Most analyses of the price impact of IMO 2020 have taken a fairly conservative approach. They look at the longer term ways in which the oil market will adjust and substitute lower-sulfur fuels for higher-sulfur fuels in order to meet the mandate that marine fuels can contain no more than 0.5 percent sulfur after January 1, down from the current level of 3.5 percent. They might refer to the possibility of disruption but it's viewed as a short-term phenomenon that will correct itself.
Then there's Philip Verleger.
Verleger is an independent economist who for years has been writing about the potential for market turmoil when IMO 2020 is introduced into the market. His weekly "Notes from the Margin," sent to his subscribers late Sunday, might be the most dire forecast of everything he's written.
A sub-head entitled "The Chaos to Come" pretty much sums up his outlook. And the chaos Verleger sees is such that he expects governments to step in and take action to try to push back against any price increases.
The fear has always been that the price of diesel in particular will be driven higher by IMO 2020. Diesel would get hit first as a rising portion of the pool of distillates used to produce over-the-road diesel will be diverted into making either more of a product known as marine diesel or marine gasoil, or to be blended into a new family of products known as very low sulfur fuel oil (VLSO). Both would substitute for the high sulfur fuel oil, also known as bunker fuel, that now powers most ships.
Product markets don't act in silos; if the price of diesel soars it will eventually pull gasoline and crude higher with it, though not at identical rates.
Verleger sees the issue through one of politics and Donald Trump, who through Twitter has railed against OPEC and in favor of lower oil prices numerous times. He notes that the U.S. is a net exporter of all petroleum products (though remains a net importer of petroleum in general due to the fact that it still imports anywhere from six million to seven million barrels per day, or b/d). Diesel exports fluctuate, but exports of all grades of diesel in December – the last full month for which there is data – were 1.377 million b/d.
President Trump does have the ability to stop those exports, according to Verleger. He cites two laws – the Emergency Economic Power Act of 1977 and the National Emergencies Act. The Emergency Power Act gives the President authority "to deal with any unusual and extraordinary threat, which has its source in whole or substantial part outside the United States, to the national security, foreign policy, or economy of the United States, if the President declares a national emergency with respect to such threat." Language in the National Emergencies Act is similar.
Citing the Trump administration's recent decision to use emergency powers to divert funds into building a border wall, Verleger asks, "Does anyone doubt he would act in a similar fashion if the IMO 2020 implementation leads to higher gasoline and diesel prices?"
Opting the U.S. out of the IMO 2020 agreement – which is not something Verleger discusses – would probably have little impact on shipowners. As was pointed out last week at a CERAWeek panel, shipowner insurers are likely to not insure companies that choose not to comply and a ship without insurance isn't going very far.
But what Verleger sees Trump doing is suspending or limiting U.S. exports. The question of how that would be implemented and enforced is largely irrelevant, Verleger writes. "Should an export ban occur, the lack of the necessary bureaucratic system to administer it would likely lead to a total suspension of U.S. shipments of key fuels for some time," he writes. "No refining or trading company would risk the penalties that could be imposed. Trade would stop." He then lays out a cascading scenario of chaos in fuel markets around the world, the impact of which would be higher prices. As anybody who studies oil markets knows, chaos never lowers prices.
In the report, Verleger discusses the Coalition for American Energy Security (CAES), a new trade group that might be the first energy-themed group to pull virtually all the major oil-related parties together that are often at odds with each other over other issues. The American Petroleum Institute, the American Fuel & Petrochemicals Manufacturers Association and the Independent Petroleum Association of America – they're all in it together. And making sure the IMO 2020 rules go into effect appear to be their only goal. "We believe the United States should adhere to the scheduled implementation of the International Maritime Organization's (IMO) standards, which will reduce sulfur emissions from nautical fuel by 80 percent when they take effect in January 2020," the group states on its homepage, whose content is devoted exclusively to information and news about IMO 2020.
The argument of groups such as CAES now is that companies dutifully invest and prepare for a new regime. Pulling out the rug from those companies at the last minute because of fears of price spikes is unfair and will inevitably lead to delayed investment in the next round of regulation. It is an argument that has prevailed at other times when a new regulation loomed and there were voices that called for a delay or suspension. Those voices inevitably fail and the regulation goes into effect, usually without huge consequences. IMO 2020, however, has been viewed as the most significant change in product specifications possibly ever.
According to Verleger, the companies that are in the CAES could reasonably thought to be expecting a windfall from IMO 2020. As we have written previously, the well-crafted models of how the world gets to meet the IMO 2020 standards can't account for short-term or medium-term disruptions. One such possibility – instead of turning to new low sulfur fuel oil blends at the start of the process, shipping companies will go with what they know, which in this case is marine diesel/marine gasoil. And that could put a squeeze on the distillate market.
"The real opportunity for profit...occurs when environmental regulations change in a way that makes it more difficult to produce specific products," Verleger writes, citing the price of gasoline moving higher in the mid-2000s as sulfur was cut back in that product. The price of the product moved up more rapidly than the price of crude and the interim can provide a profitable interlude.
But given Trump's track record on oil prices and on declaring national emergencies, Verleger sees a strong chance he might do it again. "If Trump acted to lower U.S. gasoline and diesel prices, he would be cheered by almost every voter," he writes. "There would be no effort to block it. The oil industry has few supporters in Congress and even fewer among the general population."
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