The risk of clean air

Impending regulation affecting shipping fuel will reduce atmospheric pollution but send shockwaves through the shipping and oil industries. Market players have several strategic options, but uncertainty clouds their choices. To what extent is the industry able to adapt, and what will be the likely cost of compliance?

Boat at sea

Time for change

In line with other contemporary research, the World Health Organization estimates that approximately 3 million deaths annually can be attributed to ambient air pollution. With the aim of improving air quality and reducing environmental impacts (including the acidification of rain and oceans), the International Maritime Organization (IMO) developed the International Convention for the Prevention of Pollution from Ships (or ‘MARPOL’, short for Maritime Pollution), which included an annex dedicated to reducing the atmospheric pollution from ships. This annex came into force in 2005, and includes a set of deadlines by which the maximum sulfur content of shipping fuel must be reduced. We are now rapidly approaching the next deadline.

On 1 January 2020, the maximum permitted sulfur content in maritime fuel will fall from 3.5% to 0.5% - a reduction of more than 80%. As a result, shipping firms will no longer be able to use the same relatively cheap high-sulfur fuel oil (HSFO) they have used for more than seven years. The shipping sector is by some way the main user of HSFO – which is often used as a sink for high-sulfur post-refining products, which have limited applications elsewhere due either to regulations or the physical characteristics of the fuel.*

The resulting shift to alternative fuel products represents a strong regulatory risk for shipping firms, and comes alongside indirect effects on linked industries – in particular the oil refinery sector. The regulatory change is likely to have knock-on effects for the entire oil industry (in particular increased volatility) that may take years to stabilize. Shipping companies must plan for the future or risk fines and sanctions from regulators.

Navigating change

Though complying will be a challenge, shipping companies have several options for doing so (see Figure 1).

Figure 1: Shipping firms’ options in complying with IMO 2020


Figure 1: Shipping firms’ options in complying with IMO 2020

Source: Chartis Research

Some of these options are clearly more appealing than others, though to what extent depends largely on a firm’s exact situation. In the short term, either LSFO or MGO will be popular choices, giving firms a low-cost way to wait out much of the uncertainty before choosing a longer-term strategy when the market and regulatory dynamics are clearer. Converting existing carriers to LNG is very expensive, as the fuel has unique storage and usage characteristics. LNG is far more promising for new builds, supported by the growing infrastructure around use of the fuel. As with LNG conversion, installing scrubbers to reduce sulfur emissions from HSFO to compliant levels requires a high initial cost relative to using LSFO or MGO. Scrubbers’ ability to allow firms to use low-cost HSFO makes them a tempting and potentially strong choice for many companies, although some will be dissuaded by the possibility of later regulatory action. Several individual ports have already placed restrictions on wastewater discharge from scrubbers, as has China’s Maritime Authority (although so far no restrictions have been placed on international shipping).

Facing the consequences

The cost of compliance

The necessary changes instigated by the IMO will ultimately help to improve human health and reduce loss of life. But for a broad range of market participants across several markets, the regulatory risk they impose is a cause for concern. Regardless of the options that firms choose to employ, the regulation will have far-reaching consequences.

  • Shipping firms. The cost of compliance is likely to be universally high, regardless of strategy – after all, firms currently use HSFO because it’s cheap. The alternatives are more expensive, and price effects on crude, HSFO, LSFO and diesel equivalents like MGO are far from certain at this point, and will likely take years to stabilize. Depending on uptake, there are concerns around the availability and supply of LSFO, MGO and LNG, as current infrastructure and refinery capabilities may not be able to satisfy a sharp rise in demand, although the extent of this won’t be known until after the deadline. With this in mind, many shipping firms are hesitant to invest in appropriate hardware until the situation is clearer.
  • Refineries. Refinery economics will be strongly affected: in all situations there will be a sharp decline in demand for HSFO, alongside growth in demand for other products. Simple refineries have fewer options available to them in terms of altering product ratios, and are therefore more at risk. They are more likely to face pressure to adopt newer technologies that enable them to process crude into more in-demand products. More complex refineries that already have a flexible product balance are better placed, and are more able to adapt to changing demand as it occurs.**
  • Terrestrial transport and aviation. The similarity between MGO, diesel and kerosene (all classified as ‘middle distillates’: they have similarly sized molecules, and are produced using similar processes) means that MGO production and diesel and kerosene production are in direct competition. Increased production of MGO will cause diesel and kerosene to appreciate in value, to the detriment of those that use them.


Further uncertainty originates from the regulators themselves. The IMO regulation is enforced by countries’ individual regulatory bodies, and how they do this will affect firms’ optimal strategies for compliance. In the short term, some firms may decide that it is most economical for them to simply accept the fines for non-compliance (depending on how fines are enforced in different regions) and continue to use the cheaper HSFO. In the long term, however, this is unlikely to be viable, and could create reputational damage – after all, the aim of the regulation is to improve human health.

Perhaps more concerning is the possibility that national regulators may not enforce the regulation at all – Indonesia’s Ministry of Transportation said as much in July this year, before finally stating that it intended to fully enforce compliance weeks later in August. (It had planned not to enforce the sulfur cap for Indonesian-flagged domestic shipping vessels – international vessels were always intended to comply – until lower-cost fuel alternatives became available.) The IMO has stated that consistent compliance is vital, and announcements like that in Indonesia (although it was subsequently retracted) set a troubling precedent, and could undermine the work that has already been done to reduce sulfur emissions.

Ultimately, the changes that IMO 2020 will introduce are directed at a market not known for its fast reactions, and whatever choices are made, the deadline marks the start of a period of heightened uncertainty. Though the situation will likely stabilize in a few years, for those affected that period could seem like a long time.

At Chartis we pay close attention to the issues and challenges faced by institutions over their compliance. Typically, we focus our efforts on financial regulation. However, the team covers a broad spectrum of risk – including that associated with energy and commodities. In the coming months, Chartis will publish a series of industry reports analyzing different aspects of the energy and energy trading markets. For more information, contact us at

*Though they have some marginal use for power generation. HSFO and other heavy fuel oils require heating during storage and before combustion (to reduce their viscosity), and this complicates their use in other processes that regulation otherwise permits. For power generation coal is normally considered a more viable product.

**More complex refineries involve more secondary stages after initial fractionation.

Further reading


Points of View are short articles in which members of the Chartis team express their opinions on relevant topics in the risk technology marketplace. Chartis is a trading name of Infopro Digital Services Limited, whose branded publications consist of the opinions of its research analysts and should not be construed as advice.

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