The other big deal on global trade The other big deal on global trade https://stage-fii.federatedinvestors.com/static/images/fed-logo-amp.png https://stage-fii.federatedinvestors.com/daf\images\insights\article\cargo-vessel-smoke-small.jpg August 13 2019 August 13 2019

The other big deal on global trade

New rules getting rid of 'dirty' fuel used in shipping could boost refiners.
Published August 13 2019
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Oil refining, the processing of crude oil into gasoline and other petroleum-based products, is a cyclical business. Refiners typically enjoy strong demand for their products during the summer driving season, with profitability tapering off as the cooler weather sets in across the densely populated Northern Hemisphere. But this year may be different. That’s because something big is about to happen in the world of global trade that could have a huge impact on the global economy. We’re not talking about U.S.-China trade negotiations—we’re talking “IMO 2020.”

IMO 2020 refers to a new environmental regulation on all commercial shipping, enforced by the International Maritime Organization, the United Nations-based agency of 174 member states. Effective Jan. 1, 2020, the new rule lowers the cap on marine fuel sulfur emissions from its current level of 3.5% to just 0.5%. Ocean cargo ships are being targeted because 90% of the world’s sulfur emissions are produced by the burning of bunker fuel, the primary fuel used to power the engines of the tens of thousands of ships that transport the goods of international commerce.

‘Dirty’ fuel is about to get the boot

Bunker fuel is the dirty, heavy, residual oil that is left over after gasoline, diesel and other light hydrocarbons are extracted from crude oil during the refining process. It used to account for about 7% of global oil consumption. But demand for bunker fuel, with its high sulfur content, is about to decrease dramatically when IMO 2020 goes into effect. To become compliant, marine vessels must either install “scrubbers” (special equipment designed to remove contaminants from a ship’s exhaust), switch to alternative fuel sources such as liquefied natural gas, which must be kept at sub-freezing temperatures, or pursue the easiest remedy: switching to cleaner grades of refined petroleum fuel.

As demand for low-cost, low-quality bunker fuel drops precipitously, the demand for cleaner, pricier fuel should rise in conjunction. The resulting price differential, or spread, between high and low quality petroleum—both on the output side with refined fuels as well as on the input side with different grades of crude oil—will present opportunities to refiners. Those refiners that are best positioned to take advantage of the widening spread, either through their unique supply chain dynamics or through their technological ability to produce cleaner fuels, should see rising profit margins and ample free cash flows.

So while everyone benefits from cleaner air, we think the refining industry presents investors with a compelling opportunity to benefit from higher profits at attractive valuations. IMO 2020 should lift all boats and, we think, investors may want to consider climbing aboard.

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Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

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