Starting January 1, 2020, the International Maritime Organization (IMO) will implement the IMO 2020 – a new regulation enforcing ships to use marine fuels with low sulphur content to reduce sulphur oxide emissions. Ship’s engine is powered by heavy oil – a residue from crude oil distillation that contains sulphur – that is deemed hazardous to public health and environment.
What is IMO 2020?
To protect human health, environment, and promote sustainability, the IMO 2020 regulation will cut emissions to 0.5% m/m (mass by mass) from the current 3.5% for ocean vessels operating outside the designated Emission Control Areas (ECAs), an 85% emissions reduction. According to IMO, “this will significantly reduce the amount of sulphur oxides emanating from ships and should have major health and environmental benefits for the world, particularly for populations living close to ports and coasts.” The ECAs will maintain a 2015 standard at 0.10% limit.
Looking back at previous sulphur limits
IMO has established a series of sulphur oxide emissions cap over the years for zones outside of ECAs.
The rapid growth of global logistics and the need for a sustainable industry push IMO to reduce greenhouse gas emissions. The table above shows a 22% reduction before and beginning January 1, 2012, and further trimmed to 85% starting January 1, 2020. This means that in 2020, IMO will cut 89% of sulphur oxide emissions ever since the regulation was implemented.
How can carriers comply with a lower emissions requirement?
Ocean carriers carry the burden of this new regulation. They need solutions that enable compliance without causing disruptions to their customers. Ship operators will have the following alternatives;
Use scrubber. Using scrubber – a gas cleaning technology – allows ships to use existing 3.5% heavy fuel oil because it removes pollutants from ship’s exhaust produced by engines, resulting in low sulphur emissions. One survey finds, however, that small ship operators tend to avoid scrubber than medium to large companies as it requires hefty capital investment and high operating cost which appears not affordable to small firms.
Switch to low-sulphur fuel oil (LSFO) or ultra-low sulphur fuel oil (ULSFO). Heavy fuel is classified into LSFO and ULSFO based on their sulphur content. The maximum content for LSFO is 1.0% while ULSFO is 0.1%. In terms of pricing, LSFO is cheaper than ULSFO.
Switch to liquified natural gas (LNG). It is a non-petroleum-based fuel with proven low greenhouse gas emissions compared to marine engines using heavy fuel oil. Shifting to LNG is a feasible option especially for newer vessels because it is cleaner and compliant for future emissions regulation. Additionally, LNG price tends to be more stable than LSFO/VLSO due to liquefaction fix cost and ample supply over demand.
How does IMO 2020 affect the supply chain?
IMO 2020 brings an unprecedented shift to the marine fuel supply landscape. Experts estimated that the entire shipping industry will spend $24 billion to $60 billion to comply with IMO 2020. This shift not only disrupts oil companies supply chain but also firms importing goods for local production or direct consumption.
Increase in shipping cost
Freight costs are likely to increase beginning next year as a result of IMO 2020. Unlike the current 3.5% heavy fuel oil, carriers installing scrubbers or switching to low emissions gas to comply with the new regulation will incur additional investments. Shipping companies should find ways how to offset these costs to mitigate disruption in the supply chain.
Passing these costs to customers is a common route for most carriers. In fact, shipping companies including Maersk, CMA CGM, OOCL, and APL have started announcing new fuel surcharges this year. The Bunker Adjustment Factor (BAF) – a surcharge that accounts for fuel cost – will use a new cost reference from LSFO/ULSFO replacing the HSFO, resulting in a higher transportation cost.
Increase in consumer price
Manufacturers that purchase raw materials overseas are exposed to IMO 2020 disruption as they are the ones shouldering added costs in transportation. Extra freight costs are tied on imported goods making these inventories expensive. Ultimately, finished goods made up of these raw materials carry an extra cost than products manufactured prior to IMO 2020 implementation. Except that efficiency and cost reduction targets are achieved during production, manufacturers should carry costs over to consumers to recover additional shipping costs.
The transition period to switch to compliant fuels or fitting scrubber causes service disruptions. Temporary impact includes reduction of carriers capacity by 4% to 5% due to blank sailings and temporary decommissioning of vessels for scrubber installation. Moreover, ships need additional space for scrubber and LNG tanks decreasing the total area that would have been used for cargo.
Longer lead time
Longer transit times will hit importers as a result of low steaming vessels that reduce speed to minimize the amount of fuel burned during transportation. Low steaming is another option aside from expensive IMO 2020 compliant fuels.
What manufacturers can do to mitigate the impact of IMO 2020?
Innovative firms can create a resilient supply chain built upon this new rule to gain a competitive advantage.
Consider looking for materials supply locally to save international shipping charges. Switching to local supply needs cautious steps to avoid issues in the long-term. Before changing to a local supplier, determine whether the total cost of ownership (TCO) is comparable or favorable against the existing TCO from a foreign supplier. Assess the supplier across TCO cost metrics – price, logistics, manufacturing, quality, maintenance and risk costs – to see if localization is a competitive option.
Making incremental improvements and innovations across supply chain processes can compensate for the impact of IMO 2020. For instance, establishing coordination and information sharing between departments to break silos will lead to greater visibility, improve forecast accuracy, and optimize inventory. Supply chain synchronization enables the organization to reduce inventory costs, avoid unnecessary disruption, and improve customer service. Streamlined operations make things move faster at less cost.
Better contracts and service
Carriers now are offering competitive pricing contracts to importers making the shipping industry more competitive. Obtain and analyze quotes from these shipping firms and pick the best one. Shipment consolidation or buying in bulk to increase volume can be useful to leverage bargaining power for rates negotiation. Try entering into long term-contract or lock-in price for a specified period to get favorable terms. Aside from pricing, look at the carrier’s service capabilities such as customer support, degree of digitization, cargo visibility, and so on to prevent future disruption which may cause shipment delay.
During peak season, rates tend to spike, and capacity is constrained leading to overbookings of vessels. Planning and acting for these events including collaborating with forwarders on peak season surcharges minimizes risks that often result in disruption and delay.
The implementation of IMO 2020 will impact industries at many levels across the value chain from oil refineries to carriers to importers to consumers. The cost to comply with this new regulation is significant and cost-sharing between players will start to effect to offset compliance cost.