FEATURE: Bunker industry says unpredictable compliant fuel hampering hedging
27th May 2021 15:04 GMT

The range of possible blending components for 0.5% sulfur fuel oil and the impact this has on the fuel parameters is undermining the market’s appetite to hedge against VLSFO price volatility some 18 months after the IMO rules came into place to ensure ships used compliant marine fuel.

The unpredictability around very low sulfur fuel oil is choking the development of a paper market for the bunker fuel, industry sources said, even when traders, suppliers and shippers are becoming more confident with using 0.5%S fuel oil in ships’ engines. So while the physical bunker market has largely weaned itself off the former dominant fuel, 3.5%S fuel oil, and onto the new fuel, the forward market has yet to catch up, the sources said.

A financially settled derivatives contract, which can be used as a hedge against adverse swings in price, is one in which a buyer and seller agree to a strike price in relation to a defined underlying benchmark for a defined period of time.

Ever since the International Maritime Organization-mandated 0.5% sulfur cap on emissions from ships on the high seas came into force on Jan. 1, 2020, the bunker industry has had to adapt to new ways of handling the compliant fuel.

The industry has done this successfully, benefitting from careful preparation, but hedging against future volatility in the 0.5%S fuel oil market remains relatively undeveloped. “It’s still an immature market on the financial side, at least for us,” Bjarne Schieldrop, chief analyst for Commodities at SEB said during S&P Global Platts European Bunker Fuel Virtual conference, broadcast May 20.

“[It’s] still not all that easy to trade with the product in our books against different, other benchmarks and we’re still lacking in a proper market of 0.5%S versus Brent crude in crack-terms,” he said.

Rotterdam 0.5%S is traded at a differential to high sulfur fuel oil, Singapore 0.5%S, low sulfur gasoil and even 1% sulfur fuel oil. However, there appears to be insufficient appetite for a swap that would use Brent crude as a hedging mechanism for 0.5%S buyers.


An unpredictable make-up


The liquidity of the 0.5%S fuel oil paper market may be limited but it is picking up. “We’ve seen the 0.5%S contract maturing and clients becoming increasingly confident and comfortable using the 0.5%S contract. That was typically a development in the second half of 2020,” Schieldrop said.

Through 2020, the majority of contracts were based on gasoil and diesel, Jan Christensen, senior director for global fuel purchasing at Hapag-Lloyd, said. However, he agreed with Schieldrop that things are changing. “We see more and more offers now coming from physical suppliers, where the contracts are based on 0.5% instead,” Christensen said.

The basis risk involved in hedging one product, here 0.5%S FO, against another different one, such as low sulfur gasoil, which is subject to different market dynamics, alarms some players but there is no simple alternative.

If 0.5%S fuel oil were a more consistent product it would be a simpler matter to hedge paper against physical, thereby avoiding the need to consider other products, such as LSGO. However, the varying nature of what goes into 0.5%S fuel oil is a deterrent to this.

Take-up of 0.5%S fuel oil forward contracts remains restricted, especially further down the curve. “I think its trading is mainly in the first six months of the entire curve,” Rustin Edwards, head of fuel oil procurement at Euronav said.

As far at as Cal 2023, 0.5%S fuel oil is being traded against other products such as 3.5%S fuel oil, but activity for time spreads and cracks on the Inter-Continental Exchange out that far is limited. “Until you get that kind of volumetric increase down the curve it’s going to be hard to create that forward hedging program that a lot of shipping companies have used in the past, when they had high sulfur [fuel oil] as their main fuel base,” Edwards said.

For example, low sulfur vacuum gasoil can find a home in the marine fuel when gasoline cracks are poor and jet fuel can find its way into 0.5%S fuel oil when its cracks are poor, sources said. This combination of both macro and seasonal economics means unpredictability in the make-up of 0.5%S fuel oil.

This in turn means more than a higher risk of instability in fuel and the need for careful handling; it also means there is a range of parameters, such as viscosity. 3.5%S fuel oil was assumed to have a viscosity of 380 centistokes and for instances when it was less there was a market for 180 CST. Now the range can run to as low as 1 CST, sources said.

The varying characteristics of the physical fuel mean exact matches between cargoes of what is the ostensibly the same material can be hard to find and this makes developing a forward market harder.

Platts ,
27th May 2021 15:04 GMT