Time to start worrying again about rising cost of ship fuel

September 7, 2023

At this time four years ago, before the pandemic and the Ukraine-Russia war stole the headlines, the cost of fuel was the big topic in shipping.

The industry was about to implement a sweeping new global regulation, IMO 2020, requiring the use of more environmentally friendly and more expensive very low sulfur fuel oil (VLSFO), with a sulfur content of 0.5%. Added fuel costs would be passed along to cargo shippers, and ultimately, consumers.

Fuel costs spiked as predicted after the regulation went into force on Jan. 1, 2020. Then COVID struck. Demand for gasoline and diesel collapsed, the price of oil plunged, and with it, the cost of ship fuel. By mid-2020, vessel fuel was 30% cheaper than it was prior to IMO 2020. Fears over regulatory fallout waned.

Fuel costs started rising again in the second half of 2020 and through 2021, but by that time, containerized cargo shippers had a much bigger worry: Freight rates were skyrocketing to unprecedented levels. The supply chain crisis forced shippers into the ultra-expensive spot market. Fuel surcharges on contracts rose, but they were a much smaller component of the overall cost mix.

Fuel costs shot to historic highs after Russia invaded Ukraine in 2022, then fell back as global markets adjusted. But even as fuel costs spiked during the war, ocean contract rates were still exceptionally high, continuing to overshadow the fuel factor.

Now, ship fuel costs are rising yet again. The cost of VLSFO is back near highs reached soon after the IMO 2020 first came into effect. Bunker adjustment factors (BAFs) — the surcharges the shipping lines levy on their customers — are headed up. And the cost of freight is back down to where it was before COVID — and before IMO 2020 — meaning the pass-along cost to shippers from expensive VLSFO is now a much higher proportion of their total cost.

That brings concerns over ship fuel full circle, back to where they were four years ago.

Ocean carrier fuel surcharges on the rise

According to data from Ship & Bunker, the average cost of VLSFO at the world’s top 20 refueling hubs was $662 per ton on Wednesday, up 15% from early June.

Average prices at top 20 refueling hubs. (Chart: FreightWaves based on data from Ship & Bunker)

Ship fuel has been higher than recent levels four times before: in the run-up and aftermath of the invasion of Ukraine; during a brief period in January 2020 following IMO 2020 implementation; in 2011-2013 when crude oil was over $100 per barrel; and briefly in 2008, when oil was over $150 per barrel. Price spikes prior to 2020 were for dirtier high sulfur fuel oil (HSFO), with sulfur content of 3.5%.

The rebound in VLSFO is leading to an upswing in BAFs. Multiple ocean carriers disclose BAFs through Distribution Publications Inc (DPI), which published fourth-quarter BAFs on Wednesday. Fuel surcharges steadily declined from Q4 2022 through Q3 2023 as the price of VLSFO fell back from wartime highs. Now they’re turning back up again.

The average of BAFs announced by CMA CGM, Cosco, Evergreen, OOCL and Zim (NYSE: ZIM) for Q4 2023 is $623 per forty-foot equivalent unit in the Asia-West Coast trade, up 6% from the preceding quarter. The average of BAFs announced by these five carriers is $1,142 per FEU in the Asia-East Coast trade in the fourth quarter, up 6% from the third quarter.

(Chart: FreightWaves based on data from DPI)

To put Q4 2023 BAFs in perspective, Xeneta put the average contract rate in the Far East-West Coast market at $1,676 per FEU on Thursday, and the average Far East-East Coast contract rate at $2,618 per FEU. Thus, the average of the selected Q4 2023 BAF equates to 37% of current contract rates in the West Coast market and 44% of current contract rates in the East Coast market.

Ships with scrubbers seeing less savings

Another key fuel issue for ocean shipping involves the discount of HSFO to VLSFO.

Under IMO 2020, ships that use exhaust-gas scrubbers can continue to burn cheaper HSFO. Scrubbers are widely used by larger vessels that specialize in long-haul runs, because they spend most of their time in transit, burning fuel. According to Clarksons Securities, scrubbers are currently used by 52% of very large crude carriers, 48% of larger dry bulk carriers and 56% of container ships with capacity of 8,000 twenty-foot equivalents or more.

The higher the discount of HSFO to VLSFO, the more money ship operators save by using scrubbers. As a rule of thumb, if the spread is under $100 per ton, it is considered uneconomical to invest in scrubber installations.

The spread collapsed to around $60 per ton in June 2020, at the height of COVID lockdowns, briefly raising questions about whether scrubber investments would pay off. The spread then spiked to an all-time high of $420 per ton in July 2022, in the wake of the invasion of Ukraine, according to Ship & Bunker data on the average prices at the top 20 refueling hubs.

The problem now for shipowners using scrubbers: The VLSFO-HSFO spread sank back below $100 per ton this July and has stayed down ever since. As of Wednesday, it was at just $76 per ton.

Spreads based on average prices at top 20 refueling hubs. (Chart: FreightWaves based on data from Ship & Bunker)

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