954 Source: IHS Maritime & Trade, "Scrubbers: Are they the answer

to fuel compliance?" March 2015 by Krispen Atkinson (used with

permission). Market penetration calculated by Navigistics based

on assumed fleet of 50,000 vessels.

“S-Curve” is an Analytically Rigorous Approach

• No “Leaps of Faith” – Provides analytical insight on timing of

“compliance”

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It’s all “math”

completely

dependent on the

input data.

An S-Curve has the format as follows:

Where:

Y = Market share in a given year

ϒ = Maximum market share, taken as 60%

consistent with low 3rd GHG HFO fuel

mix X = Year (Start 2010 is start year

after trial period)

α = Independent variable, intercept

β = Independent variable

𝑌=Υ(1+𝑒𝛼+𝛽𝑋)

Where α and β are found by linear

regression.

EGCSA Member Input would be very helpful • Regression analysis

12

The “R-Squared”

of 0.99699 says

we can “fit” the

data to an “S-

Curve” but

remember

“GIGO”

Linear Regression

Regression Statistics

R 0.99699

R Square 0.994 Adjusted R

Square 0.992

S 0.13719 Total number

of

observations 5

10.3089193267554 = 10.4891 - 0.9669 * 1

ANOVA

d.f. SS MS F p-level

Regression 1. 9.34921 9.34921 496.75005 0.0002

Residual 3. 0.05646 0.01882

Total 4. 9.40567

Coefficients

Standard

Error LCL UCL t Stat p-level

H0 (2%)

rejected?

Intercept 10.48909 0.18406 9.65333 11.32484 56.98794 0.00001 Yes

1 -0.96691 0.04338 -1.1639 -0.76992 -22.28789 0.0002 Yes

T (2%) 4.5407

LCL - Lower value of a reliable interval (LCL)

UCL - Upper value of a reliable interval (UCL)

Thinking “Outside the Box”

• 2020 or 2025 – What if the choice became a non-binary approach?

• What if a phased approach to 2020 – 2025 was an option?

• Similar to the Ballast Water Management System regulations in

which compliance is required at first dry dock after 1/1/2016 (in U.S.)

• For Global 0.5% Sulphur rule this could be only for vessels with firm

contracts to install an EGCS (contract by 1/1/2020)

Otherwise must use 0.1% Sulphur fuel from 1/1/2020.

• This approach would reduce regulatory uncertainty.

The goal is to inform the IMO’s MEPC with the “best”

information available for making a decision.

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The Survey

1. Identify scrubber installations to date and underway

(by year and ship type, ship name, and if available

horsepower). (excel spreadsheet is ideal)

2. Manufacturing capacity to produce and install

scrubbers (per year by year through 2025)

3. Provide information on scrubber economics (scrubber

cost by engine size, installation costs, time out of

service, and annual costs – energy and materials).

4. Can you provide any technical papers or info on the

economics (e.g., case studies) of scrubbers.

14

EGCSA Member Input is Essential

• Please complete the survey and return to DaveSt@Navigistics.com as soon as possible.

• All individual responses will be kept confidential.

• Only aggregate data will be used / reported.

• Output would be a new “S-Curve” and ancillary assessment of scrubber uptake and impacts.

The goal is to inform the IMO’s MEPC with the “best” information available for making a decision.

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Extras

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Acronyms used • IEA –International Energy Agency

• WEO – (IEA) World Energy Outlook

• MTOMR – Medium Term Oil Market Report

• MGO – marine gasoil

• MDO – marine diesel

• DMA – MGO at ISO 8217 DMA standard

• DMB – MGO at ISO 8217 DMB standard

• IFO – intermediate marine fuel oil

• HS – high sulfur (typically refers to 3.5%S)

• LS – low sulfur (either 0.1 or 0.5%S)

• VGO – vacuum gasoil

• FCC – fluid catalytic cracker

• HCR – hydrocracker

• HDS – hydrodusulfurization (unit)

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WORLD Model Methodology

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WORLD Model Overview

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WORLD Model Overview

“Bottom up” model of global petroleum downstream which works with “top down” oil outlooks

“Supply” LP extended to encompass whole world simulates the detail of the global system’s activities

captures the interactions within the global downstream

eliminates boundary assumptions

different concept e.g. most economics output (main input price is marker crude oil)

21

WORLD Model Overview Encompasses: total “liquids”

consistent with the major statistical sources (IEA, EIA, OPEC etc.)

crudes & non-crudes supply, refining and blending, transportation/trade, demand & product quality

Does not forecast oil supply/demand/ “world oil price”

Rather it simulates how the global industry will operate given a price/supply/demand scenario

EnSys: Refining Economics Technology Markets 22

WORLD Model Versions • Formulation user definable

• Latest version breaks out Mexico hence 23 regions

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WORLD Model Scope

• Main inputs:

• Supply/demand • Overall world oil price/supply/demand scenario for case year

e.g. from EIA or IEA projection

• Supply projection detail (crudes, non-crudes) matched to supply scenario

• Non-crudes: NGLs, petchem returns, biofuels, methanol, GTL, CTL

• Product demand projection detail by region based on historical data plus growth rates tuned to demand projection

• Multiple product grades: • Gasoline, distillates, residual fuels, marine fuels, other products

• Transport • Trade movement detail:

• Crudes, non-crudes, products, intermediates

• Marine, pipeline, minor

• Built up freight rates / tariffs / duties

• Pipelines and projects

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WORLD Model Scope

• Main inputs: • Refining:

• Base/current (Jan 2016) refinery capacity data • By refinery by unit worldwide

• Regionally aggregated

• Known (firm) refinery projects • Categorized by stage of development

• User controls which are allowed / dis-allowed

• Refinery technology database • Multiple processes

• Yields, utilities, OVCs

• Current technologies but can accommodate/evaluate new processes

• Merchant processes: MTBE, GTL, CTL

• Product blending & specifications

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WORLD Model Scope

• Main inputs:

• Economic: • Marker crude (“world oil”) price (Saudi Light FOB)

• Regional prices for:

• natural gas (stranded, industrial)

• purchased electric power

• methanol (for MTBE feed)

• Petroleum coke and sulfur prices (by-products)

• CO2 allowance prices (if/where applicable)

• WorldScale flat rates & percents of WorldScale by major tanker class

• Pipeline/canal tariffs, import duties

• Process unit capital costs with regional differentiation & capital cost escalation

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WORLD Model Scope

• Results: • Integrated “snap-shot” of how the global

refining/supply/trade system can be expected to operate under the given scenario and year • Run deterministically

• Underlying premise is that the industry gravitates toward economic operation • Subject to (user-input) geo-political / commercial

constraints/realities

• Short term (fixed capacities), solutions reflect strain/slackness in the market (wide/narrow differentials / margins) – 2020 analysis

• Long term (investment open), solutions reflect long run balanced market but can embody strained conditions

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WORLD Model Scope

• Main results - physical: • Refinery throughputs, operations, capacity additions

• Product blending & qualities

• Crudes, non-crudes, products, intermediates inter-regional trade movements & pipeline throughputs

• CO2 emissions: refinery, products

• Main results - economic: • Refining $ investments (long term cases)

• Marginal/supply costs of all crudes, products by region

• (relative to marker crude)

• Refining crack spreads (margins can be derived)

• Aggregate product supply costs by grade and region