Brent-WTI Diff Should Widen Earlier As Shanghai Port Leads With A 15-Mth Earlier Adoption Of IMO 2020 Lower Sulphur Limits

There was big news on Friday with the Bloomberg terminal story “Shanghai Port to Start Tighter Marine-Fuel Sulfur Cap on Oct. 1”.  Shanghai has surprised by being an early adopter of the lower sulphur 0.5% limits 15 months ahead of the IMO 2020 formal start date of Jan 1, 2020.  With China’s continued push on pollution, we have to believe other Chinese ports will follow Shanghai’s lead as early adopters.  Shanghai is #1 for the most port container volume in the world, and Chinese ports, in total, represent approx. 1/3 of total global container volume.  The IMO 2020 lower sulphur limits are leading to heavy oil being hit in 2019 ahead of the Jan 1, 2020 start date.  But we expect that if others in China follow Shanghai’s earlier adoption, it will bring forward (earlier) the negative IMO 2020 impact to widen heavy oil differentials.  And an earlier widening of the heavy oil differential should lead to Brent winning more than WTI as the Permian oil takeaway constraints as not expected to be fixed until H2/19.

Shanghai port moves to an early adoption of 0.5% sulphur content 15 months earlier than IMO 2020 start on Jan 1, 2020.  There was a short, but very significant, early Friday morning (04:38 GMT, 12:38 AM EDT) Bloomberg story that was overlooked by the market.  The Bloomberg story “Shanghai Port to Start Tighter Marine-Fuel Sulfur Cap on Oct. 1” said ”All ships entering, anchoring and operating within Shanghai port are required to use bunker fuel oil with 0.5% or lower sulfur content from Oct. 1, according to Shanghai Maritime Safety Administration.”  The story has significant implications to global light and heavy oil differentials as the Shanghai Port (the #1 most active port for container ship volume) is moving 15 months early to meet IMO 2020 standards that require all vessels comply with the max 0.5% sulfur content.  Shanghai is adopting this standard effective Oct 1, 2018 and not the IMO 2020 start date of Jan 1, 2020.

Given China’s push to fight pollution, we have to believe other Chinese ports will be following Shanghai’s lead in moving to lower sulfur levels.  China continues to surprise most outsiders by its urgency and seriousness in dealing with pollution.  Other major Chinese ports are placing a priority in fighting pollution in the seas and we expect Shanghai will not be alone in being the only Chinese port to be an earlier adopter of the lower rules, sometime prior to the Jan 1, 2020 official start. The media reports may not specify the lower sulphur limits but we would think that would be consistent with the fight on sea pollution.  A good example is the port city of Tianjin, which ranks #10 in the global ranking ports by container volume.  This week, Xinhua reported [LINK] that the Chinese port city of “Tianjin fights pollution in Bohai sea” as part of its 3-yr 2018-2020 plan.  Xinhua did not provide details on the plan so it isn’t clear if Tianjin is or plans to move early on the lower sulphur. We haven’t seen it yet, but we won’t be surprised to see other ports around the world look for earlier adoption ahead of the IMO 2020 formal start date of Jan 1, 2020.

Chinese ports represent ~1/3 of total global container volume.  The reason why we see the potential to bring forward the IMO 2020 impact on global light and heavy oil prices is that Chinese ports probably represent about 1/3 of total world container volumes.  The International Association of Ports and Harbours data [LINK] shows that for the 8 yr period ending 2014, the top 20 ports in the world were typically ~50% of total world container port volumes every year.  We built the below table of the top 20 ports from the World Shipping Council’s Top 50 list [LINK].  It shows 10 Chinese ports (including Hong Kong) in the top 20, and these 10 Chinese ports are ~56% of the top 20 volume, ie. ~28% of total world container port volumes.  We looked at the next 30 ports and we think it is reasonable to assume that Chinese ports, in total, represent ~1/3 of total world container port volumes.

Top World Container Ports By Volume

container-ports-by-volume

 

 

 

 

 

 

 

 

 

 

 

Source: World Shipping Council

Earlier adoption of lower sulphur limits will bring earlier pressure on heavy oil diffs and Brent should win more as Permian is still short takeaway until H2/19.  More earlier adoption of lower sulphur limits will bring earlier pressure on heavy oil differentials.  We aren’t reviewing the IMO 2020 impact on heavy oil differentials because it is a well discussed and strong consensus view among markets, investors, and analysts.  We share that consensus view that heavy oil diffs will be hit by the implementation of IMO 2020, and that the wider diffs are being increasingly reflected in 2019 futures ahead of the Jan 1, 2020 start date for the lower sulphur limits.  But the move to an even earlier (ie, 15 months early) adoption of the lower sulphur limits by Chinese ports or others will only move forward the pressure on heavy oil diffs.  The other well discussed and strong consensus view is that Permian oil is takeaway constrained until H2/19.  As a result, if there is an earlier pressure on heavy oil, the light oil stream that stands to benefit the most will be Brent as opposed to WTI ie. more pressure for a widening Brent less WTI differential.

China’s urgency and seriousness in fighting pollution should not be ignored.   We don’t believe people should underestimate China’s resolve in moving on pollution issues.  Rather, Shanghai’s decision to be an earlier adopter of the lower sulphur limits should not surprise anyone.  Many (most?) still are skeptical whenever China is discussed as a leader in the fight against pollution.  That may have been right two years ago, but that isn’t the case in the last year.   We first noted this a year ago, when we wrote our Sept 20, 2017 blog “China’s Plan To Increase Natural Gas To 10% Of Its Energy Mix Is A Global Game Changer Including For BC LNG[LINK], wherein we wrote “The news flow from China this summer on its increasing fight and urgency to fight pollution supports China’s plan to increase natural gas to 10% of its energy mix in 2020 and 15% of its energy mix in 2030.  This is a game changer to global natural gas markets and, by itself, can bring LNG to undersupply 2 to 3 years earlier than expected”.  China is serious about fighting pollution and is taking clear action in this fight.  Shanghai being a leader and moving to be an early adopter for the IMO 2020 lower sulphur limits is a perfect example.  And if, as we expect, other Chinese ports move to an earlier adoption of the lower sulphur limits, it will move forward (earlier) the already anticipated negative impact on heavy oil and positive for light oil.