Diesel prices have been taxing for onsite installers 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 a week or so later.
And forget the traditional price advantage that diesel once had over gasoline. During midsummer, peak-demand time for many installers, 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 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 — which increased 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.
Even then, the EIA says, diesel prices on the West Coast tend to be higher and more variable than elsewhere in the country. That reflects higher state and local taxes and relatively few refineries, which can lead to tight supplies and higher prices, if more than one experiences operating problems. In addition, transportation costs increase with long distances from refineries in other countries and from the Gulf Coast, source of nearly half the diesel produced in the U.S.
The price of crude oil, in turn, is affected by a number of other 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 other countries rely more heavily on diesel fuel than the U.S. does.
“There’s been a huge worldwide increase in oil demand, particularly in developing countries,” says Tavio Headley, staff economist with the American Trucking Associations.
Demand is also being driven by other factors, Headley reports. China, for example, stockpiled diesel to power backup generators to provide electricity for the summer Olympic Games in case of power grid problems. The country also has been using diesel fuel to power equipment for repairing damage in the Sichuan province caused by an earthquake in May.
Government subsidies for gasoline and diesel have also pushed up demand for crude oil. “These fuels are heavily subsidized in many countries,” says Montalbano. “In Venezuela, motorists are paying 12 cents a gallon for gasoline. In a lot of the oil-exporting countries in the Middle East, the pump price for gasoline is about 40 to 50 cents per gallon.”
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 per 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. Montalbano attributes that to a variety of factors, including:
• Attacks by rebels on Nigeria’s oil infrastructure.
• Fighting in Sudan, which has slowed development of new production in many oilfields.
• Declining oil production in Argentina since the country’s oil sector was nationalized in 2004.
• Forced renegotiation of contracts with foreign oil companies by Kazakhstan, which could hinder investment in oil production in that country.
• Declining oil production since 2004 in Mexico, where lack of funding for the country’s state-owned oil monopoly, Pemex, prevents exploration and development of new fields.
“The refining capacity for diesel and other middle distillates is just about maxed out,” says Montalbano. “There will be significant new capacity in the next two years, which might, depending on crude oil prices, ease the refining burden.”
In 2002, OPEC-member countries had an excess oil-pumping capacity of 5.8 million barrels per day. That has fallen to about 2 million, says Montalbano. “Saudi Arabia has increased production twice in the past few months, and fuel prices still continued to go up, partially because Middle Eastern demand for crude has risen quickly,” he says.
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.
“These risk premiums are more of a factor than they were several years ago,” Headley notes. In fact, risk factors conspired around midyear to cause crude oil prices to swing wildly. Over a three-day period in July, oil spiked 8 percent from $136 per barrel to a record $147. The reasons included fears of possible disruptions in supplies caused by tensions between the U.S. and Iran, the threat of a strike in Brazil, and another drop in the value of the U.S. dollar against other major currencies. Five trading days later, crude had fallen by almost 11 percent to $131, the biggest one-week drop ever, as fears subsided.
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. In the meantime, the costs of preventing or correcting any contamination of ULSD with higher-sulfur diesel, and the higher costs of producing ULSD, could continue to influence prices, the EIA reports.
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. Critics charge that speculators are manipulating oil prices. As the value of the U.S. dollar has fallen, says Headley, 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 Commission is looking into the matter.”
Diesel overtakes gasoline
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.
European countries, for example, have used taxes to encourage use of cleaner-burning diesel over gasoline. This has resulted in excess production of gasoline in that part of the world, notes Montalbano. “When you refine crude oil into diesel, you also produce a certain amount of gasoline,” he says. “There’s not enough demand in Europe for all this gasoline, so they export it to the U.S. Those imports have helped keep gasoline prices in the U.S. from rising as much as they would have otherwise.”
No sudden price decreases
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 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.” The higher prices reflect demand for diesel, particularly in emerging markets, which has significantly increased the margins between diesel prices and crude oil costs from those of last year, the analysts noted.
Lidderdale attributes the slowing price increases through the rest of this year and into early next year to increased production in the U.S. as two oil platforms in the Gulf of Mexico come on line, and to new production in Brazil and the Siberian region of Russia.
However, he advises caution. “There’s always a certain degree of uncertainty in the world oil market,” he says. “So many things can happen to prove us wrong.”
Greg Northcutt is a freelance writer based in Port Orchard, Wash. He can be reached by e-mailing this publication at editor@onsiteinstaller.com.
