IMO’s 2020 Sulphur Cap Seen Ushering In New Era of Slow-Steaming

If you happen to be at the beach this summer, make a mental note of any giant freighters crossing the horizon. In a few years’ time those same ships will probably be moving just a fraction slower.

If the slowdown does happen — and the likes of Citigroup Inc. say it will — then the wider consequences would be profound for both the shipping industry and its customers, given that about 90 percent of world trade moves by sea. The cause of this deceleration? A rule to combat the merchant fleet’s emissions of sulfur oxides starting in January 2020.

While such a slowdown might shave billions of dollars off shipowners’ single largest expense — fuel — it would also effectively limit the number of available vessels, risking an upward spiral in freight costs.

“It’s going to impact all of shipping: containers, tankers and in particular dry-bulk,” said John Kartsonas, New York-based managing partner at Breakwave Advisors LLC, which runs an exchange-traded fund for dry-bulk shipping. “You will have shipowners instructing their captains to slow down, and if everybody does, global supply will come down significantly.”

Forward Freight

Over the past year, derivatives to bet on, or hedge, shipping rates in 2020 surged by 44 percent for giant Capesize ships that haul hundreds of thousands of tons of iron ore and coal, according to data from the Baltic Exchange Ltd. in London. The 2020 contracts, called forward freight agreements, were near $19,000 a day on Thursday, close to the highest since that specific contract began trading. Across every class of commodity shipping, FFAs for 2020 are trading much higher than they were a year ago.

The fleet slowdown is being anticipated because of rules mandated by the International Maritime Organization in October 2016 that vessels cap sulfur levels in their fuel from 2020. Doing so should help to fight human health issues such as asthma, as well as acid rain. As the deadline approaches, the decision is starting to ripple through the global trading system, creating winners and losers in both the refining and shipping industries.

Slow-Steaming

The rule is expected to make IMO-compliant fuel more expensive, which shipping companies are trying to offset.

Reducing speeds, or slow-steaming, “will be part of the arsenal of options that we as shipowners will have available to us,” said Brian Gallagher, head of investor relations at Euronav NV. “It will be very dependent on what the costs are and what the environment is when we get to 2020.”

Svein Moxnes Harfjeld, the joint chief executive officer of DHT Holdings Inc., said speed cuts “will be positive for the market” in the event that rates are weak, because fleet capacity would effectively drop.

Analysts from Goldman Sachs Group Inc. to Wood Mackenzie have predicted that the rule change will create an additional $40 billion to $60 billion in costs for shipping companies, which the industry will pass along to its customers. That could affect trade in everything from commodities like oil, soybeans and steel to items that move on container ships, like TVs, furniture and clothes.

Pass It On

“We see that as a critical issue, the ability of operators to pass on this extra cost,” said Peter Sand, chief shipping analyst at BIMCO, a Denmark-based industry group that represents shipowners. “The shipping industry does not have a financial war chest to cover an escalating cost like that.”

Shipowners have limited ways to comply with the rule change. They can buy IMO-compliant fuels, though it’s not clear there will be enough to go around. They can install pollution-reducing scrubbers but the cost of those upgrades has deterred investment. A third option is to simply slow down, since owners can cut fuel consumption disproportionately by sailing their fleets more slowly.

“For tankers, the majority of the fleet will show up in 2020 without scrubbers,” Harfjeld said. “That fleet will have to consume compliant fuel. This fuel is expected to be quite expensive. This part of the fleet might consider slow speed to save cost on fuel.”

Fuel Savings

While rising earnings will always tempt some owners to speed up, the need to cope with complex and shifting fuel economics will work in their favor as not all vessels will accelerate at a uniform rate, says Eirik Haavaldsen, head of research at Oslo-based Pareto Securities AS, which focuses on the energy and shipping industries.

Higher fuel costs will, in particular, encourage owners to sail slower when they don’t have cargoes on board, said Kartsonas of Breakwave. In addition, while more modern carriers might be able to accelerate when rates rise, the economics for older vessels to do so may still not work, he said.

Slow steaming is the most likely way for shippers to respond to high fuel costs, analysts at RBC Capital Markets LLC including Brad Heffern said in a July 11 research note.

“Fuel consumption has a non-linear relationship with speed, so any given reduction in speed leads to a greater reduction in fuel consumption,” the analysts wrote.

Slowing by just 1 knot, or 1.2 miles per hour, could allow oil tankers to save as much as 17 percent on its fuel consumption, analysts at Citigroup said in a June report. Bulk carriers — those carrying cargoes like iron ore, coal and crops — and container vessels could save as much as 37 percent by slowing by 1.5 knots.

Higher Rates

“Rates benefit from slow-steaming because the existing fleet is essentially being spread out further by completing fewer round trip voyages,” said Jonathan Chappell, an analyst focusing on marine transportation equities at Evercore ISI.

That’s not good news for companies looking to send their commodities from continent to continent in a hurry. Not only would the voyage become more expensive, a reduction in speed could add days to a trip from, say, Europe to Asia. Fortunately for them, slow-steaming is likely to be only a temporary fix as the market adjusts to the IMO’s rules and the associated higher fuel costs.

“You may slow-steam initially, but there will always be someone who will sail a little bit faster and charter a little bit less, to get the business done,” said BIMCO’s Sand.