Analysts expect a diesel price spike — and it could affect the cost of almost anything

10/31/2018

A looming global deadline for the shipping industry could drive up the price of diesel for years, with widespread ripple effects through the economy, energy analysts are warning.

In 2016 the United Nations shipping agency, the International Maritime Organization (IMO), finalized rules that would reduce water pollution starting in 2020. By Jan. 1 of that year, it was agreed, the shipping industry would have to decrease the sulphur content in marine fuel for large vessels to 0.5 per cent from 3.5, an 86 per cent reduction.

Oil refiners around the world, though, won’t be equipped to produce enough low-sulphur fuel by 2020, so many ships will likely resort to using diesel instead — at least in the short term.

“It will be a difficult transition. It will cause consumer prices to go up,” said Richard Joswick, an analyst with S&P Global Platts in New York.

It’s hard to tell how much diesel prices might rise but the increase will likely be significant, he added.

“It’s not 10 cents a gallon, but it’s not $1 a gallon — it’s someplace in the middle of that range.”

It won’t be just motorists who feel the pinch. Because much of the transport industry uses diesel fuel, the price spike is expected to reverberate throughout a variety of sectors — from retail to the food industry — potentially driving up prices for a number of consumer products.

“If left unchecked, rising diesel prices will act as a tax on economic growth,” a recent CIBC report warns.

Other low-sulfur distillates, like heating oil and jet fuel, will also see a jump in prices, Joswick said.

Fuel accounts for 25 per cent of airlines’ costs, according to a report by Macquarie Research. It’s not clear to what extent that increase would result in pricier airline tickets. But airlines are already under pressure from soaring fuel prices, which have risen over 30 per cent compared to a year ago. Both Air Canada and WestJet have recently raised fare prices and at least considered cutting flights amid rising costs.

The price increases will likely start in the second half of 2019, and reach a peak in the spring of 2020, before gradually dissipating in the span of two years, Joswick predicted.

Higher demand for light crude oil from shippers could also drive up the price of gasoline, although likely with a six-month lag compared to diesel prices, he added.

Over time, the global refining system is expected to retool itself to be able to produce more low-sulfur marine fuel. Ships are also installing sulfur-removing scrubbers that would allow them to meet IMO limits even while using regular fuel.

The refinery industry will need around five years for the turnaround, although some of that is already underway, Joswick said. New low-sulfur refinery capacity will likely start to come online in the second of half of 2020.

Cruise lines have already installed scrubbers, and around 2,500 cargo ships are expected to have the necessary equipment by the deadline, according to the Canadian Fuels Association. That, though, is still a small number compared to the over 85,000 ocean-going ships around the globe.

This short-term price pain was likely an unavoidable step in the road toward cleaner shipping fuel, Joswick said. And, he added, “most of the world is on board with this.”

Although there will be “some cheating,” global shipping companies will comply with the new rules, he added.

And the industry will move ahead with the changes, despite the reservations about the rule expressed by the Trump administration, according to Joswick.

The White House had sought a phase-in of the new rules, which will drive up prices during a presidential election year in the U.S.

However, IMO pushed back against the proposal last week, vowing to stick to the original timetable for implementation.

Ships found in breach of the new rules will face fines or the risk of impoundment by IMO member states.

The U.S. is too small a player in the global shipping sector to be able to play by its own rules, Joswick said.

However, the administration could use its Strategic Petroleum Reserve to ease the low-sulphur fuel shortage, he added.

“That could help.”

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