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Commentary by Antoine Halff • January 15, 2019
If any opponents of the International Maritime Organization’s (IMO) new sulfur standards for marine fuels were counting on the U.S. Energy Information Administration (EIA) to give them ammunition against the rules, they are in for a disappointment.
Senior Trump Administration officials have reportedly grown increasingly worried about a potential oil price rally during the 2020 election year when the new IMO rules come into effect. Several oil analysts have been forecasting that the sky would fall when that happens: namely, that increased demand for both distillate fuel oil and distillate-rich low sulfur crude oil, as a result of the IMO’s cap on sulfur emissions from ships, would cause an epic oil rally. A first attempt by Washington to get the IMO to delay or phase-in the rules was defeated in October 2018, at the most recent meeting of the relevant IMO committee, but the U.S. government is expected to try again.
The EIA, an independent arm of the U.S. Department of Energy, could have gone some way towards empowering such an effort if its monthly Short-Term Energy Outlook (STEO), released today, had predicted a huge price spike due to the IMO 2020 rules. The January STEO is the first one to include a 2020 price forecast, and as such, had been awaited with a great deal of anticipation. While the report does anticipate a bump in both diesel retail prices and diesel refining margins from the IMO 2020 effect, that increase is more than offset by downward pressures that are expected to result from other factors, notably continued U.S. shale oil production growth.
At $3.13 per gallon, U.S. retail diesel prices are expected to average 5 cents less in 2020 than in 2018. While the STEO forecasts diesel margins (the difference between the wholesale price of diesel and the price of Brent crude oil) to rise by 5 cents per gallon in 2019 and 17 cents in 2020, this will be more than offset by an underlying drop in crude oil prices. The EIA reckons that the wholesale diesel margin — which the IMO 2020 effect will presumably push up — only accounts for about a sixth of the U.S. retail price of diesel, compared to nearly half for the underlying crude price. This means that changes in the price of crude have a much bigger effect on diesel prices at the pump than even a significant expansion of the wholesale diesel margin. The price increase of Brent pushed up retail diesel prices by an average of 40 cents per gallon in 2018, about twice as much as the IMO sulfur cap would boost diesel margins in 2020 in the EIA’s estimate.
The STEO thus achieves an astounding political balancing act: while acknowledging upward price pressures from the IMO rules, it simultaneously diffuses the political charge of this increase by placing it against the broader context of a well-supplied oil market where global stocks of crude oil and liquid fuels are projected to keep building at a 240,000 barrels per day this year and by another 430,000 barrels per day in 2020, extending gains of 410,000 barrels per day in 2018. Sure, the STEO effectively says, there will be a price to pay for the health benefit of cleaner air emissions from ships. But this price is going to be dwarfed by the benefits of higher shale oil supply and other crude production growth globally. Even after accounting for the new marine regulations, consumers will pay less at the pump than they did last year. The price impact on other products will be even more muted. Gasoline prices are projected to average $2.62 per gallon in 2020, up 15 cents on the year but down 11 cents from $2.73 in 2018.
To be sure, forecasting the price effect of the IMO rules is an extraordinarily complex task. There is still a great deal of uncertainty about the shipping industry’s response to the rules and the way in which it will seek to comply, including but not limited to, the use of scrubbers to remove emissions from high-sulfur fuel. The broader outlook for distillate oil demand is equally fuzzy, if not more so. The IMO’s price impact on diesel will depend not only on the trajectory of marine transportation demand for diesel-like products, but also on the path of diesel demand from other sectors of the economy, including trucking demand in China, the U.S. and around the world, passenger vehicle demand in Europe and elsewhere, power generation demand in emerging economy where diesel-fired back-up generators make up for the shortfalls of the grid, etc. Equally important, the IMO price impact will also depend on the refining industry’s ability to raise its low-sulfur fuel output and yields, another area of uncertainty. And oil demand, in general, will likely be at least in part a function of underlying economic growth, which many observers increasingly expect to slow down if not swing into reverse by 2020.
For all the impressive talent and expertise of its analysts, the EIA does not have a crystal ball. The latest STEO does assume a “small decline” in the rate of GDP growth from 2018, offset by lower oil prices in 2019 and 2020 compared with 2018, “along with increases in petrochemical demand” and slightly higher demand for marine fuels due to the switch for high-density high-sulfur fuels to lower-density, lower-sulfur products. The STEO does not elaborate on the global refining industry’s ability to ramp up its supply of low-sulfur products at the expense of high-sulfur ones. This should not come as a surprise, given the EIA’s capacity to effectively model the global refining industry. STEO models do not capture non-U.S. refining activity at all. For the purpose of projecting the IMO effect, the STEO had to rely on the models used for generating another EIA report, the Annual Energy Outlook (AEO), of which the 2019 edition is due out next week. Those models treat the entire refining industry outside of the U.S. as a single plant.
That is to say that no one will probably expect the STEO, or the forthcoming AEO, to close the debate on the IMO price effect. Its analysis of the impact of the new rules on diesel prices remains, on the face of it, relatively cursory and high-level. It certainly doesn’t check all the boxes. It will not reassure those who worry about the price impact of the new marine rules. It may not stop the debate about the IMO rules from rising in prominence in the next few months.
Much work on the IMO impact remains to be done. The Center on Global Energy Policy at Columbia University, among others, is taking a close look at this issue and plans to build on the research that has already been developed on this topic. But the STEO’s reasonable and, on the face of it, balanced approach to this thorny issue at least ensures that it will not encourage hasty conclusions one way or the other. It might not give IMO opponents any ammunition. Given the enormous complexity of the issue and the constraints under which the EIA operates, this is as good an outcome as could have been expected from this important report.
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Commentary by Antoine Halff • January 15, 2019