Adjusting accordingly how bunker adjustment factor clauses may mitigate the impacts of IMO 2020
Following the IMO’s decision to implement amendments to MARPOL ANNEX VI (“IMO 2020”), the cost of compliant fuels is likely to rise. How will the cost and risk of price volatility be borne in the global logistics chain? We explore a legal device commonly found in voyage charters and contracts of affreightment attempting to address price volatility: BAF clauses.
IMO 2020’S impact on Fuel Pricing
IMO 2020 aims to reduce the global sulphur cap for marine fuels from 3.5% to 0.5% from 1 January 2020. With more than 90% of global trade of physical goods being transported by sea, its consequences are far reaching across the shipping industry.
The availability of standard specification of compliant fuels or fuel blends in the period immediately prior to and following the implementation is currently unclear.
Question marks also exist regarding the extent to which refineries will prioritise the production of low sulphur fuels, and logistical or capacity constraints at various ports or supply terminals – particularly during the early days of implementation.
IMO 2020 will impact the price of maritime transportation of goods globally – for higher sulphur fuels (sulphur content above 0.5%) burned with scrubber fitted vessels and lower sulphur fuels (sulphur content of 0.5% or less) alike. The latter are expected to be used in the vast majority of vessels following implementation1.
The potential role of Bunker Adjustment Factor (BAF) clauses’ role
When bunker prices significantly fluctuate, a carrier’s ability to offer its customers a stable base freight rate is reduced. With the price of bunker fuel typically a key cost driver in vessel operation, this is an unsatisfactory scenario for carriers.
ABAF clause addresses this uncertainty by importing a type of cost/bunker surcharge on the base rate freight price, reflecting the increased cost of the voyage(s) to be performed.
The customer could be Avoyage Charterer and a Cost, Insurance & Freight (CIF) seller of cargo carried on board the vessel. The charterer/seller may therefore wish to pass on any increased costs of transporting its cargo to the cargo buyers under the CIF sale contract. This may be achieved through the use of back-to- back BAF clauses.
Parties’ respective bargaining positions determines the exact drafting of BAF clauses, which will determine the indices to be utilised, degree of any adjustment to be applied and how and when the adjustment computation is to be carried out.
An example of Avoyage Charter BAF clause
“The Freight Rate is based on Platts Bunker FO 380 CST dlvd Singapore. It is agreed that the Freight Rate shall be increased or decreased by US$0.125 for every US$1.00 and/or prorated for the difference between US$300 [this figure is adjustable and usually based on geography and previous pricing realities] and the price per metric ton of spot IFO 380 CST in Singapore as per advice from “Platts Oilgram Bunkerwire” on the Bill of Lading Date”2.
In this case, if the price of IFO 380 CST as published by Platts Oilgram Bunkerwire on the bill of lading date was US$310/mt spot in Singapore, then the freight rate should be increased by US$1.25.
Conversely, if the Singapore spot price was US$290/mt, then the agreed charter freight rate would decrease by US$1.25.
Potential pitfalls and practical tips
Existing clauses may become outdated with IMO 2020’s implementation. An alternative index to IFO 380, such as Platts FOB Singapore Gasoil, would more likely align with IMO 2020-compliant fuel pricing.
Other potential drafting issues or anomalies stand out: no provision is made for an index more closely aligning with ultra low sulphur fuel oil (i.e., with a maximum sulphur content of 0.1%) as would be required to be burned in Emission Control Areas (ECA).
Also, no provision is made for the burning of high sulphur fuel where owners are at liberty to use scrubbers at their own discretion. In such instances, utilising the IFO 380 CST Singapore price may in fact be more appropriate.
BAF clauses typically track against prices fixed on a passed date (the bill of lading date in the clause above). They will not track the present pricing reality at the time the bunkers are purchased or stemmed.
If parties wish to track actual bunker costs during the voyage more closely, they should consider incorporating Bunker Escalation and De-Escalation clauses.
These are particularly useful where it is difficult to nominate suitable indices (not least where one is dealing with different blends of fuels stemmed on board with broad pricing variances) and where pricing movements are uncertain/volatile.
BAF clauses help carriers hedge against the risk of bunker price volatility.
Markets will likely adjust in line with carriers’ obligations to purchase more expensive low-sulphur fuel.
Whilst parties’ relative bargaining powers will determine the extent to which carriers may pass on these additional costs to their customers, BAF clauses are malleable and can be drafted to suit the wants and needs of the parties involved and are therefore a viable device.
The immediate challenge for carriers will be winning their customers’ hearts and minds to accept revised BAF clauses ahead of IMO 2020’s implementation.
Should you have any questions, please do not hesitate to contact the author of this briefing, which was first publish by ADM Investor Services International Limited in The Ghost in the Machine publication.
- Maximum sulphur limits for fuel burned in ECA zones are already capped at 0.1%.
- Figures used in this sample clause are for illustrative purposes only.