Aspects of the Gulf conflict have trickled down to North Africa and fault lines have further hardened in various states due to their own internal political and socioeconomic dynamics.
“IMO 2020” is a term that global commodities and energy analysts are now very familiar with, if they are not completely exhausted at its very mention. The new set of regulations established by the International Maritime Organization, an arm of the United Nations, will impact oil and gas markets around the world, and the hydrocarbon-exporting countries of the Gulf region will be no exception. The regulations are aimed at drastically reducing sulfur emissions that are heavily produced by popular variations of marine fuel, also known as bunker fuel. The IMO intends to accomplish this by banning the use of fuels with a sulfur content greater than 0.5% under almost all circumstances. Heavy fuel oil, or HFO, the most commonly used marine fuel in the world, has a sulfur content of 3.5% and this year HFO demand was approximately 3.13 million barrels per day. As a result, Gulf states that can fill the demand for lower-sulfur fuel oils and substitute marine fuels, such as diesel and liquefied natural gas, will stand to benefit once IMO 2020 goes into effect.
Countries like Saudi Arabia, the United Arab Emirates, and Kuwait, which all export larger quantities of lower-sulfur (or sweet) crude oil and whose refineries have undergone years of upgrades, will be the foremost beneficiaries of the demand for low-sulfur alternatives to HFO. Refiners around the world will require higher volumes of sweeter crude to produce IMO-compliant low-sulfur fuel oil, as well more valuable products like marine gas oil and diesel, which are also likely to see an increase in demand in 2020. While the projected impact of IMO 2020 remains a topic of considerable debate, these effects are the most immediately clear. What remains less certain is how the behavior of shipping firms that decide to seek alternatives to HFO will affect the Gulf’s energy industry. Fujairah, which is now the world’s second largest bunker fuel port, has already taken extensive measures to ensure the availability of low-sulfur, IMO-compliant fuel oil at its facilities. Fujairah has mounted serious competition against Singapore as a global bunker hub, and increased attention to the bunker fuel market may spur greater international interest in the UAE’s bunker fuel market.
This is yet another area where IMO 2020 may create volatility. Should there be a substantial increase in demand for LNG as a bunker fuel, other ports in the Gulf may rise to compete with Fujairah. Qatar, the largest LNG exporter of the Gulf Arab states, has already begun investing in LNG bunker fuel infrastructure. Oman has followed suit, with a surge in gas production that may propel it toward a competitive status in the LNG bunker market once its project at Sohar is operational. However, there is still skepticism surrounding assertions that demand for LNG bunker fuel will drastically increase beyond 2020. In May 2018, only 121 LNG powered vessels were in service. Though LNG represents a cheaper fuel source than oil-based products, construction of these vessels is very expensive, as is retrofitting older vessels with LNG engines.
Perhaps more importantly, the infrastructure for LNG bunkering has been slow to develop around the world, providing little incentive for shippers to invest in it. Another deterrent to investment is that while the emissions from LNG-powered vessels are a low-sulfur solution, they are not a low-carbon solution and may be vulnerable to future regulatory measures targeting carbon output. However, if IMO 2020 motivates a serious adoption of LNG bunker fuel technologies, Gulf states that have taken the risk of financing LNG bunker fuel infrastructure will enjoy significant returns on their investments.
While Supplies Last
IMO 2020 will not be a boon for everyone in the region. Uncertainty from the effects of new IMO regulations looms large over efforts to rehabilitate Iraq’s long-suffering energy industry. Iraq’s crude reserves are known for their high sulfur content, which reduces the appeal of its exports to refiners. Demand for high-sulfur (sour) crude will be impacted by IMO 2020, as the average barrel of sour produces almost 50% fuel oil. Demand for Iraqi crude is currently buoyed while production by the world’s largest heavy crude producers Iran and Venezuela remains effectively offline. Yet a re-entry into the market by either country would surely damage the amount of limited revenue Iraq is able to collect from its exports. One of the most effective steps toward reorienting Iraqi energy exports to evolving demand induced by the IMO would be the diversification of its crude grades, which Iraq has stated its intentions to do for some time. The introduction of its Basrah Medium grade product, with a lower sulfur content than Basrah Heavy or Basrah Light, would have a greater appeal to refiners and trade at a competitive price. Unfortunately, Iraq’s launch of Basrah Medium has been stalled for more than five years by delays in completing an oil storage project.
Yet the largest complication that IMO 2020 creates for Iraq is that worldwide demand for HFO is expected to plummet by over 50% in 2020. According to the International Energy Agency, Iraq is the world’s third-largest producer of fuel oil and is projected to retain this status into 2030. Its largest refinery at Baiji went offline in 2014 when it was severely damaged by militants from the Islamic State in Iraq and the Levant. Although it was restarted in late 2018, Baiji’s current operational capacity is only 70,000 b/d. While Iraq’s refining capacity grew nearly 11% in 2018, much of this capacity remains underutilized, and its operational facilities are not complex enough to produce higher-value products for which IMO 2020 will generate increased levels of demand. The IEA reports that Iraqi refineries continually produce more HFO than any other products at a level that is astronomically higher than the global average and even much higher than average refineries in the rest of the Middle East. Without upgrades to its downstream infrastructure that are only likely to come from foreign investment, Iraq is set to continue generating a product that is neither desirable for exportation nor in great demand domestically. Since retooling and construction of downstream assets is a time- and capital-intensive process even in the most stable parts of the world, offering sweeter crude may be Iraq’s best way to avoid completely forgoing any potential benefit of IMO 2020.
Fuel Surplus, Power Shortage
While IMO 2020 was initially conceived with the intention of reducing global sulfur emissions, its implementation may do little to stem carbon emissions from the largest polluters in the Middle East and in fact may have a completely adverse effect. The regulations that are meant to curb global usage of HFO will create a surplus of cheap fuel in a region that produces much of the world’s supply and is more dependent on it as a means of power generation than any other. With almost all of the carbon content of fuel oil converted to carbon dioxide when burned, IMO 2020 may unintentionally contribute to an explosion in carbon emissions from the Gulf.
Saudi Arabia, the United Arab Emirates, and Iraq are the top three carbon dioxide emitters of the Gulf region. In 2018, Saudi Arabia emitted 571 million tons of carbon dioxide: approximately 1.7% of global carbon emissions. To its credit, this number is actually a 3.4% decrease from 2017. At 151.4 million tons, Iraqi carbon dioxide emissions grew 13.3% in 2018. Despite the slow pace of Iraq’s economic recovery, carbon emissions are rising at a breakneck speed and are being pushed higher by domestic oil consumption, which rose 6.1% in 2018. Assuming the country remains on the road to recovery, it is likely emissions will rise in the coming years.
Power generation and water desalination are the primary drivers of these figures; Saudi Arabia is more reliant on oil-based fuels for these processes than any other country in the world. Anticipation of lower demand for fuel oil in 2020 is likely what is leading Saudi Aramco to pursue a goal of zero fuel-oil production by 2024. Nonetheless, as recently as June, the kingdom produced 519,000 b/d of fuel oil and imported another 223,000 b/d. Figures like this will be important to observe as the effects of IMO 2020 take hold in order to determine whether the impending surplus of HFO will prove too attractive for the kingdom’s authorities to pass up as a source of cheap fuel for power generation.
With dim global growth forecasts and volatile crude prices increasingly shaping up to be the order of the day, policymakers in Riyadh may decide that initiatives to reduce carbon emissions will take a backseat to measures that offset the need to cut fuel subsidies enjoyed by power and water desalination plants for so long. More important is the fact that crude oil makes up 24.2% of the fuel used for power generation in Saudi Arabia – a much greater share than HFO at 16.5%. With a surplus of HFO at home, Saudi policymakers may be keen to substitute HFO to generate power, thereby enabling a greater share of crude oil to be exported whenever the kingdom decides to increase its oil production.
In Iraq, an abundance of HFO caused by IMO 2020 creates as many issues for power generation as it does exports. Iraqi power plants have gradually been transitioning to gas-fueled electricity generation, and 55% of Iraq’s power generation capacity is now served by facilities that can burn either oil or gas. The limited ability to burn fuel oil for power will not alleviate issues Iraq has faced in importing all of the gas it needs, nor will it completely resolve the question of what refineries should do with all the excess fuel oil they will be producing. Ironically, the Iraqi oil and gas industry is the largest consumer of electricity in the country, and Iraq’s inability to generate enough power for this sector will harm its ability to maintain a badly needed revenue stream.
Iraqis are accustomed to the fact that Baghdad is not able to meet their demand for electricity and have long taken matters into their own hands. The IEA estimates that approximately 20% of Iraqi power demand relies on diesel generators to provide businesses or residential homes with electricity, especially during the increasingly hot summer months. The diesel fuel that is used in private generators is typically purchased from government-regulated distributors, but rationing has led diesel to be sold at a significant markup by black marketers, placing yet further strain on Iraqi consumers. However, as many of these generators can be reconfigured to burn HFO, a large supply of cheap fuel may provide temporary relief for Iraqis who are badly in need of additional power generation capacity. Such a measure will only make a small-bore impact on excess HFO supplies, and it will not help Iraq’s billowing carbon dioxide emissions, but as in Saudi Arabia this matter is arguably less of a concern weighed against more immediate needs. Substituting HFO for diesel also remains a stopgap solution. Iraqi refineries still produce fuel oil at a rate that far exceeds demand while producing diesel and other, more valuable refined products at an inverse rate. Iraqi dependence on generators for electricity needs is compounded by additional dependence on imports of diesel fuel, the price of which may increase once IMO 2020 goes into effect.
After a year of decreasing oil prices and bearish global growth forecasts, IMO 2020 may finally bring some positive developments for the oil and gas industries of the Gulf. The full effects of the new regulations will remain unclear until they have been in effect for some time, but the larger questions surrounding market reactions to the regulatory change will soon give way to the policy reactions of individual states that experience some of the unintended consequences of such a massive change.
Correction: This piece previously stated that Iraq’s Baiji refinery has been offline since 2014. The Baiji refinery went offline in 2014 and was restarted in 2018.
Biden will likely put weapons sales to the Gulf on the back burner, but, at the end of the day, the administration’s positions on arms sales will reflect continuity, not change.
Through its careful examination of the forces shaping the evolution of Gulf societies and the new generation of emerging leaders, AGSIW facilitates a richer understanding of the role the countries in this key geostrategic region can be expected to play in the 21st century.Learn More