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Paradigm shift coming for oil industry

Pollution controls on shipping to lower price of oil, increase price of diesel
The Parkland Fuels refinery in Burnaby will not be affected by increased demand for diesel, but large complex refineries will. | BIV Archives

New International Maritime Organization (IMO) caps on pollution from international shipping will likely have an impact on the price of many consumer goods, but the biggest impact for Canada will be on oil.

The industry can expect a couple of years of disruption and uncertainty, as the refining industry scrambles to meet new demands for diesel and shifts its sourcing and production.

Generally, the changes will be good for complex heavy oil refiners in the U.S. that can increase production of diesel, but bad for some oil producers as well as domestic diesel consumers, like the trucking industry.

“Everyone’s going to face additional costs, except refiners,” said Allan Fogwill, president of the Canadian Energy Research Institute (CERI).

It’s estimated that 60% to 70% of shippers will switch from the cheaper bunker fuel to marine gas oil, which is a lower-sulphur distillate similar to diesel.

IHS Markit predicts the demand for diesel will increase by 1.2 million barrels per day in 2020 over 2018.

Refiners that can increase diesel production will profit, while Alberta oil producers may see the existing discount for Alberta crude widen, according to a recent CERI study.

The Parkland Fuel Corp. (TSX:PKI) refinery in Burnaby is not likely to be affected by the change, since it’s a light sweet crude refinery that doesn’t process marine bunker fuel.

“This whole situation is a major change for the industry but not that big a deal for us,” said Dave Schick, Parkland’s director of policy and external relations.

A normal average discount on Western Canadian Select is $13 per barrel compared with West Texas Intermediate. That discount is a function of both quality and transportation costs.

CERI estimates the discount could widen to as much as $31 to $33 per barrel. That’s because refineries that produce bottom-of-the-barrel bunker fuel will suddenly see profits fall, and may pass that loss on to oil producers.

“We’ve made the assumption, which some people can challenge, that the refineries will pass back the full amount of that margin loss to producers,” Fogwill said.

That discount could be offset, however, by an increasing demand for Canadian heavy crudes by complex refiners, especially on the U.S. Gulf Coast, which could increase diesel production.

But as long as there are pipeline constraints, Canadian producers may not be able to capitalize on the demand.

“If the barrels can make it to the Gulf Coast markets, or they can make it to PADD 2 [U.S. Midwest] markets, there are many refiners that can use and destroy this high-sulphur crude oil,” said Sandeep Sayal, vice-president of oil markets and downstream for IHS Markit.

“They would welcome this kind of material. But the question is: Is there take-away capacity to bring the crude oil to these markets?”

High-sulphur bunker fuel currently accounts for about 70% of the fuel used in international shipping. According to the International Energy Agency, bulk wholesale prices for diesel could increase by up to 30% as ship operators scramble for supplies of cleaner marine fuels to meet the new IMO regulations.

“Refiners are in a good situation because they’ll be able to increase their margins for their low-sulphur distillates,” Fogwill said. “It’s their customers that are going to face additional costs.”

There’s some question as to whether an increase in diesel production will have a negative or positive impact on gasoline prices. Some refiners may be able to increase diesel production at the expense of gasoline.

But refineries typically produce not just one type of petroleum product but several: gasoline, middle distillates (diesel and jet fuel) and the bottom-of-the barrel fuel oil and bunker fuels.

A refinery that increases diesel production will also produce more of those other products, so there may actually be more gasoline being produced as a result of increased diesel production.

While the impacts of the IMO regulations on the oil industry could be significant, they are expected to be temporary. It’s a shift in demand, not a decline.

“We think the impact of the IMO is going to be a transitory measure,” said Kevin Birn, oil analyst for IHS Markit. “We do think it will incent refiners to make the investments to process more heavy oil.

“High-sulphur crude oil will fall through that period, and that’s going to incent refiners to make investments to pick up that price difference. That will help pull in the demand, and the price will come back over time.

“We think there could be a large price impact on the sour side of the heavy game, and that will affect Western Canadian heavy crude oil, because it is a heavy sour crude oil, but we think it’s going to be a transitory measure.”

LNG playing minor role in shipping sector’s fuel switch

One of the options for the shipping industry as it scrambles to meet new sulphur emission caps is to switch to cleaner fuels like methanol and liquefied natural gas (LNG).

That could provide new opportunities for B.C., which has abundant natural gas, a developing LNG industry and a major port.

FortisBC would like to see B.C. develop an LNG bunkering capacity – a move that has the support of the provincial government, which has been working with the Port of Vancouver and industry to develop LNG bunkering.

That would give the Port of Vancouver an edge, since there aren’t many ports in the world that currently have LNG bunkering.

Some cruise and container ship companies are making the switch to LNG in order to meet new caps on sulphur emissions being implemented by the International Maritime Organization (IMO) in 2020.

But the vast majority appear to be taking a wait-and-see approach, opting to simply switch from bunker fuel to diesel, since it requires no major retrofits.

The shipping industry faces a conundrum when it comes to LNG as a fuel. For one thing, it may be cheaper to switch from bunker fuel to diesel than to invest in expensive retrofits. The current lack of LNG bunkering worldwide is also a problem.

As a consequence, the Canadian Energy Research Institute (CERI) does not expect to see a significant shift to LNG in the international shipping sector, at least in the near term. A recently published study by CERI estimates that only 2% to 7% will switch to LNG.

“We don’t see a lot of the conversion going to LNG,” said CERI president Allan Fogwill. “Our estimate is, by 2025, maybe 5% of the shipping fleet will be LNG. And these will all be new.”

The other problem for the shipping industry is that in 2050 another IMO regulation goes into effect that will require the shipping industry to reduce greenhouse gas emissions by half.

Not even low-carbon LNG may be able to meet those new emission reduction targets, said Robert Lewis-Manning, president of the Chamber of Shipping of BC.

“This is where there’s a real debate in the industry,” he said. “How do you plan your fleet out to 2050 – which, in investing in capital assets, is not very far away – considering most people buy ships for 20 years and you know that LNG isn’t going to be enough to get you to those targets in 2050?

“So you see a cadre of ship owners that are going to LNG quickly, understanding that by 2050 they’re going to have to retool all these vessels, or buy new ships, for 2050 targets on a fuel that really isn’t understood yet.

“I think most people that are experienced are saying there will need to be a technological revolution to get us to those 2050 targets, and that is actually a bigger concern than the switch to compliant fuels in 2020.”

Barring a breakthrough in fusion energy, that could mean that the ocean-going vessels of the future will have to use nuclear power, hydrogen fuel cell power or zero-carbon biofuels.

See related story on impact on consumer prices.

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