Let's Talk about Regulation and IMO 2020
October 2017 - Regulation in the petroleum industry is a frequently discussed topic. In the Canadian landscape, the mere mention of the word 'regulation' evokes highly polarized feelings.
Many of those in the Canadian extractive energy sector feel that regulation unnecessarily adds to the cost of production, thereby serving as a disincentive for businesses. In contrast, regulatory proponents argue that responsible resource development and environmental stewardship are paramount for the long term sustainability of modern society.
Regulatory Impacts in Canada
While Canadian federal government has detailed a plan to put a price on carbon starting in 2018, some provincial governments, such as Alberta’s and British Columbia’s, have already rolled out their own carbon pricing programs. Companies operating in these jurisdictions must now budget and adjust their investment strategies by accounting for the added costs. Conversely, Saskatchewan’s premier has marketed his province as a carbon tax safe haven and has gone so far as to announce his preparedness to take the federal government to court over the issue.
Regulation has also impacted pipeline approvals in Canada. In late 2016, the federal government approved the Kinder Morgan Trans Mountain and Enbridge Line 3 pipelines, while simultaneously rejecting Enbridge’s Northern Gateway project. More recently, TransCanada announced the withdrawal of its Energy East pipeline proposal, citing uncertainty in the cost and timing of the regulatory process.
Whether you are a Canadian stakeholder or an outside spectator, there is something important to be learned from the Canadian story: regulation cannot be ignored and it will have a tangible impact on business in the oil patch.
While Canadians are still busy debating the merits of a carbon tax and extensive pipeline approval processes, another regulatory specter looms on the horizon. Unlike the local carbon tax and pipeline debates, this regulation will have a more widespread impact because it reaches far beyond the Canadian jurisdiction. So what is this regulation? IMO 2020.
The International Maritime Organization and IMO 2020
The International Maritime Organization ("IMO") is a specialized agency of the United Nations. Established in Geneva in 1948 and currently headquartered in London, the IMO seeks to create “a regulatory framework for the shipping industry that is fair and effective, universally adopted and universally implemented”. Currently, the IMO has 172 Member States and 3 Associate Members.
The IMO has played a pivotal role in developing regulations surrounding maritime safety, security, and environmental protection. Regulations for the Prevention of Air Pollution from Ships are covered in Annex VI. Those regulations specifically address sulfur oxide (SOx) and nitrous oxide (NOx) emissions.
Since 2012, the sulfur content in marine fuel oil has been capped at 3.5% m/m (mass by mass). In 2016, the IMO announced a 2020 effective date for globally reducing sulfur content in marine fuel oil to 0.5% m/m. This initiative has been dubbed ‘IMO 2020’.
Why You Should be Concerned
We now live in a global economy. Due to the supply chain also being globalized, interests both upstream and downstream from affected shippers will also be impacted due to a ripple effect from the imposed global regulation.
In this case, should the IMO 2020 regulation add incremental costs to shippers? Some of those costs will likely get passed onto the consumer downstream. Likewise, since IMO 2020 places a more stringent restriction on fuel oil sulfur content, shippers are now incentivized to seek out alternative fuel sources in order to maintain compliance, which affects suppliers upstream.
To date, global refiners have led the discussion on how best to tackle IMO 2020. At the core of these discussions lies the question: what makes the most economic sense? While some refiners have signaled that they are looking into revamping their operations to produce a lower sulfur product from existing feedstock, other refiners are tendering the idea of simply changing to lower sulfur-containing feedstock altogether.
From Canada’s perspective, this shift could be devastating as the majority of exported raw bitumen contains 2.0-5.0% sulfur content. By sitting back and allowing the status quo to run its course, the Canadian petroleum industry could very quickly find itself in a weakened bargaining position.
According to Houston-based Edwards Energy Consultants, the effect of new sulfur limits will lower heavy oil prices, increase competition between heavy oil-producing jurisdictions, and ultimately force Canada to shut-in some of its production due to economics if precautionary steps are not taken. They have called on local governments and the petroleum industry to seriously consider low-cost technologies that could selectively remove sulfur-containing compounds from Canadian heavy oil.
Globally, we have also seen indicators that other players in the primary petroleum extractive business are already preparing for IMO 2020. It is widely known that Saudi Arabia has been trimming its production due to OPEC cut agreements. However, a closer look has shown that most of the production being taken offline is Arabian Heavy, which contains 3.0% sulfur content. While it may be debatable whether IMO 2020 is a primary influencer behind the Saudi strategy, it would certainly be a consideration at the least.
In its 2016 announcement, the IMO pointed to an increasing number of ships using LNG as a negligible sulfur oxide-emitting fuel alternative. Industry discussions have noted the lack of LNG infrastructure, the need for additional on-board LNG storage space, and the cost of LNG itself would be limiting factors to making a full transition. The IMO also pointed to methanol as a potential alternative low sulfur fuel, but cost once again becomes an issue.
The IMO suggested that sulfur oxide emission requirements could be met through “equivalent methods” such as the installation of exhaust gas cleaning systems, or scrubbers. However, this option does not provide for a widespread solution, as scrubbers would need to be retroactively installed on thousands of ships, and can cost millions of dollars per ship. This option may only be a solution on a case by case basis.
Some have asked whether non-compliance is a viable option. Currently, there is uncertainty surrounding enforcement actions and the magnitude of non-compliance penalties. Moreover, noting the importance that today’s society places on environmental sustainability, non-compliance should not be contemplated.
Others have proposed blending as another solution. This option entails blending high sulfur-containing fuel oil with more expensive low sulfur-containing fuels in order to meet specifications. Given that there is a limited market for marine fuel oil, this option would conceivably lead to an oversupply situation, which would lead to an array of other problems for the market.
A Call for Innovation
The petroleum industry appears optimistic for innovation as a long-term, sustainable answer to IMO 2020. There are varying opinions on what this innovation looks like. One commentator may suggest that innovation entails developing technologies that turn high sulfur-containing feedstock into other products, bypassing fuel oil production altogether. Another commentator may advocate that innovation entails the development of more efficient and cost-effective sulfur removal processes.
Whatever that innovation looks like, we need to ensure that we build a culture of support around innovators that are looking to solve tomorrow’s problems. At the same time, we, as stakeholders need to acknowledge and understand the policy in order to prepare ourselves for when the regulation comes into effect.
About Well Resources
Well Resources is an Alberta-based technology company with local offices in Calgary and Edmonton. Its areas of focus are in the energy and life sciences sectors, where Well Resources develops and licenses green technologies that promote effective resource utilization.