New Marine Fuel May Spoil Frontline's IMO 2020 Strategy

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About: Frontline Ltd. (FRO), Includes: EURN, GNOLF
by: Robert Boslego
Summary

Frontline is betting on oil market price spreads.

It acquired scrubber-equipped ships.

It formed a JV with a trading firm to supply marine fuel.

In the hopes that low sulfur fuel will command a high premium to high sulfur fuel.

But now a new low sulfur bunker fuel is being produced and the spread to high sulfur may be small.

Source: International Maritime Organization.

From 1 January 2020, the International Maritime Organization will limit the sulfur in fuel oil used on board ships operating outside designated emission control areas to 0.50% m/m (mass by mass), from 3.50% m/m. Of total global air emissions, shipping accounts for 9 percent of the sulfur oxides.

A Frontline crude oil tanker. Photo: Flikr/Kees Tom.

Frontline Ltd. (“Frontline”) (NYSE:FRO) is a world leader in the international seaborne transportation of crude oil. Hemen Holding Limited (“Hemen”) is a major owner of FRO stock and is a company indirectly controlled by trusts established by John Fredriksen, the world’s most famous living shipping magnate.

According to Deutsche Bank transportation Amit Mehrotr, Frontline is “levering up ahead of the IMO [2020] catalyst.” First, FRO announced an acquisition of a fleet of Suezmax tankers from Trafigura, the international trading company. Details of the acquisition overview appear in the press release. An article about the acquisition can be found on this link. The acquisition increases its exposure to spot market rates in both the tanker and dry bulk sectors.

Second, all 10 Suezmax tankers FRO is acquiring are equipped with scrubbers and the four it has options to acquire also have scrubbers. In addition, FRO is retrofitting a significant number of the other ships it owns with scrubbers.

When IMO 2020 goes into effect, ships will have to either utilize a lower sulfur fuel or install scrubbers to continue using the higher sulfur fuel. Scrubbers allow ships to continue to purchase the lower cost, higher sulfur fuel, but come at an upfront cost, as well as reduce potential cargo sizes and increase fuel costs per mile. There's also a cost associated with their use. And so the issue becomes whether the discount of the lower cost, higher sulfur fuel will justify installing the scrubbers.

Third, Frontline announced a joint venture (“JV”) with Trafigura, the global trading firm, and Golden Ocean (“GOGL”), another Fredriksen company, to establish a global supplier of marine fuels. The JV will supply fuel to FRO and GOGL as well as third parties.

According to Robert Hvide Macleod, CEO of Frontline Management AS and Birgitte Ringstad Vartdal, CEO of Golden Ocean Management AS:

It is anticipated that IMO 2020 will create logistical marine fuel supply issues for shipowners globally. In addition to presenting a compelling economic opportunity, our participation in the JV will ensure our ability to source and acquire marine fuels at competitive prices on a continuous basis. This transaction represents yet another instance where we have been able to leverage our relationship with other entities of Hemen Holding Ltd to create significant economies of scale and a real competitive advantage. We look forward to working with Trafigura, our JV partner, to create one of the world’s leading suppliers of marine fuels.”

High v. Low Sulfur Spread

The spread between high sulfur fuel oil (HSFO) and very low sulfur fuel oil (VLSFO) has narrowed from $400 /mt to $200 /mt over the past year. Furthermore, marine gasoil (MGO), a diesel fuel used on ships, was originally believed to be the fuel ships without scrubbers would use. However, the refining industry has created supply of the VLSFO, a new fuel which is similar to the HSFO that ship engines were designed to use. Therefore, there is almost no cost of conversion.

Genoil Inc. (OTCPK:GNOLF), the publicly-traded clean technology engineering company for the energy industry, recognized ship owners and cargo owners face a dilemma:

Switch to distillates or potentially costly blended marine diesel oil (MDO), pay for an onboard scrubber unit at the cost of millions of up front dollars in capital expenditure, or invest in LNG, where the global infrastructure and standards for bunkering are currently very embryonic.”

And so, it developed a fourth way to comply,

Enabling the conversion of Heavy Sulphur Fuel Oil (HSFO) and crudes into more valuable low sulphur fuel that will be compliant with new International Maritime Organization (IMO) Annex VI Sulphur rules from 2020.”

Genoil’s Hydroconversion Upgrader (GHU®):

Its $48.00 charge per ton, including fixed investments, overhead, operating costs, and profit to the shipping industry, on a per ton basis amounts to about the operating costs of scrubbers, so that it is drastically cheaper for the shipping industry compliance."

Regarding the option to install scrubbers to use high sulfur fuel, Euronav (EURN) chief executive officer Hugo de Stoop recently said on a conference call:

We don’t want to do a speculative investment. If it turns out that the spread is narrow and the curves show it will be narrow for a long time, it’s probably not necessary to do any scrubber retrofits.”

The global shipping industry previously had doubts about switching to the cheaper VLSFO. “It’s being tested left, right and center. Most of the fuels available are stable, fit for use, and in general of good quality,” Lars Malmbratt, General Manager for Bunker Procurement at Swedish shipping company Stena Bulk said.

“The closer we get to 2020, the more it seems there will be more low sulfur fuel oil than people previously thought,” Matt Stanley, an oil broker at StarFuels in Dubai said.

Conclusions

If Genoil can reduce the cost to desulfurize bunker fuel to $48.00 per ton, it follows that the refiners can match that cost as well. Therefore, the high v. low sulfur spread should eventually drop to about $50/ton, making the use of scrubbers uneconomic. The FRO strategy appears to be highly speculative and one that may fail once the market transitions in the 4Q19.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.