Managing IMO 2020 Compliance: The Importance of Engagement Between Bunker Suppliers and Consumers

Introduction

IMO 2020 is almost upon us. Readers are well aware of the impending switch to 0.5 percent fuel mandated by Annex VI of MARPOL which will cause an anticipated drop in HSFO demand, the potential hazards of new untested LSFO blends, the concerns around scrubber operations, the debate over open loop versus closed loop, and the myriad of other risks associated with the impending regulatory change. We are now past the point of discussing those basics. We are also past hoping for deadline extensions or experience building phases. There is little doubt that from January 2020 Port State Control Officers (PSCOs) will board vessels to verify compliance with Annex VI. Equally, there is little doubt that from March 2020 PSCOs will test compliance with the carriage ban. 

Where we are now (and where we have been for the past several months) is developing and executing strategies for IMO 2020 compliance. Time charterers, owners, and operators are analyzing their bunker supply chains and speaking with fuel vendors to discuss the availability of compliant fuel; some bunker consumers are planning ahead by pre-ordering bunkers, hedging, or arranging to pre-position stocks of compliant fuel, often in floating facilities; refiners and bunker suppliers are developing and testing appropriate blends; owners and operators are preparing Ship Implementation Plans; time charterers, owners, and operators are analyzing BIMCO and Intertanko fuel clauses to determine whether they cover all relevant risks; industry participants are developing plans to manage the transition from 3.5 percent to 0.5 percent fuel, which will need to occur in Q4 2019; bunker purchasers are wary of new and unscrupulous entrants into the bunker supply market who may sell “sulphur compliant” blends that are otherwise not fit for purpose; and, port state control authorities (PSCs) are issuing guidance on future enforcement. Of course, this list is far from comprehensive. The takeaway is that while some are prepared for the transition, many are not.

The time for talk is now behind us. It is now time to execute IMO 2020 mitigation strategies. To that end, we briefly discuss three key elements of any such strategy – engagement with bunker suppliers, managing credit risks in the bunker supply chain, and understanding the likely enforcement landscape. 

Engagement with bunker suppliers

Any party with an obligation to fuel a vessel, whether a time charterer, owner, or operator, should be revising its bunker sourcing strategy and engaging with its bunker suppliers. Parties opting for compliant LSFO blends should be discussing availability, quality, viscosity, stability, and compatibility issues with their suppliers and their equipment manufacturers/maintainers. Much of the equipment currently at sea was not designed to operate on low sulphur fuel for extended periods, and performance will suffer as a result, sometimes alarmingly.

Parties opting for scrubbers, should be analyzing availability of HSFO, particularly in smaller ports where there are fewer suppliers and where demand for (and supply of) HSFO could be limited post-2020. Installing scrubbers and ensuring HSFO supply is only half the battle; operators must ensure that there are sufficient numbers of trained crewmen to maintain these, sometimes temperamental, units over long periods of time. Moreover, even voyage charterers, who typically have no responsibility to fuel vessels, should be engaging vessel operators with whom they typically charter to understand the operators’ strategy for sourcing compliant bunkers.  

We have also seen evidence that bunker suppliers and purchasers have discussed altering standard contractual terms in advance of 2020. Some consumers are contemplating eschewing their spot bunker purchase strategy in favor of entering into longer term bunker supply contracts to secure availability of compliant fuel. Others have attempted more aggressive contracting changes, including lengthening limitations periods within which contamination claims can be brought and requesting warranties for compatibility with onboard fuel. In our experience, bunker suppliers have largely rejected these requests. But, for certain long-term customers, bunker suppliers have been willing to compromise on other areas, such as the credit issues discussed below.

As a minimum, bunker suppliers and consumers should be engaging in a dialogue both to manage operationally the risks arising from IMO 2020 and to allocate contractually those risks as appropriate.

Managing credit risk in the bunker supply chain

It is widely expected that LSFO and MGO fuel prices could spike in the early days of 2020. Operators who have opted against scrubbers could see their bunker bills double in the span of a few weeks. Likewise, bunker traders and suppliers who operate on thin margins and tight credit terms could see costs rise without any ability to secure equivalent increases in bank lines of credit. While some companies may be large enough to absorb the additional cost and while others are trying to mitigate risk operationally (by storing compliant fuel in ULCCs, for example), many medium and small operators and suppliers will experience a significant credit crunch. If these credit risks are not carefully managed, the industry could experience a series of non-payments that result in vessel arrests or insolvencies that cause pockets of (or worse, widespread) commercial disruption. Moreover, we could see consolidation in the bunker supply market as smaller suppliers are unable to independently manage the price changes.

In the lead up to 2020, bunker suppliers are also examining their customer lists and reconsidering whether to keep doing business with higher-risk operators. Additionally, suppliers are looking to tighten credit terms where commercial leverage so permits. Some have tried to reduce payment terms to 14 or 21 days. Of course, such strategies are untenable when dealing with the largest ocean carriers, but smaller owners, operators, and time charterers could face onerous bunker credit terms post 2020. These risks can be somewhat mitigated by engaging with bunker suppliers now and building mutual financial credibility so risks can be reduced and evenly allocated before January 1.

Enforcement in 2020 and beyond

The undercurrent to all 2020 planning, mitigation, and compliance is enforcement. It is axiomatic that if enforcement is uneven, irregular, or lax, compliance will wane. As a threshold matter, the IMO itself has no enforcement role. That is left up to flag and port state authorities. As a practical matter, most enforcement will arise out of PSC inspections. Either way, owners, operators, and charterers of ships that have spent time and funds in preparation for compliance will urge the authorities to enforce the new regulations so that those who are not compliant do not enjoy a significant competitive advantage. Indeed, we expect PSCOs to be quite active after 2020, and prosecutions will surely follow for those who have made little attempt to be compliant.

Accordingly, the IMO has recently issued guidelines to PSCs regarding the enforcement of IMO 2020. As with typical PSC inspections, compliance with Annex VI will be tested in two phases – the initial inspection and the more detailed inspection. During the initial inspection, PSCOs will review key documents, including bunker delivery notes, IAPP Certificate, EIAPP Certificate, EGCS Record Book, and others. In some jurisdictions, initial inspections could also involve preliminary fuel tests via portable sulphur kits, although the results from these are unlikely in themselves to be reliable enough to allow a prosecution. If the overall condition of the ship meets generally accepted rules and standards and the PSCO’s general impressions and observations onboard confirm a good standard of maintenance, the inspection will be concluded. However, if the initial inspection reveals clear grounds to conduct a more detailed inspection—including absent certificates, malfunctioning scrubbers, irregularities in bunker delivery notes or FONARs, the results of portable sulphur kits, or evidence of non-compliant emissions detected by drones or other sensors—PSCOs will move to the second phase of the inspection and scrutinize the vessel in greater detail. This second phase will involve laboratory testing of bunker samples, the results of which would be persuasive evidence in court.

As set out above, we anticipate that PSCOs will strictly enforce Annex VI from January 2020. PSC authorities in the US, Singapore, Europe and other major jurisdictions have signaled that enforcement will commence in January 2020. Accordingly, voyage planning with an eye toward bunker availability will be critical. Indeed, the US Coast Guard recently commented that careful voyage planning would be critical to managing compliance in 2020. And, FONARs should not be viewed as a “get-out-of-jail-free” card. Once again, this underscores the importance of ongoing dialogue and coordination between bunker consumers and suppliers, not just in the months leading up to the January 1, 2020 deadline, but continuing thereafter.

IMO 2020 represents a significant change in the day to day running of ships at sea. This article touches on a mere handful of risks arising from this change. Those who prepare well will benefit – or at least they will not suffer as much as those who have not prepared at all.