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By Jeff Weniger, WisdomTree Investments
Special to the Financial Independence Hub
If the term “IMO 2020” doesn’t resonate with you, pay attention: it could be front-page stuff soon.
The International Maritime Organization is putting fuel cleanliness standards in place on January 1, 2020. But the shipping companies have been caught flat-footed, despite years of forewarning. Their scramble could have a bigger effect on 2019–2020 petroleum markets than OPEC deliberations.
According to the U.S. Energy Information Administration, the shipping industry used 3.9 million barrels of crude oil per day in 2016, about equivalent to Canada’s total output. The fuel supply chain could be upended, because the “light sweet” crude oil that you find in Texas is going to be in demand, while the portion of Canada’s production that is “heavy” will want for bids.
That’s because of the pollution dynamics of the oil varieties. Think about what ships use: “bunker fuel.” Filthy, thick and viscous—one step above the tar-like stuff used to pave roads. An important component of this fuel — the enemy — is sulphur, which leads to acid rain, the destruction of ocean ecosystems and respiratory ailments. And the full-scale attack on this generation’s Big Tobacco is underway.
The regulations weren’t decided yesterday, but you wouldn’t know it from the shippers’ snail-like efforts at preparedness. Outside the “Emissions Control Area” standard for areas such as the coastal waters of North America and Europe, sulphur content must fall to 0.5% by January 1, 2020, for a ship to be allowed to set sail. In some jurisdictions, violators will even face jail time.
Figure 1: Sulphur Content: “IMO 2020”
Heavy Western Canada Select oil, with all that thick, sticky, high-sulphur bitumen, is exactly the variety of oil that, when refined, results in the kinds of fuels the IMO is essentially banning.
Remember when Canadian oil reached a US$50 discount to light sweet West Texas Intermediate oil last year (figure 2)? Alberta was gushing oil with no easy route to buyers. The province’s OPEC-like production cuts of 325,000 barrels per day, recently reduced to 250,000 barrels, are a temporary solution. It works, as long as nothing unexpected wallops the supply/demand dynamic.
Figure 2: U.S. vs. Canadian Oil
If the number of questions I’m fielding about this issue (zero) is any indication, global oil dynamics are in for a big surprise when everyone starts to take notice.
Refiners should love this scramble, because only a fraction of the ships have sprung for the expensive “scrubbers,” machines that can clean up high-sulphur fuels to get it compliant. If they don’t shell out for the scrubbers, I’ll have losses to present to Mrs. Weniger.
That means the other route — buying low-sulphur fuels and hoping the price remains on planet Earth — is necessary if you intend to haul cargo. What happens to the demand from shippers for the high-sulphur fuels of yore? It is likely to collapse.
Low sulphur brings images of natural gas, light sweet crude, Texas, shale.
High sulphur is the Canadian oil sands’ problem.
Pay attention.
Jeff Weniger, CFA serves as Asset Allocation Strategist at WisdomTree. Jeff has a background in fundamental, economic and behavioral analysis for strategic and tactical asset allocation. Prior to joining WisdomTree, he was Director, Senior Strategist with BMO from 2006 to 2017, serving on the Asset Allocation Committee and co-managing the firm’s ETF model portfolios. Jeff has a B.S. in Finance from the University of Florida and an MBA from Notre Dame. He is a CFA charter holder and an active member of the CFA Society of Chicago and the CFA Institute since 2006. He has appeared in various financial publications such as Barron’s and the Wall Street Journal and makes regular appearances on Canada’s Business News Network (BNN) and Wharton Business Radio.
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