Seeking Alpha

Riding The IMO 2020 Tsunami

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Includes: EURN, FRO, GOGL, SBLK, STNG
by: Shipping Equity Analysis
Shipping Equity Analysis
Shipping, long/short equity, Deep Value
Summary

IMO 2020, according to which fuel sulphur emissions will be cut from 3.5% to 0.5%, brings uncertainty and residual risks to shipping companies.

Companies' approach to IMO 2020 regulatory change varies. Knowing the strategy of the big shipping players is vital to make the “right” investment decision.

Euronav NV, Frontline Ltd., Scorpio Tankers Inc., Star Bulk Carriers Corp., and Golden Ocean Group are well-positioned to ride the IMO 2020 tsunami.

Executive Summary

In January 2020, the shipping industry will head to the brave new world of 0.5% low sulphur cap. IMO 2020 brings uncertainty to the shipping industry. The residual risks of the new regulation are:

  • Shortage of compliant fuel leading to operational disruptions
  • Compliant fuel price spikes
  • Shipyard congestion for scrubber installations

When it comes to shipping companies, the most prevalent strategies that address the IMO 2020 challenges are:

  1. Switching to compliant fuel
  2. Installing scrubbers

Still, some companies have taken additional action by building strategic partnerships with important stakeholders (Trafigura Group, Feen Marine Inc.), proactively purchasing and storing compliant fuel (ULCC Oceania) and installing scrubbers way before the IMO 2020 kicks in (Star Bulk Carriers Corp.).

From my standpoint, Euronav NV (EURN), Frontline Ltd. (FRO), Scorpio Tankers Inc. (STNG), Star Bulk Carriers Corp. (SBLK) and Golden Ocean Group Ltd. (GOGL) are well-placed to ride the IMO 2020 tsunami. Therefore, I believe that their potential valuation upside is huge.

IMO 2020

90% of global trade is seaborne, and the world fleet of some 60,000 ships is the horsepower. Those vessels use 3.5 million barrels per day as bunker fuel to transport the cargo from point A to point B. Burning this bunker fuel generates close to 90% of all sulphur emissions globally.

The International Maritime Organization (IMO) introduced a fuel regulation that will come into play on January 1, 2020. According to the new regulation, fuel sulphur emissions will be cut from 3.5% to 0.5%. IMO 2020 brings one of the most dramatic changes ever implemented. For sure, it is about to set off a tsunami in the shipping world.

IMO 2020 Residual Risks

Shortage of Compliant Fuel

The major bunker hubs are preparing to accommodate the anticipated demand for low sulphur fuel oil (LSFO). Cockett Marine Oil, a leading supplier of bunker fuels, indicates that over 100 major ports will be ready to meet the demand for compliant fuel oil. Yet, it is not the same with the smaller ports, where shortages of compliant fuel are expected from the very beginning of IMO 2020 implementation.

The seaborne transportation of wet and dry cargoes is fragmented. Dry bulk and tanker vessels call both first- and second-tier ports around the world. Thus, any fuel shortages in smaller ports will have a serious impact on voyage operations. Slow steaming and voyage detours practices may be used to deal with LSFO shortages.

Compliant Fuel Price Spikes

During Q4 2019 and Q1 2020, LSFO demand will increase. Hence, general or location-specific price spikes for compliant fuel is risk number two. After January 1, 2020, high sulphur fuel oil (HSFO) will drop in price due to the steep decrease in demand.

According to S&P Platts, many shipping companies will start using LSFO in Q4 2019. The opposite direction between LSFO and HSFO prices will lead to a fuel spread. The key characteristics of the fuel spread are size and duration.

Shipyard Congestion

Scrubber demand is the key driver of shipyard congestion. Due to the heavy workload, shipyards almost reached their breaking point. Also, some shipyards have accepted more scrubber retrofits than they can accommodate.

According to Euronav's Q3 2019 data for scrubber installations in VLCCs, the average loss of hire to install a scrubber is approximately 50 days. Adding the deviation and waiting time, the total off-hire days is higher than 50.

When some companies get a better view of the price spread between LSFO and HSFO, they may choose to install scrubbers. When, and if, the second wave of scrubber retrofits materializes, extra shipyard congestion may emerge. Companies that choose to install scrubbers in late 2020 will capitalize on the second-mover advantage. This advantage derives from the experience gained during the first installation cycle.

IMO 2020 Strategies

Switching to Compliant Fuel

Switching to compliant fuel is a popular choice. The success of this strategy depends on the following factors:

  • The availability of compliant fuel in major and secondary ports at the right time and quality.
  • The size of any compliant fuel price spikes.
  • The duration of any compliant fuel price spikes for the compliant fuel.

Signing long-term agreements with oil majors for bunkers provision is among the best strategies. Furthermore, storing compliant fuel at a competitive price is another strategy that can lead to great results. This way guarantees a seamless provision of fuel at the right time, quality and price.

Installing Scrubbers

According to Euronav’s webinar on September 5, 2019, by August 2019, 3,505 vessels are scrubber-fitted. Scrubbers remove the sulfur (SOx) and nitrogen oxides (NOx) from the exhaust gases. The options for the scrubber solution are the following:

  • Closed-loop scrubbers wash exhaust gases, and harmful substances are collected in a tank.
  • Open-loop scrubbers wash exhaust gases. The washing water, together with the harmful substances, is discharged into the sea.
  • Hybrid scrubbers which can be set for either open-loop or closed-loop operation.

The closed-loop type of scrubbers is environmentally sound. Open-loop scrubbers follow the sulphur directive. Yet, they discharge harmful substances into the sea.

Scrubber strategy ensures that the company:

  • will continue using HSFO, which is a fuel being used in the shipping industry for so many years;
  • will take advantage of the fuel spread between LSFO and HSFO; and
  • will ensure minimum operational disruptions, since HSFO is available in every port.

Other Strategies

Switching to LNG and distillates are strategies that can tackle the IMO 2020 challenge. Yet, they are not that popular among companies.

The LNG solution is largely overlooked in favor of scrubbers. Less than 50 tankers and bulkers are powered by LNG. Restrictions on the global bunkering infrastructure and the high costs of introducing LNG fuel to diesel engines are the main reasons. Still, scrubber installation is a short-term measure because of the aggressive emission caps that come into play in 2030 and 2050. Sooner or later, LNG as a fuel will become the established solution in the shipping industry.

Since MDO and MGO fuels are more expensive than HSFO and LSFO, switching to distillates has serious financial implications for the companies.

Riding the IMO 2020 Tsunami

Moving forward, we analyze the strategies of five shipping companies. The companies under consideration are listed in New York Stock Exchange (NYSE). Their market capitalization is greater than $0.8 billion. We chose those companies because they are perceived as leaders in their sectors. The table below presents details of the selected companies:

Company Shipping Sector Market Cap. ($m) Fleet
Euronav NV Dirty 1,845 69 Vessels*
Scorpio Tankers Inc. Clean 1,400 142 Vessels*114 Scrubber-Fitted Vessels**
Frontline Ltd. Dirty & Clean 1,494 61 Vessels*20 Scrubber-Fitted Vessels**
Star Bulk Carriers Corp. Dry Bulk 940 119 Vessels*114 Scrubber-Fitted Vessels**
Golden Ocean Group Ltd. Dry Bulk 870 77 Vessels*23 Scrubber-Fitted Vessels**

* The total number of vessels includes commercial managed and chartered-in fleet as applicable.
** Scrubber-fitted vessels are on a fully delivered basis.

(Source: Market Cap - Seeking Alpha)

In the tables that follow, starting from the second column, the IMO 2020 risks are considered. Next, we present the IMO 2020 strategy for every selected company. Then, we assess which risks are adequately mitigated. Finally, we evaluate whether the company is well-positioned to take advantage of IMO 2020 challenges.

Crude Tankers
Company Risks IMO 2020 Strategy Risk Mitigation
Euronav → Compliant fuel shortage leading to operational disruptions→ Compliant fuel price spikes.→Scrubber installation delays · 420,000 tons of LSFO purchased and stored on ULCC Oceania covering a substantial part of 2020 fuel requirements. · Branch office set up in Geneva (Fuel Hub). → Secured compliant fuel supply at the right time and quality, ensuring seamless operations→ Secured fuel supply at the right price→ "Second-mover" advantage for scrubber installations in late 2020 and 2021 (if any)
Product Tankers
Scorpio Tankers → Compliant fuel shortage leading to operational disruptions→ Compliant fuel price spikes→ Scrubber installation delays · Total of 114 scrubber-fitted vessels. · 37 of which to be scrubber-fitted in 2020. · Trafigura is the largest shareholder. 80% of the fleet is scrubber-fitted. HSFO as main bunker fuel. Trafigura is the largest shareholder:→ No significant compliant fuel dependence→ Reduced possibility of material delays for scrubber installations, since the remaining scrubber schedule is minimal
Mixed Tankers
Frontline → Compliant fuel shortage leading to operational disruptions→ Compliant fuel price spikes→Scrubber installation delays · Team up with Feen Marine Scrubbers Inc., a provider of scrubbers. · Team up with Golden Ocean & Trafigura to establish a joint venture for the supply of marine fuels. · Total of 20 scrubber-fitted vessels. A joint venture with Trafigura for the supply of marine fuels provides and Feen Marine for scrubbers:→ Secured compliant fuel supply at the right time and quality, ensuring seamless operations→ Secured fuel supply at the right price → Reduced possibility of delays for scrubber installations
Dry Bulk Shipping
Star Bulk → Compliant fuel shortage leading to operational disruptions→ Compliant fuel price spikes→Scrubber installation delays · Total of 114 scrubber-fitted vessels. · 10 of which to be scrubber-fitted by Q1 2020. 96% of the fleet is scrubber-fitted. HSFO as main bunker fuel:→ No significant compliant fuel dependence→ Reduced possibility of material delays for scrubber installations, since the remaining scrubber schedule is minimal
Golden Ocean → Compliant fuel shortage leading to operational disruptions→ Compliant fuel price spikes→Scrubber installation delays · Team up with Frontline and Trafigura to establish a joint venture for the supply of marine fuels. · Total of 23 scrubber-fitted vessels. · 8 of which to be scrubber-fitted by Q1 2020. A joint venture with Trafigura for the supply of marine fuels provides:→ Secured compliant fuel supply at the right time and quality, ensuring seamless operations→ Secured fuel supply at the right price

Based on the above tables, we conclude that Euronav NV, Frontline Ltd., Scorpio Tankers Inc., Star Bulk Carriers Corp. and Golden Ocean Group are well-positioned to ride the IMO 2020 tsunami.

Conclusion

I view that IMO 2020 will have a net positive impact on the global tanker (both crude and product) and dry bulk market. Specifically, compliant fuel shortages leading to operational disruptions, compliant fuel price spikes and scrubber installation delays will make a Q4 2019 tight market even tighter.

Euronav, Frontline, Scorpio Tankers, Star Bulk and Golden Ocean approached the new regulation as an opportunity rather than a risk. In my opinion, they managed to mitigate the residual risks that IMO 2020 brings sufficiently.

I am constructive on the valuation outlook for Euronav, Frontline, Scorpio Tankers, Star Bulk and Golden Ocean. I believe that on the back of a seasonally strong fourth quarter and imminent IMO 2020 disruptions, their potential valuation upside is huge.

Disclosure: I am/we are long EURN, SBLK. 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.