The shipping industry is finally cleaning up its act. On January 1, 2020, the planet will switch over to a new fuel standard handed down by the International Maritime Organization (IMO), a United Nations agency, resulting in a seven-fold reduction in the amount of sulfur allowed in shipping fuels.
It will be a remarkable achievement for public health and environmental stewardship. It could also create some sweet opportunities for individual investors.
Thanks to the finer details separating high-sulfur and low-sulfur fuels, IMO 2020 could allow companies up and down the supply chain -- and even a few currently on the outside looking in -- to cash in. That includes renewable diesel leader Renewable Energy Group (REGI) and natural gas fuels leader Clean Energy Fuels (CLNE 3.85%).
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The IMO 2020 standard, explained
Today the world consumes about 8 million barrels per day (bpd) of residual fuel oil, a petroleum product leftover after refining heavier crude oils. Residual fuel oil is relatively dirty itself, which limits its use in applications near population centers. That explains why nearly half of global consumption is owed to the maritime shipping industry -- and why IMO is targeting the market.
In an effort to significantly improve global air quality and air quality near coastal regions, IMO 2020 will reduce the amount of sulfur allowed in shipping fuels from 3.5% today to 0.5%. That's expected to make 3 million bpd of residual fuel demand disappear overnight. Cleaner-burning distillate fuels, such as low-sulfur diesel grades, are expected to fill the void with an additional 0.8 million bpd to 2 million bpd in demand. That's an extra 12 billion to 30 billion gallons per year.
However, there's an open debate about whether or not the world will be ready in 2020. Some analysts have declared it's already too late to expect a smooth transition because not enough petroleum refinery output is being retooled to increase diesel output. Prepared or not, global markets for transportation fuels on land and at sea will be permanently altered by the new standard. And that's great news for Renewable Energy Group and Clean Energy Fuels.
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Indirect opportunities for alternate fuels
Pressure on diesel fuel markets could create a sweet opportunity for both Renewable Energy Group and Clean Energy Fuels. While neither is likely to insert itself directly into the maritime supply chain, the heavy-duty trucking industry may be forced to increase purchases of biodiesel, renewable diesel, and compressed natural gas (CNG) fuels.
Renewable Energy Group, North America's largest biodiesel producer, would benefit from the fuel standard through increased diesel selling prices. Of note is the fact that the business generates 74% of sales from states with clean diesel policies. Even though the policies take aim at carbon dioxide emissions (highway-based diesel fuel is already low sulfur), those markets would be the first to feel the effects from a global vacuum caused by IMO 2020. That's because maritime shippers would be competing with long-haul truck fleets in Texas, California, and New York for the good stuff.
The business is in a great position to capitalize. In the last 12 months Renewable Energy Group sold 639 million gallons of fuel (including renewable- and petroleum-based) and generated $2.4 billion in revenue. It boasts 575 million gallons per year of production capacity today, and has identified expansion projects totaling 210 million gallons per year. That doesn't include a large-scale renewable diesel (chemically identical to petroleum-based diesel) facility announced with Phillips 66. The capacity will be unveiled when the pair make a final investment decision in 2019, but it could be anywhere from 75 million to 200 million gallons per year. It would come online in 2021.
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Meanwhile, Clean Energy Fuels could use IMO 2020 as a thumb on the scale when persuading heavy-duty truck fleets to make the switch from diesel fuel to CNG. While natural gas fuels are already cleaner and lower-cost compared to diesel, the large upfront investment in natural gas engines and a lack of refueling infrastructure complicate matters. A volatile outlook for diesel fuel in just over 12 months' time could change the calculus.
The timing is perfect (and likely not a coincidence) as the new "Zero Now" financing program from Clean Energy Fuels and Total SA launched late in the third quarter of 2018. When the oil supermajor acquired a 25% equity investment in the natural gas transportation fuels leader in early 2018, it also pledged $100 million in financing to reduce the risk for fleet owners contemplating a switch from diesel. Investors don't know many details about orders or have a "who's who" list of customers yet, but management did say there was strong interest in the program.
Truck fleets worried about risks from IMO 2020, and navigating increasingly strict state policies for carbon dioxide emissions, might find value in the technology platform of Clean Energy Fuels and new financing options from Total.
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Investors can't overlook this global fuel standard
If maritime shippers switch to low-sulfur diesel fuels en masse in 2020 as expected, it could have a profound impact on global transportation fuels. The sudden surge in diesel demand could create immediate and lasting opportunities for companies such as Renewable Energy Group and Clean Energy Fuels, which would benefit mostly indirectly. The renewable diesel leader would likely enjoy higher selling prices for its products, while the natural gas fuels leader could capitalize on truck fleets looking to hedge their bets against pricing volatility.
Of course, these two stocks are barely scratching the surface of the far-reaching impacts expected from IMO 2020, but they demonstrate that non-obvious opportunities are there for investors that do their homework.
