The Diesel Crunch: Why Diesel Prices Are Skyrocketing

Back in October 2005, I wrote an article for predicting that U.S. diesel prices would hit $4 or $5 per gallon within 18 months. I’m not recalling that story to brag. I rarely predict energy prices. And my estimate for when prices would hit $4 was a little premature. It took about 30 months to break that barrier. But it’s worth noting the factors I cited in that column, written shortly after Hurricanes Katrina and Rita. I wrote:
The coming diesel disaster will be caused by several other things that have nothing to do with the weather. Those factors include stringent new federal regulations on sulfur content in motor fuel, a global shortage of refining capacity, and soaring demand for diesel, both in the United States and around the globe.

Today, those factors are not only still in play, they are even more acute. Add in two others – the growing refining imbalance in the European market and the U.S. ethanol mandates – and you have a recipe for sustained high diesel prices.
Given those conditions, I am going to make another prediction: for the next 5 to 8 years, diesel fuel will sell at a significant premium over gasoline. And by significant, I mean in the range of 15 to 30 percent. In late July, according to the Energy Information Administration, diesel was selling for about 15 percent more than regular conventional gasoline. Now that I’ve gone out on a limb, let me explain why diesel prices will remain high.
The first problem, not surprisingly, is due to government regulations. In 2006, U.S. refiners were required to meet the new federal standards for ultralow sulfur diesel U.L.S.D.. Designed to improve America’s air quality, these standards required fuel manufacturers to reduce their diesel’s sulfur to 15 parts per million, from 500 ppm. But in reality, to account for sulfur contamination that might occur during transport by truck, tank, or pipeline the refiners had to produce diesel with a sulfur content of 6 ppm at most. Going from 500 ppm down to 6 ppm is a reduction of about 99 percent. And that huge reduction requires refiners to do more hydrotreating, which means they have to produce more hydrogen, which requires additional equipment, which raises costs and reduces output.
The U.L.S.D. mandates have added yet more complexity to the motor fuel supply chain, and that complexity increases costs. While refiners are producing U.L.S.D., they are also producing conventional diesel that meets the old 500 ppm standard. Thus, the U.L.S.D. must be segregated from the conventional diesel. Add in statespecific blends of diesel and the situation becomes even more complex. California, Minnesota, and Texas are all implementing regulations that will require specific diesel blends for their states. For instance, Minnesota is requiring refineries to add 2 percent biodiesel to their product. Segregating these boutique diesel blends, U.L.S.D., and highsulfur blends means more tanks and pipes, which means more capital investment, which means higher costs.
In 2005, I mentioned the global shortage of refining capacity as a cause of higher diesel prices. This is still true. And while new refineries in Asia are helping to meet demand there, Europe continues to suffer from a lack of the complex refineries that can produce lowsulfur motor fuel as well as handle lowerquality crudes that, given the right upgrading equipment, could be turned into usable motor fuel. This shortage is due in part to the E.U.’s strict environmental regulations, which have slowed refiners’ upgrade efforts. That, in turn, will leave them more dependent on imports of U.L.S.D. According to the Mediterranean Energy Observatory, by 2010 the E.U. will need 100 million tons per year of U.L.S.D. and 40 million tons per year of ultralow sulfur gasoline.
There is also a shortage of refining capacity in South America. And that has led to increasing exports of diesel from the U.S. For instance, in April, U.S. diesel fuel exports averaged 387,000 barrels per day. That’s an almost sevenfold increase from the 59,000 bbl/d exported in April 2007. Overall, refined product exports have also increased. During the first four months of this year, refiners exported a record 1.6 million barrels per day, a 33 percent increase over the yearearlier levels. And February exports exceeded 1.8 MMbbl/d/.
Those exports are indicative of a booming global diesel demand. On July 1, the International Energy Agency released its mediumterm oil market report, which said that the “bulk of oil demand growth” worldwide “will be concentrated in transportation fuels.” It stated that while global gasoline demand is growing, “distillates jet fuel, kerosene, diesel, and other gasoil have become – and will remain – the main growth drivers of world oil demand.” The agency published a graphic that projects stunning demand growth for distillates. Between 2002 and 2013, the I.E.A. expects distillate demand to increase nearly fivefold.
At the report’s presentation in Madrid, Lawrence Eagles, its editor, told reporters, “It’s going to be very hard to keep pace with growth in middle distillate demand.” He went on to say, “At the moment it’s demand for diesel that is driving the increased consumption.” Furthermore, Eagles pointed to the lack of upgrading capacity in many refineries as a reason global demand for crude is rising, as some refiners are aiming to increase their diesel output. The result is that “you are consuming far more oil than you otherwise would.”
While all of those factors are important, perhaps the biggest reason gasoline can be expected to sell for substantially less than diesel over the next half decade or so is the refining imbalance in Europe. Simply put, European refineries are producing too much gasoline and not enough diesel. And they are doing so as European gasoline demand is declining and diesel demand is growing. This increasing demand is largely the result of the “dieselization” of the European auto market. About 30 percent of all vehicles on the road in Europe are now diesels. And by 2015, if current sales patterns continue, about 40 percent of the European motor fleet will be diesel powered.
The result of this shift toward diesel autos is easy to predict. European refiners will have to sell their excess gasoline to the closest market that has lots of gasolinefueled cars and few diesels – and that means the U.S. But there’s a problem with that plan: gasoline demand in the U.S. isn’t growing. In fact, domestic gasoline consumption dropped by 1.7 percent during the first six months of this year. And analysts expect little growth in U.S. gasoline demand over the next decade or so. Indeed, according to the Mediterranean Energy Observatory, by 2015, Europe will likely be producing some 12 million tons of excess gasoline per year, but U.S. imports will only grow by about 2 million tons.
And if gasoline supplies exceed demand by such a wide margin, it can be assumed that gasoline prices will be depressed, particularly when compared to diesel’s.
This imbalance between gasoline and diesel is being exacerbated by a familiar boondoggle: the ethanol scam. At the same time that European and American refiners face an excess of gasoline, the ethanol mandates are adding more fuel into the U.S. gasoline pool. This year, U.S. corn distilleries will likely produce about 9 billion gallons of ethanol, and every gallon of that product makes gasoline more plentiful, while doing nothing to slow demand for the products that we need most, namely middle distillates like jet fuel and diesel.
All of these factors have led European analysts to expect that the disparity between gasoline and diesel will continue for several years to come. JeanFrancois Lariv’e, a technical coordinator with the European Oil Company Organization for Environment, Health and Safety, participated in a 2007 study of the refining imbalance problem. In early July, he told me that the trend now underway “cannot reverse because all the new demand is coming from diesel.” As for the pricing disparity between gasoline and diesel, he said that it may even “get worse.”
In other words, the diesel crunch has just started. And the inflationary effects of the higher costs of diesel fuel are going to be felt throughout the U.S. economy and the global economy for years to come. .

© 2013 Energy Tribune

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