The Dope On Diesel

Market conditions and other factors drive up the price of fuel for heavy trucks and equipment. Expect prices to remain high in the foreseeable future.

Diesel prices have been taxing for municipalities and utilities and anyone else who depends ­on diesel-powered equipment and trucks. From July 2007 to July 2008, the national average price of diesel fuel in the United States increased 65 percent from $2.89 to a record $4.76 per gallon before dropping slightly.­

And forget the traditional price advantage that diesel once had over gasoline. During midsummer, the average retail price of diesel was 66 cents higher than that of regular gasoline.

The reason for the rise in diesel prices comes down to supply and demand. Supplies are limited by diminished refinery capacity and areas of strife in oil-producing regions. And demand is up all over, especially in China and India, where construction is ramping up and more people are driving cars. And demand for diesel is growing over gasoline because it is the fuel of choice for autos in Europe and elsewhere.

While the experts say a little price relief may come, it’s not just around the corner. They say fuel prices will probably never drop to where they were a few years ago.

If there is any good news, it is that analysts with the U.S. Department of Energy’s Energy Information Administration (EIA) expect the rate of increase in diesel prices — about 40 percent during the first half of 2008 — will taper off significantly between now and the end of 2009. But that’s barring further changes in crude oil supplies or demands — a big if these days.

A closer look

Supply and demand issues have affected the petroleum industry in general. Lucian Pugliaresi, president of the Energy Policy Research Foundation, said at a May hearing before the U.S. House of Representatives: “Over the last 10 years, the world oil market has clearly experienced an unprecedented number of new and sustained impediments to development. At the same time, global oil demand has grown robustly.”

Ben Montalbano, a senior research analyst for the foundation, adds, “It’s basically a matter of supply and demand forces at work, but the main point to realize is that demand for diesel is being met. There have been no shortages.”

­Diesel is one of several middle distillates refined from crude oil. The price of No. 2 distillate, the main source of motor diesel fuel in the U.S., is affected by various factors, the largest being the price of crude oil, which accounts for nearly two-thirds of the retail price. “The rule of thumb is that every one-dollar change in the price of crude results in a 2.4-cents-per-gallon change in the price of diesel,” says Tancred Lidderdale, a senior economist with the EIA. The price of crude oil, in turn, is affected by various factors.

Growing demand. World oil consumption continues to grow despite seven consecutive years of increasing prices, the EIA reports. Rising incomes in many areas of the world, including India and China, have increased the demand for diesel significantly. In fact, most countries rely more heavily on diesel fuel than the U.S. does. Government subsidies for gasoline and diesel have also pushed up demand for crude oil.

Tight supplies. The oil market remains tight, as shown by rising prices, low surplus production capacity, and concern that global supply growth may not keep pace with demand growth, at least in the short run. Two years ago, the U.S. consumed 20.7 million barrels of petroleum products a day, 60 percent imported. Almost half the imports came from the Western Hemisphere.

Today the EIA estimates the world supply of crude oil at 86.5 million barrels per day. “The market these days is calling for just about all of that supply immediately,” says Montalbano. What’s more, he notes, world oil supplies are about 2.5 to 4.5 million barrels per day less than predicted at the beginning of this decade.

Risks to production. The price of diesel is also tied to the actual and perceived risks of a reduction in supplies of crude or refined oil. Those risks range from war and weather-related threats at production and transportation facilities to government policies affecting development of oil resources. The higher the risks, the more money oil investors and buyers demand.

Cleaner-burning fuels. The phase-in of U.S. EPA standards to reduce sulfur content in diesel fuel helped pressure diesel prices upward, according to the EIA. These standards require all on-highway diesel fuel sold in the U.S. to be ultra-low-sulfur diesel (ULSD) by Dec. 1, 2010. Phasing in of clean-fuel requirements for off-highway began last year. Nearly all diesel fuel used in the U.S. must be ULSD by the end of 2014.

Market speculators. Rising crude oil prices have prompted calls in the U.S. Congress for closer scrutiny of trading in oil futures contracts and for limiting the role of speculators. As the value of the U.S. dollar has fallen, says Tavio Headley, staff economist with the American Trucking Associations, investors have been buying petroleum futures contracts as a hedge against inflation. “The big question is how much this is contributing to the run-up in crude oil prices,” he says. “The federal Commodity Futures Trading Com-­mission is looking into the matter.”

No sudden price decreases

Historically, the pump price for diesel has been lower than that of regular gasoline, except during some winters when demand for heating oil was high. However, since fall 2004, diesel prices have generally been higher than gasoline prices. One reason is an increase in federal tax on diesel fuel. Another is increasing global demand.

By late summer, there were signs of moderation in diesel fuel prices. In July, EIA analysts projected the rate of increase in the spot price of West Texas Intermediate (WTI) crude oil to be moderate, peaking at $140 per barrel in the fourth quarter before declining to $127 by the fourth quarter of 2009.

Analysts expected a similar trend in the refinery price of diesel fuel, rising from $3.67 per gallon in the second quarter to $4.01 in the fourth quarter, then falling to $3.53 by the fourth quarter of 2009.

In their July 2008 Short-Term Energy Outlook, the analysts reported, “WTI prices, which averaged $72 per barrel in 2007, are projected to average $127 per barrel in 2008 and $133 per barrel in 2009. Diesel fuel retail prices in 2008 are projected to average $4.35 per gallon, up from $2.88 per gallon last year, and increase to an average of $4.48 per gallon in 2009.”

EIA’s Lidderdale observes, “We don’t see the global forces pushing up oil prices over the past four years letting up immediately. There’s always a certain degree of uncertainty in the world oil market. So many things can happen to prove us wrong.”



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