Mind the sulphur gap

WWL’s global head of environment, Roger Strevens (left) warns that shipping lines and cargo owners risk falling into a trap if they fail to look over the horizon when adjusting fuel costs, as well as if they ignore proper enforcement of new sulphur emission control zones

Of all the scenarios that were imagined for when the new sulphur emission control area (SECA) limits took effect on January 1st, few foresaw that the low-sulphur marine gas oil (MGO) that satisfies the regulations would be available at the higher sulphur HFO prices (heavy fuel oil). However, that’s exactly what has come to pass. Of course, the recent shift in global oil prices was not precipitated by the then forthcoming SECA limit change, but it has prompted many involved in the shipping sector to conclude that, in effect, the cost of the sulphur regulations won’t be felt. Such conclusions betray a lack of understanding of how the industry deals with fuel price fluctuations.

Shipping is an industry that must operate with an eye to the far distant horizon. The vessels that are being designed and built today will be in operation till nearly 2050. Since it is impossible to accurately predict how fuel prices will develop over such a long interval, the industry has developed mechanisms to cope with fuel price fluctuations. This is particularly the case with longer-term shipping contracts of a year or more in duration.

To illustrate the need for price fluctuation mechanisms, consider a vessel now reaching the end of its service life. When it came into service in the early 1980s, the price of HFO was a few tens of dollars per tonne. In the course of its working life HFO has peaked at more than $700 per tonne. The proportion of the total cost base for operating a vessel represented by that range goes from a few per cent to over 60%. Shipping is a highly competitive industry; it doesn’t enjoy the margins to absorb such price swings.

To cope with such HFO price variability, contracts may include bunker clauses that modify the rate payable according to a recognised HFO price index. The clause may not provide full insulation against price volatility, but it should even out the extremes. However, it is important to note that bunker clauses are based on an HFO price index since that has been the most cost effective, compliant fuel in recent decades. However, this mechanism has been upset by the SECA limit change.

Most vessels switch from HFO to MGO to achieve compliance with the new 0.1% sulphur limits that are now in effect for most of northern Europe and the coasts of the US and Canada. Making the switch from HFO to MGO presents operational and technical challenges, but also commercial ones since MGO has for years been 50-75% more expensive than HFO. An HFO-based bunker clause would not take account of the price differential between HFO and MGO. In short, as a shipping company, it is important to ‘mind the gap’ between the two. This can be done by implementing a clause relating to sulphur regulation cost in commercial contracts. Again, it may not provide full coverage, but it could be the difference between staying afloat and going under.

Allies in enforcement

The significant price differential between HFO and MGO puts another matter in stark contrast, namely the need for effective enforcement. When compliance is costly, the role of enforcement in maintaining a level playing field really comes to the fore.  While most shipping lines and their customers are committed to compliance, when it is reaches the unprecedented cost of sulphur regulation, and enforcement is poor, there can be temptations to cut corners. That represents an unacceptable threat to competition for those playing fair.

The Trident Alliance is a shipping industry group established last July to draw attention to the need for robust and effective enforcement, which, particularly in the European SECA, has been weak.

Fortunately, enforcement is now a topic in the spotlight and perhaps that is partly the reason why officials have redoubled enforcement efforts of late. So far, the focus has been on compliance testing in ports, which, although welcome, is only the ‘low-hanging fruit’ of the enforcement tree. What remains are, literally, the difficult to reach parts: open waters, especially international waters.  

Enforcement in these areas is what the Trident Alliance is seeking to draw attention to. It’s a step to answering questions that include: who will test for compliance in international waters? How should compliance testing be done? Finally, will those with the jurisdiction to sanction those in violation actually do so in a meaningful manner? Specific to the last point, there are limits on resources and potential conflicts of business interests that suggest the current policing may exist more in theory than in practice.

Although compliance rates may be acceptable within the SECAs now, it is critically important to get an effective mechanism for high seas enforcement in place before the 0.5% sulphur global cap becomes a reality. Unless this issue is addressed now, the words of Benjamin Franklin may become uncomfortably familiar: by failing to prepare, you are preparing to fail.  
Let’s not allow that to happen, rather let us show that on the environment, we mean business!