The final fuel countdown

A major challenge facing shipowners this year is the requirement to reduce sulphur emissions dramatically on 1 January 2015. In order to address concerns about the health impacts of sulphur on local populations, this change will apply to ships trading within the Emission Control Areas (ECAs) that have been established in North America, the North Sea and the Baltic, in accordance with the 2008 amendments to MARPOL Annex VI.

For the vast majority of ship operators this will require the use of far more expensive distillate fuel (gas oil) with a sulphur content of less than 0.1%. Distillate currently costs about 50% more than the residual fuel oil that most ships presently burn, the pre-2015 sulphur limit in ECAs being 1.0% (with the current global limit in waters outside ECAs being 3.5%). But many observers expect the price differential to be even greater due to uncertainties about the extent to which oil refiners will be able to produce distillate in the quantities that will be required.

Fuel costs, by far, represent a ship operator’s largest expense, having increased about 400% in the last 10 years. Over the life of a ship, fuel costs used to represent only a fraction of a shipowner’s capital costs. Today this relationship is the other way around, with the cost of fuel now far exceeding capital costs including debt servicing. At a time when the industry may be about to turn a corner following many years of very depressed freight rates, there is thus a real danger that the switch to distillate could inhibit recovery as it begins.

Alternatives exist

It is important to remember that, largely as a result of efforts by ICS, MARPOL Annex VI permits options for alternative compliance instead of switching to distillate. However, very few companies will be in a position to use Exhaust Gas Cleaning Systems (‘scrubbers’) before 2015, due to questions of cost, reliability and uncertain environmental performance. They are nevertheless expected to play an important role in the future, and it may be easier for ships to make investment decisions about installing such equipment once there is greater clarity about the cost of distillate when the 0.1% ECA limit applies.

Similarly, relatively few ships are expected to make immediate use of low sulphur LNG. Although projects exist to fit new build ships with dual-fuel systems that can use LNG in ECAs, for most existing vessels the engineering involved will probably be too expensive to permit retrofitting. The other challenge is addressing the current lack of LNG infrastructure. It is therefore disappointing that a proposal by the European Commission to require that EU ports should have LNG bunkering facilities in place by 2020 has been watered down by EU Member States. It could therefore be another decade before LNG is widely available throughout European ports. This could also impact unhelpfully on the industry’s efforts to deliver further CO2 emission reductions.

But the most pressing challenge of ECA compliance is economic. With freight rates still depressed, many shipping companies are unlikely to be able to pass on all of their vastly increased fuel costs to their customers. In certain trades in North West Europe and the US/Canadian Great Lakes there is genuine concern that some shipping routes, carrying relatively low value cargoes, will no longer be viable, and that the effect of the switch to low sulphur fuels will be to encourage shippers to shift to less carbon efficient forms of transport, especially road.

Enforcement issues

Another important question is the extent to which the authorities will actually enforce the 0.1% sulphur limits in 2015. The vast majority of responsible ship operators are of course preparing for full compliance. But the unfair competitive advantage that could be derived from using non-compliant fuel will be significant, unless it is clear that non-compliance will be detected and that there will be serious consequences for those that are caught. While the United States has seemingly been taking a robust approach with respect to enforcement of the current 1.0% fuel limits, evidence of strict enforcement in the Baltic and North Sea ECAs has been patchy since their establishment in 2010.

The issue of ECA enforcement and preventing market distortion is a complicated one. While it is vital that the authorities maintain the level playing field, any measures that provide a strong deterrent to non-compliance will also need to be balanced with assurances that operators acting in good faith are not confronted with draconian penalties for what may be minor technical anomalies or genuine bunker supply problems. This will especially be the case when it is the bunker supplier rather than the ship operator that may be responsible for the specification of the fuel. On the other hand, if the authorities decide initially to apply a pragmatic approach towards enforcement it will be vital that all ships are treated equally.

Serious concerns remain about the accuracy of any fuel testing that might be undertaken during Port State Control (bearing in mind that many ships will be switching between residual fuel and distillate before entering an ECA) and the arrangements that will apply for assessing compliance when a ship may only be in transit through an ECA. There are also big questions about the accuracy of ambitious proposals for enforcement methods using aerial surveillance. It remains to be seen if these questions will be fully resolved before 1 January 2015.

In preparation

With respect to the issue of fuel availability and the economic impact on the industry, there is also growing concern about the implementation of the global cap that will reduce the sulphur content in fuel consumed outside ECAs to 0.5%. This is scheduled to take place in 2020, with an option for IMO to decide to delay until 2025 if necessary, depending on the outcome of an IMO fuel availability study due, as required by MARPOL, to be completed no later than 2018. It is assumed that most ship operators will comply with the global cap using a blend of distillate and residual fuel.

The EU has already decided that the global 0.5% cap will apply in the EEZ of EU Member States from 2020, regardless of the outcome of the IMO study. Nevertheless, at the IMO Marine Environment Protection Committee (MEPC) meeting in April 2014, ICS repeated its plea that the conduct of the IMO study should be brought forward. This is so that any necessary action can be taken by governments to ensure that refiners produce a sufficient quantity of diesel grade fuel, especially as shipping will be in competition with land based demand for similar fuel from trucks, trains and users of heating oil.

In April 2014, the IMO MEPC agreed to continue its consideration of a methodology for conducting the fuel availability study, under the leadership of the United States. While this is welcome, it remains to be seen whether IMO will conduct the study in sufficiently good time before the entry into force of the global cap.