Ever since the International Maritime Organization said the maximum sulfur content in marine fuel must drop to 0.5% from 3.5% from 2020, shipping companies have been wrestling with how to comply without driving up costs at an uncertain time for global trade.

Some shipowners are installing exhaust cleaning systems known as scrubbers so they can continue to use high-sulfur fuel and some are switching to low-sulfur marine diesel, but all expect a period of turbulence when the “IMO 2020” rules come in.

Investors in turn are coming up with strategies and launching funds with exposure to parts of the oil and shipping industries they expect to benefit from the new emissions caps.

John Kartsonas, managing partner of Breakwave Advisors, said while broader concerns about trade have dented investors’ views on shipping, IMO 2020 was likely to drive freight rates higher.

Breakwave launched an exchange-traded fund last year to invest in dry bulk freight derivatives, hoping to benefit from IMO 2020.

“Rarely you see such a potentially massive disruption,” said Kartsonas. “Delays, a reduced active fleet supply, slow steaming and port congestion can push freight rates to decade highs, and beyond.”

The Baltic Exchange’s main sea freight index, which tracks rates for ships carrying dry bulk commodities, slumped after the financial crisis to 700 points from a record 11,793 points in 2008. It’s now about 1,500 points. .BADI

Dry bulk ships make up more than a fifth of the world’s ocean-going vessels and many are among the most polluting ships.

DERIVATIVE BY DESIGN

At hedge fund Svelland Capital in London, one strategy is to focus on petroleum products likely to be affected by the rules.

“IMO 2020, together with the ballast water treatment, will turn shipping upside down and create supply shock,” chief investment officer Tor Svelland said.

Svelland Capital is launching an “IMO direct exposure fund” in July aimed at investors who want to take positions based on IMO 2020, but are less familiar with oil derivatives.

“This is the largest regulatory change in the oil space ever and it will have a massive effect far outside of shipping,” said the fund’s portfolio manager Kenneth Tveter.

For now, there is no consensus on whether there will be enough low-sulfur fuel to meet demand come 2020. Of the roughly 60,000 vessels worldwide, industry consultants estimate only 3% to 5% are likely to have scrubbers by 2020.

It is also unclear what will happen to demand for high-sulfur fuel - all of which means the price gaps between different fuel grades, as well as the different types of crude used to make them, are likely to change.

“You can try and pick winners in the shipping segment of the equity markets, but to get a pure play you need the derivatives market,” Tveter said. “The new fund will look at all the parts of refining that will be affected by the new regulations.

In another sign of the impact of IMO 2020, China said on July 4 that it planned to launch a futures contract for low-sulfur fuel oil by the end of the year.

REFINING REFINING

Dutch asset manager Robeco is also focusing on fuel, but it’s investing in oil refineries that are well-placed to produce large quantities of low-sulfur diesel.

“We are invested in refiners since earlier this year and this has been one of the drivers for that investment,” said Fabiana Fedeli, global head of fundamental equities.

Robeco is selecting so-called complex refineries, plants with lots of units that can turn low-value fuel oil into higher-value products such as distillates, octane and low-sulphur fuel.

Fedeli said concerns about disruptions to global trade had weighed on refining margins and related stocks this year, but IMO 2020 could change that.

“We expect that the impact on refinery margins will become tangible from late Q3 2019 when ships are likely to begin shifting to compliant fuels,” she said. “Interestingly, this is still not reflected in diesel crack futures.”

Alistair Way, head of emerging market equities at UK asset manager Aviva Investors, said refineries that have invested to produce more compliant fuel would benefit.

He said Asian refiners such as Thai Oil (TOP.BK) and S-Oil (010950.KS), were well placed as they produced a bigger than average proportion of middle distillates and had less exposure to high-sulfur fuels.

Hedge fund CF Partners in London is focusing on price gaps between different crudes. It expects sweet crude with higher levels of distillates such as Nigeria’s Bonny Light or U.S. shale to be more in vogue than heavier, sour crude.

SCRUB THAT

CF Partners is also getting exposure to U.S.-flagged ships known as Jones Act carriers after a law requiring goods shipped between U.S. ports to be transported in U.S. vessels.

Elvis Pellumbi, manager at CF Partners, said it was buying stocks in shipping firms such as Overseas Shipholding Group (OSG.N). Pellumbi’s fund has $400 million under management, of which 30 percent is investments related to IMO 2020.

George Kaknis, portfolio manager at hedge fund LNG Capital, said he was looking at shipping firms such as American Shipping Company (AMSCA.OL), on the basis IMO 2020 would boost demand for U.S. shale - and Jones Act tankers would benefit.

“The more shale is produced out of the U.S., the more these guys are kept busy and the more the day rates go up,” he said.

According to data from Symmetric, which tracks investment funds, hedge fund ownership of some shipping stocks rose in the first quarter. Their ownership of Nordic American Tanker (NAT.N) rose to 12% from 8% in the fourth quarter last year, while hedge fund stakes in DryShips (DRYS.O) rose to 13% from 5%.

Other shipping firms investors said they were looking at with IMO 2020 in mind include Scorpio Tankers (STNG.N), Navios Maritime Acquisition (NNA.N), DHT (DHT.N), Frontline (FRO.OL) and Euronav (EUAV.BR).

While some shipowners have installed cleaning systems, others see them as potentially high risk as some ports have already banned or restricted scrubbers that pump waste water into the sea, and more may follow suit.

Some investors say the upfront cost of installing scrubbers - about $2 million to $3 million each - also means it would take longer for them to pay off, especially if the price gap between low and high-sulfur fuels narrows.

“We don’t believe that those who have invested in scrubbers will achieve the amazing returns they have been advertising,” said Pellumbi at CF Partners. “Refiners have/are adapting their production slates to produce more of the right product.”