JS Securities Limited – Morning Briefing

Karachi, March 14, 2019 (PPI-OT): IMO 2020 piles on the misery for local refineries

From Jan 2020, International Maritime Organization (IMO) will enforce new emissions standards to curb pollution. Consequently, the Marine sector will have to reduce sulfur emissions by (greater than) 80% from 3.5% to 0.5%.

The Marine sector consumed about 4mn bpd of high sulfur (HSFO) and Low sulfur furnace oil (LSFO), but ~3mn bpd of the demand could disappear overnight due to IMO 2020.

These new standards pose a serious challenge to local refineries, since FO margins will come under significant pressure, while they will be hard pressed to find buyers for FO in local and/or export markets.

Local refineries are already facing numerous challenges on other fronts, including Manganese content ban from Apr-2019, shift to LNG, etc.

IMO 2020 to limit sulfur content from 3.5% to 0.5%

International Maritime Organization (IMO) set new standards to cut pollutants blamed for environmental damage. Hence, ships from Jan-20 are required to use fuel oil with a sulfur content of less than 0.5% compared to the existing 3.5%. Note that our local refineries produce HSFO and LSFO, which contains sulfur content of approx. 3.5% and 1% respectively. The global marine sector consumes ~4mn bpd of high sulfur (HSFO) and Low sulfur furnace oil (LSFO) combined; however, ~3mn bpd of this demand could virtually evaporate overnight according to market forecasts once IMO 2020 sulfur fuel cap of 0.5% comes into effect.

IMO 2020 mayhem for the local oil-refining sector

If this scenario plays out, we expect margins of higher sulfur content petroleum products (Furnace Oil) to weaken significantly. Winners in this scenario in our opinion (and as per international research) will be highly complex refineries and refiners with deep conversion/distillate-oriented configurations (unfortunately none of these exist in Pakistan). Our local refineries are based on a less complex hydro skimming technology, giving an output with 25% of FO as a % of total production. This poses a massive challenge for local refineries since FO margins could fall significantly. Local refineries sell FO to IPPs, while in winter they are expected to export excess FO in international markets. In either case, it is bad news for local refineries since margins will deteriorate further from an already challenging position. Moreover, it will be difficult to find new buyers in international and local market after this event.

Other negatives persist

To recall, local refineries are already facing numerous problems, which include (1) Ministry of Energy imposing ban on use of manganese content in Motor Gasoline (MS) from April 2019. This will limit benefits of Isomerization plant, (2) Govt. decision to rely more heavily on gas-based power production would result in significantly slower off-takes of FO. (3) Kuwait Petroleum Company (KPC) – Pakistan’s largest fuel supplier has demanded phasing out of low quality high- speed diesel – Euro-II – by Dec 2020. This is because KPC would shift to production of Euro-V diesel. In this context, domestic refineries would eventually have to make another round of significant investments in upgrades to meet the new standards. (4) Recent up gradation projects by local refineries have yet to deliver in terms of their desired returns given weak fundamentals and deemed duty sticking to 7.5% rather than the agreed 9%.