Trans-Pac carriers begin levying low-sulfur surcharges

Date: Wednesday, September 4, 2019
Source: Journal of Commerce

Container lines are beginning to give US importers from Asia a sense of just how much extra they’ll have to pay for fuel tied to the new low-sulfur mandate, with initial ranges of $164 to $375 per FEU for West Coast routings and $276 to $625 for East Coast sailings. 

The extent to which carriers can push higher fuel surcharges starting Oct. 1 will provide a sense of not just how well they will recoup costs on Asia-United States trades, but also globally. However, because carriers will not start burning low-sulfur fuel until November-December, cargo owners and non-vessel operating common carriers (NVOs) don’t consider the bunker adjustment factors (BAF) the final word. 

“No one knows what the actual cost will be. We will see adjustments,” said David Bennett, Americas president at Globe Express Services.

Since the JOC’s TPM conference in Long Beach in March, carrier executives have informed beneficial cargo owners (BCOs) that they intend to pass most, if not all, of their higher low-sulfur fuel costs on to their customers in the form of a floating bunker fuel surcharge. Despite historical norms of all-in rates, carriers say they concluded trans-Pacific annual service contracts with mechanism to recoup the higher operating costs. The standard service contract between carriers and BCOs in the eastbound Pacific trades each May 1 includes a base freight rate and a clause that includes provisions for an additional bunker fuel surcharge.

Until now, there was little controversy surrounding the bunker fuel surcharges because only one grade of fuel was involved. Looking ahead to implementation of the International Maritime Organization (IMO) 2020 low-sulfur requirement on Jan. 1, though, has both carriers and BCOs confused because there is little if any low-sulfur fuel being sold today, and there won’t be until later this year. 

Although a half-dozen carriers have reportedly sent advisories to their customers, JOC.com has seen low-sulfur fuel charges filed by only two carriers, Ocean Network Express (ONE) and Hamburg Sud. The charges are quite detailed, broken down by container size as well as dry and refrigerated containers. 

For the standard 40-foot dry container, ONE lists the Asia-US West Coast low-sulfur bunker charge as $164 per FEU, and the East Coast charge as $276 per FEU. Hamburg Sud’s customer advisory lists the West Coast bunker charge as $375 per FEU and the East Coast cost at $625 per FEU. 

Although the IMO 2020 mandate doesn’t officially take effect until Jan. 1, carriers are already retrofitting some vessels with scrubbers because they take three weeks or longer to install.

Most vessels, though, will simply be transitioned to the use of low-sulfur fuel. Carriers are not rushing to pull those vessels out of service for about one week to transition to the use of higher-cost low-sulfur fuel because as soon as they do, their fuel costs will increase. Therefore, a carrier executive told JOC.com, the transition to low-sulfur fuel use for most vessels will not occur until November-December. Nevertheless, carriers intend to recoup their investments in scrubbers and low-sulfur fuel costs soon, so some have filed for fuel surcharges to take effect on Oct. 1. 

It’s essential for the carriers to recoup the higher operating costs tied to the IMO’s low-sulfur mandate in today’s relatively weak pricing environment in the major east-west trade lanes as they transition from the current bunker fuel with a sulfur content of 3.5 percent to low-sulfur fuel blends of 0.5 percent. There is very little margin in today’s trans-Pacific eastbound rates to allow carriers to absorb higher fuel costs.

This peak season, which historically runs from August through October, is expected to be moderate, if not weak. Eastbound peak season spot rates are down more than 20 percent from last year.  

BCOs and NVOs look at the initial carrier filings for low-sulfur surcharges as testing the water. 

“We’re watching this closely, but we do not look at this as what the surcharges will actually be,” Kevin Krause, vice president of ocean services at SEKO Logistics, told JOC.com. 

A customer advisory last week from ONE listed the following low-sulfur fuel oil (LSFO) charges effective Oct. 1 for contracts that have been in effect since Jan. 1, 2019; ONE lists the bunker charge as “OBS” (one bunker surcharge) for purposes of simplicity: $164 per FEU port-to-port from Asia to the West Coast of North America, $412 per FEU IPI (inland point intermodal) to the West Coast and on to the inland destination, and $276 per FEU all-water from Asia to the East Coast.

Complicated pricing 

The dynamics of surcharge pricing through the burning of new low-sulfur fuels is complex. Factors include the TEU capacity of the vessel, the length of the voyage, and the price of petroleum, which varies from day to day. Furthermore, each carrier has its own methodology for pricing bunker fuel, and how often the price will be adjusted. ONE will adjust its OBS surcharge quarterly. 

Because of this, the Oct. 1 BAF implementation will differ from carrier to carrier and trade lane to trade lane. Matt Muenster, senior manager, applied knowledge at Breakthrough Fuel, said BCOs told him they found a large variance in fuel cost quotes received across their carrier base for comparable service.

“Breakthrough has noticed the variations of surcharge methodologies add up to significant cost differences for shipper fuel estimates across common trades,” Muenster said. “A primary critique from shippers following 1H 2019 negotiations is the large variance in fuel cost quotes received across their carrier base for comparable service.”

Major container lines are taking different approaches in how they calculate changes in low-sulfur bunker fuel pricing, with some calculating prices on a quarterly, rolling average, while others are based on a five-week average. The shorter the period, the closer the BAF is tied to current market bunker fuel prices. Adding complexity to shippers’ monitoring of the various BAF is that some carriers include emission control area (ECA) surcharges while others don’t. Additionally, some surcharge programs will adjust the cost of fuel outside of their normal quarterly cadence should the fuel market experience significant volatility. The trigger point for these changes is a rise or fall in high-sulfur fuel oil (HSFO) — soon to be replaced by very low-sulfur fuel oil (VLSFO) — of typically between $40 to $50/mt.

The picture is muddled even further by the volatility in spot rates in the eastbound trans-Pacific this summer, a condition that is expected to persist for the remainder of the peak season into November. The West Coast spot rate from Shanghai increased 25.6 percent to $1,615 per FEU and the East Coast spot rate increased 10.5 percent to $2,691 per FEU after declining for three straight weeks, according to the Shanghai Containerized Freight Index (SCFI) published Friday in the JOC Shipping & Logistics Pricing Hub.

Bunker fuel surcharges are technically independent of the base freight rate. However, with the spot rates in the eastbound Pacific last week 22 to 30 percent lower than they were in August 2018, carriers’ ability to increase the BAF because their fuel costs are going up will be compromised. BCOs and NVOs over the next few months will have options in their choice of carriers, so customers in a soft market will naturally try to leverage either the BAF or the base rate to negotiate the most favorable all-inclusive rate possible. 

Blake Shumate, COO at American Global Logistics, said carriers may have no choice but to absorb some of their increased fuel costs, one way or another, if peak-season imports continue to disappoint. Customers are especially sensitive to increases in transportation costs in today’s environment given the added costs many are experiencing due to the Trump administration tariffs on US imports from China, he said. 

Carriers showing some flexibility in BAFs

Carriers, in fact, are showing more flexibility on low-sulfur BAFs than they indicated they would do earlier this year at JOC’s TPM conference. At that time, carrier executives said they anticipated quoting BAFs this fall that were a 100 percent pass-through of their added fuel costs. 

However, the vice president of global transportation at a home improvement products importer said he approached all of his carrier partners with an in-house BAF that was developed with the assistance of a third-party consultant, and only one of a half-dozen carriers flat-out rejected the proposal. The other carriers countered with proposed BAFs that fell generally in the range of prices that were developed in-house, the logistics manager, who asked not to be identified, told JOC.com.  

As of last week, most carriers still did not have a clear plan as to what their proposed BAF would be, said Christian Sur, executive vice president of sales and marketing at Unique Logistics International. Customers will have no tolerance for complicated formulas that include variations based on whether vessels are equipped with scrubbers or are burning low-sulfur fuel, or proposed BAFs that come in significantly higher than what other lines are quoting. “Keep it simple so as not to confuse the customer base,” he said.

According to TOC Logistics International, carriers may implement the charges across the board, but then reduce base rates on some trades to compensate when they can’t implement the higher surcharges. “That makes it tough to manage from a client perspective,” the forwarder said in a statement. 

Alphaliner, in its Aug. 27 newsletter, noted that quotes for low-sulfur bunker have been volatile given the underlying price of petroleum and the low volumes of VLSFO being traded at this time. In July, the premium for VLSFO was $100 to $150 a ton over heavy fuel oil (HFO), but the spread jumped to $200 per ton in August because recent price declines for standard bunker were not immediately mirrored by falling VLSFO prices, Alphaliner said.

Carriers that intend to begin levying LSFO surcharges in the coming weeks must file those rates soon because of the Federal Maritime Commission’s 30-day advance filing requirement. Carriers are basically making their best guess as to what the actual price of low-sulfur fuel will be when they start burning it in November-December. This prompted the vice president of a large NVO to tell JOC.com that everyone, be they carrier, BCO, or NVO, finds the BAF question “very confusing” right now. “To me, everything is up in the air,” he said.

The move by some carriers to begin implementing LSFO surcharges on Oct. 1, at the height of a peak season that has so far disappointed, opens up the possibility of serious negotiations on base freight rates, the NVO said. To fill their ships before import volumes drop — possibly precipitously — in November and December, some carriers may lower their base freight rate for shipments not moving under contract. “The market hasn’t spoken yet on what the rates will be, which is a function of supply and demand,” he said.

Oil market shift has begun

The IMO-influenced shift in oil markets has already begun, according to energy news and pricing outlet Argus Media, which notes that demand for low-sulfur blendstocks is rising based on strength it sees in the 1 percent sulfur fuel oil refining margin.

“The Northwest Europe 1 percent fuel oil crack spread to North Sea Dated crude averaged a premium of 40 cents/barrel in July, the highest monthly average in more than 20 years,” Matt Wright, Argus’ manager of crude and refined products consulting services, said in an August blog post. “1 percent fuel oil is expected to be a popular blend component of 0.5 percent fuel oil [VLSFO] blends.”

Argus expects the price spread between HSFO and IMO-compliant fuels to be at its widest in the early months of implementation, possibly jumping to more than $300/mt. That is based on its analysis that some 800,000 b/d of excess HSFO “residue” will remain in the market next year.

“This will need to be priced low enough to be adopted in alternative markets, predominantly power generation,” Wright said. “Scrubbing, non-compliance, refinery optimization, a lighter global crude slate, and blending into low-sulfur bunkers will collectively reduce the surplus, but they won’t be enough to eliminate it entirely.”

The spread should narrow after the first quarter, pushed by more vessels with scrubbers going online and shipowners generally feeling more comfortable operating in the new fuel environment, according to Argus. But it still sees the spread above $200/mt.

“If spreads do materialize at these levels, we expect shipowners to return to the scrubber market,” Wright noted. “Scrubber orders have cooled over the past six months as shipowners have decided to wait and see how things pan out.”

According to energy analysts at IHS Markit, the parent company of JOC.com, refiners will be able to supply half of the global low-sulfur marine fuel demand in 2020 with VLSFO bunkers. The remaining demand for low-sulfur fuel compliant with the IMO mandate will be satisfied with marine gasoil (MGO), which is essentially diesel fuel.

IHS Markit sees “diesel prices rising sharply and HSFO prices plummeting,” due to what will be a sharp pullback in demand, said Daniel Evans, vice president and Paris-based head of refining and marketing. “As a result, the price spread between light and heavy oil products will widen significantly.” In an analysis, IHS Markit found a 60 percent probability that the light-heavy spread will be greater than $36 per barrel, versus $10 as of mid-July. 

 

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