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4. Fuel Quality and Availability
Given the recent but consistent differences in diesel prices relative to gasoline prices, consumer interest in light-duty diesel vehicles may be influenced by expectations of a continued large price premium for diesel fuel. The recent premium can for the most part be attributed to an imbalance of supply and demand for the two fuels both in the United States and abroad. In particular, the growth of diesel demand and decline in gasoline demand in Europe, which exports much of its excess gasoline to the United States, has kept and will continue to keep pressure on the price differential between diesel fuel and gasoline.
Until 2005, gasoline prices usually were higher during the summer months as a result of higher demand associated with the summer driving season, whereas diesel prices typically were higher during the fall and winter months because of demand for heating oil and diesel use in farm equipment for harvesting. In 2005, a tightening of the distillate market,56 coupled with a loosening of the gasoline market, especially within the Atlantic Basin (i.e., the United States and the European Union), was becoming apparent. The growing market shifts led to a large and persistent price differential. Some of the diesel price premium can be attributed to costs associated with the transition to ULSD for highway freight fuel here in the United States, especially from 2005 to 2006, when the transition to cleaner diesel was just beginning.57 As detailed below, however, it is the increasing demand for distillate relative to demand for gasoline that plays the major role in determining the price differential.
Although the price impact of growth in distillate demand relative to gasoline demand was not reflected in retail prices until 2005, worldwide supply and demand imbalances had been occurring before 2005 (Figure 4.1). A major contributor to the growth in world distillate demand has been increased consumption in developing nations. For example, the power industry in South America (in particular, Chile, where a drought has curtailed hydropower output) has recently increased its reliance on diesel fuel.58 China also has seen a dramatic increase in distillate demand (accompanied by an increase in diesel imports) as a result of its rapid economic growth in recent years and its buildup of distillate stocks in preparation for the 2008 Olympics. In India, where there is an effort to boost refining capacity, distillate supplies will continue to be tight in the near term because of the large growth in electric power demand, which in the face of limited growth in refining capacity growth has led to growing use of small generators that burn diesel fuel.59
Increased distillate demand in the United States is correlated with economic growth and the associated increase in freight traffic. More significant, however, is the fact that U.S. distillate demand has been increasing at a faster rate than motor gasoline demand since 2002, as evidenced by highway diesel consumption that grew by about 3 percent per year from 2002 to 2007 (overall distillate demand grew by 2 percent per year) while gasoline consumption grew by 1 percent per year.60
The U.S. refining industry has tried to keep pace with the shift in petroleum product demand. From 2002 to 2007, net production of distillate fuel by domestic refineries and blenders increased by 15 percent, while production of highway diesel fuel increased by more than 33 percent.61 The growth in production was only slightly higher than the increase in demand for distillate and diesel fuel over the same period. U.S. refineries have adapted to the shift in product demand by producing more distillate and less gasoline—mostly through operational changes, as opposed to major plant additions. From 2002 to 2007, the yield of gasoline products fell by more than 2 percent, while the yield of distillate products increased by almost 3 percent.62
The shift in product yield has allowed U.S. refiners to meet growing distillate demand without relying solely on increasing the amount of crude oil throughput. As a result, many refineries have been able to take economic advantage of the growing demand for diesel in recent years. The relative shortage of production capacity, however, has put strain on the refining industry.63 U.S. gasoline production has increased by about 3 percent over the same period, and to meet the 5-percent growth in gasoline demand over the period, motor gasoline imports, in particular from Europe, have been increasing. Europe’s increasing ability to supply (and, in the future, perhaps to oversupply) the North American gasoline market is a key factor in the price differential between diesel and motor gasoline.
The most prominent force in changing the dynamics of petroleum product markets has been growing demand for diesel fuel to supply the growing diesel component of the European Union’s light-duty vehicle fleet, which together with declining demand for gasoline in Europe has led to a tighter diesel market and a looser gasoline market in the Atlantic Basin. The shift in the European transportation fuel market is illustrated in Figure 4.2, which shows the rapidly increasing consumption of diesel relative to gasoline. Since 1997, demand for diesel fuel and heating oil has increased by 15 percent, while demand for gasoline has fallen by 22 percent.64
With refineries in Western Europe struggling to keep up with diesel demand, European imports of diesel fuel are on the rise. In fact, the International Energy Agency (IEA) projects that, despite efforts to expanded middle distillate production capacity, Western Europe will remain a net importer
of diesel at least through 2013.65 On the other hand, limitations on refinery yield have created an excess of lighter naphtha products and gasoline in Western Europe. The United States has served as a large export market for the excess gasoline, as evidenced by an increase in net imports of motor gasoline (finished and blending components) from 335 thousand barrels per day in 2004 to 559 thousand barrels per day in 2007.66
In the future, the supply imbalance for petroleum products, especially in the Atlantic Basin, may continue to exacerbate the diesel price premium. Worldwide, distillate supplies are likely to remain tight for some time, and Europe is likely to continue importing distillate well into the future (although some additional supply should become available as refining capacity both in Asia and the Middle East continues to grow).67 At the same time, the Atlantic Basin probably will continue to be awash in gasoline from European refineries, thereby continuing to put downward pressure on U.S. gasoline prices.
Petroleum distillate demand in the United States is also expected to grow in the medium to long-term, while petroleum gasoline demand is expected to fall (Table 4.1). The expected decline in gasoline demand would be driven largely by more stringent CAFE standards and mandated use of biofuels, particularly ethanol, which displaces motor gasoline. The opposing demand trends could support or even increase the diesel price premium well into the future.
In Europe, biofuel production is geared more toward biodiesel than ethanol, which is consistent with the expected long-term growth in product demand. In the short term, however, the IEA projects that biodiesel consumption will reach only about 1 percent of global gasoil consumption by 2012,68 and it is widely agreed that the incremental increases in biodiesel production both in Europe and elsewhere will continue to be small relative to the growing demand for distillate fuel.69, 70
Although much of the projected increase in U.S. distillate demand is expected to continue to be met with operational changes at U.S. refineries, many refiners have also expressed optimism about a host of technologies involving new diesel catalysts71 that will further increase diesel yields, as well as the use of specialized cokers to upgrade heavy bunker fuel efficiently to diesel fuel.72 Given the expected increases in future distillate demand, as well as the long-term potential profitability of diesel relative to gasoline, some refiners are making concerted investments in boosting diesel production. Some current refinery expansions are geared toward producing more diesel fuel. For example, Marathon’s refinery in Garyville, Louisiana, includes the addition of a 180,000-barrel-per-day hydrocracker, and Motiva’s large expansion of its Port Arthur refinery73 will allow for greater flexibility in switching from light product (gasoline blending components) to diesel. In addition, ExxonMobil recently announced that it would invest more than $1 billion to increase its global diesel production by 10 percent.74
As a whole, the role of alternative fuels in relieving tight distillate markets in the future may be limited. Biodiesel, made from soybean oil or grease feedstocks, is not completely fungible with petroleum diesel, and its content in diesel fuel is often limited to 5 percent (7 percent in Europe). Renewable diesel, which is created by hydrogenating vegetable oil, is completely fungible with petroleum diesel. BTL fuels (which EIA projects to grow to 5 billion gallons per year of domestic production by 2030) are created via the same Fischer-Tropsch process used to make CTL fuel, and they also are completely fungible with petroleum-based diesel. Biodiesel production, however, has a much lower capital cost, because renewable diesel production requires the acquisition or production of hydrogen gas, and BTL production requires a gasification reactor. Thus, biodiesel is more prevalent.
In the United States, the Energy Independence and Security Act of 2007 mandates consumption of 0.5 billion gallons of biodiesel in 2009 and 1.0 billion gallons in 2012 and thereafter. Renewable diesel, for which there is no specific mandate, can be used to meet part of the overall requirement for advanced biofuels, and BTL counts toward the cellulosic portion of the renewable fuels mandate. Although biofuels could make a significant contribution to diesel supplies, there is significant uncertainty about the capital and variable costs of renewable fuels projects; and because refinery investments require long lead times and planning, their impact may not be realized for many years. In addition, the future of biofuels is vulnerable to sustainability issues with regard to land use and the potential displacement of food crops. CTL and GTL production of diesel fuel also could help to alleviate diesel supply issues, but the future of CTL is highly speculative, given the capital-intensive nature of CTL projects, their significant GHG emissions and other environmental concerns, their low energy efficiencies, and their water use.
Another issue of particular importance to future distillate supplies is marine bunker fuel regulations mandated by Annex VI of the International Convention for the Prevention of Pollution from Ships
(MARPOL).75 The key goal of the Annex VI amendments is to set a timeline for the reduction of sulfur in marine fuels.76 The current global limit for sulfur content in marine bunker fuel is 4.5 percent, and the treaty mandates that the limit be reduced to 3.5 percent in 2012 and 0.5 percent by 2020 or 2025, depending on the future feasibility of obtaining the goal. In addition, there is a provision for Sulfur Emission Control Areas, which are coastal areas, often near populous ports, where even more stringent sulfur limits can be applied. The United States is a signatory to the 1997 MARPOL Annex VI international agreement, including the amendments ratified in 2008.
Lowering the sulfur content of bunker fuel would necessitate either the use of desulfurized marine diesel and gasoil as ship fuel or a massive investment by shippers in exhaust scrubbers to continue using high-sulfur marine bunker fuel. Given the tightening supply of diesel, potential new demand for more diesel to fuel marine freight travel would bring additional pressure on diesel supplies, further increasing the price differentials between distillate and other petroleum fuels. In addition, although marine bunker fuel makes up less than 5 percent of total global petroleum product consumption, it nevertheless has served as an important market for high-sulfur heavy residual fuels. One potential solution would be for refiners to invest in heavy residual conversion projects to break down residual oil into middle distillates. The capital and operating costs associated with such conversion projects would be high, however, and they would be passed on to ship operators. As a result, the ultimate affect of the MARPOL agreement on diesel supply is uncertain.
Finally, the possibility of a low-carbon fuel standard (LCFS), currently being considered in California, could provide a price advantage for diesel fuel.77 From a refiner’s perspective, production of diesel fuel may have an advantage within a carbon tax or a cap-and-trade regulatory framework. For example, a 2005 study of the European refining industry78 demonstrated that, on average, refineries producing diesel emitted about one-half the CO2 emitted by refineries producing naphtha/gasoline streams. Because European refineries are configured somewhat differently from their American counterparts (to produce more distillate), GHG emissions in the processing may be different; however, given the savings in GHG emissions from diesel refining and vehicle operations described above, a national LCFS framework probably would narrow the price differential between diesel fuel and gasoline and provide incentives for diesel car purchases. Notes |
