Disruption caused by IMO 2020 is an opportunity: investment funds

From 2020, shipping companies will have to comply to International Maritime Organization IMO 2020 rules which states that sulfur content in marine fuel must be 0.5%, down from 3.5%.The biggest polluters are dry bulk ships, which make up more than a fifth of the world’s ocean-going vessels.

With new sulfur emission rules coming up from 2020, investment funds are charting a new course as they place their bets for the shipping sector.

According to the International Maritime Organization, the maximum sulfur content allowable in marine fuel from 2020 will be 0.5%, down from 3.5%. Shipping companies have caught in a conundrum on how to comply with this regulation without significantly driving up costs.

Many shipowners have installed exhaust cleaning systems, known as scrubbers so that they can continue to use high-sulfur fuel, while others are switching to low-sulfur marine diesel. Most expect a period of turbulence when the “IMO 2020” rules come into effect.

Investors have come up with strategies and are launching funds, which have exposure to parts of the shipping and oil industries, in order to reap the benefits from the new emissions caps.

As per John Kartsonas, managing partner of Breakwave Advisors, investors’ views on shipping and IMO 2020, is likely to drive up freight rates.

In 2018, Breakwave launched an exchange-traded fund to invest in dry bulk freight derivatives, hoping to benefit from IMO 2020.

“Rarely you see such a potentially massive disruption,” said Kartsonas. “Delays, a reduced active fleet supply, slow steaming and port congestion can push freight rates to decade highs, and beyond.”

The Baltic Exchange’s main sea freight index, which tracks rates for ships carrying dry bulk commodities, had crashed to 700 following the 2007-2009 financial crisis from a record 11,793 points. It is now at around 1,500 points.

Dry bulk ships make up more than a fifth of the world’s ocean-going vessels and many are among the most polluting ships.

London-based Svelland Capital, a hedge fund, is focusing on petroleum products that are likely to be affected by the rules.

“IMO 2020, together with the ballast water treatment, will turn shipping upside down and create supply shock,” said Tor Svelland, Svelland Capital’s chief investment officer.

Later this month, Svelland Capital is set to launch a “IMO direct exposure fund” aimed at investors who want to take positions based on IMO 2020, but are less familiar with oil derivatives.

“This is the largest regulatory change in the oil space ever and it will have a massive effect far outside of shipping,” said Kenneth Tveter, the fund’s portfolio manager.

There is a lack of consensus among investors whether there will be enough low-sulfur fuel to meet demand once IMO 2020 comes into effect. According to industry consultants, of the 60,000 odd vessels worldwide, only 3% to 5% are likely to have scrubbers by 2020.

Significantly, the uncertainty surrounding the demand for high-sulfur fuel is likely to translate into a wider price gap between various fuel grades, as well as the different types of crude used to make them.

Hedge Funds

“You can try and pick winners in the shipping segment of the equity markets, but to get a pure play you need the derivatives market,” said Tveter. “The new fund will look at all the parts of refining that will be affected by the new regulations.

Incidentally, on July 4, China had stated, it plans on launching a futures contract for low-sulfur fuel oil by the end of 2019.

According to Dutch asset manager Robeco, it is investing in oil refineries that are well-placed to produce large quantities of low-sulfur diesel.

“We are invested in refiners since earlier this year and this has been one of the drivers for that investment,” said Fabiana Fedeli, global head of fundamental equities.

Robeco is selecting complex refineries, plants that can turn low-value fuel oil into higher-value products such as distillates, octane and low-sulphur fuel. According to Fedeli, “concerns about disruptions to global trade had weighed on refining margins and related stocks this year, but IMO 2020 could change that”.

She went on to add, “We expect that the impact on refinery margins will become tangible from late Q3 2019 when ships are likely to begin shifting to compliant fuels. Interestingly, this is still not reflected in diesel crack futures.”

As per Alistair Way, head of emerging market equities at UK-based asset manager Aviva Investors, refineries, which have invested to produce more compliant fuel are likely to benefit.

Asian refiners such as S-Oil, Thai Oil, are well placed since they produced a bigger than average proportion of middle distillates and had less exposure to high-sulfur fuels.

Hedge fund CF Partners in London is focusing on price gaps between different crudes. It expects sweet crude with higher levels of distillates such as Nigeria’s Bonny Light or U.S. shale to be more in vogue than heavier, sour crude.

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