Paying a Premium

Oil prices of $140 a barrel will naturally apply significant upward pressure on all transportation fuels, but diesel prices have ballooned relative to gasoline in recent times. High global demand and slow-to-catch-up diesel refining capacity are largely to blame, so what's being done about it?
By Ron Kotrba | August 08, 2008
American Petroleum Institute top brass Red Cavaney, in a speech at the United States Energy Association's Energy Supply Forum in mid-July, said sustaining 3 percent annual growth in the global economy through 2030 would require an expansion of crude oil production equivalent to the amount currently consumed by the United States and China.

Clearly something has to be done including discovering and refining more crude oil, implementing environmentally sound recovery methods, increasing sustainable production of alternatives and modifying driving habits. Biodiesel is a small important part of the overall solution. Its lifeblood is in the diesel markets, so when U.S. truckers and trucking associations support biodiesel, it helps. If U.S. passenger vehicle drivers would tune into the increasing availability of diesel cars and trucks, that would be even better.

In the United States, the affinity for cars run on gasoline is engrained in the culture but it's an anomaly on the global scale, as diesel cars and light-duty trucks are much more common elsewhere except in countries such as Brazil, where government directives over the past 25 years gave ethanol from sugarcane a tremendous foothold in the transportation fuels markets. Historically in the United States, the price of a gallon of diesel fuel was consistently lower than gasoline. This was the case until a few years ago and begs the questions why, and will this situation continue?

"The days of diesel costing less than gasoline are gone," says Allen Schaeffer, director of the Diesel Technology Forum. "Going back to 2004, diesel was always less expensive than gasoline. About that time you see this confluence of factors in the global market that changed this. For a consistent number of years, we were exporting distillate fuel to Europe to satisfy their demand, and they were [exporting] gasoline to us to satisfy our demand, so we had a situation where diesel fuel prices were typically less than or on parity with gasoline on a consistent basis. Things have really come together on the global oil market. In the developing countries, their appetite for distillate products is now the major determinate for where the price is today, with the crude price being at the heart of that. Distillate fuel is a much more global fuel than gasoline."

Over the past year, the average price of gasoline increased $1.12 a gallon in the United States while diesel fuel skyrocketed with an increase of $1.81, according to the U.S. Energy Information Administration.

Europe's Growing Product Imbalance

Middle distillates include jet and distillate; 2006 is January-October average.
INTERNATIONAL ENERGY AGENCY


U.S. gasoline demand in May was down 1.4 percent from a year ago, according to API, which stated this was the "first gasoline demand drop for the January-May period since 1991." On the contrary, May deliveries of distillate fuel oil rose 5.5 percent from May 2007 to a record-setting 4.3 million barrels per day for the month. API says the reason for this was "a big rise in low-sulfur diesel demand." The demand for jet fuel also rose more than 5 percent in May. "If you have an entire refining system in the U.S. that is optimized to produce gasoline but the demand for gas isn't there so much, and demand for diesel is really high but the supply is not that great, that's going to lead to a price run-up," Schaeffer says. Ron Planting, API information and analysis manager, says "Gasoline demand has weakened with higher prices, but diesel demand has proved to be more resilient. The needs of highway freight transportation are inherently less flexible than consumers' travel behavior."

A commentator for Bloomberg News, John Berry, even wrote in July that a possible cause for the high per-barrel price of crude today is the demand for diesel fuel-the tail wagging the dog, in a manner of speaking. Regarding the reduction in U.S. gasoline consumption, Berry writes "The ethanol mandate is accomplishing its mission, reducing how much gasoline gets used in the [United States]. Gas prices in excess of $4 a gallon are doing the same. As we've seen, however, the side effect of less gasoline consumption is less production of diesel-and more pressure on crude oil prices."

The 1.4 percent reduction in gas consumption in the United States has nothing to do with ethanol blending, says Cindy Schild, API manager of refining issues, downstream. "Ethanol is included in the finished gasoline statistics so increased ethanol production does not impact reduced U.S. consumption because it's accounted for as part of
the product," Schild tells Biodiesel Magazine. "When refiners take a barrel of crude they are never going to not produce gasoline and they are never going to not produce diesel. They can try maximizing yields a bit by configuring the refinery accordingly." Historically in the summer refiners dial up gasoline production, and in the winter they scale up heating fuel oil. Schaeffer says there is about a 7 percent adjustment range in most refineries, which provides flexibility in the system to produce more or less of any given product.

Confluence of Factors
Diesel demand from Europe, China, India and elsewhere has led to the rise in diesel fuel prices surely, but other phenomena may be playing a role. "It's a volatile circumstance and this year is really weird," Schaeffer says. "You've got people talking about China stockpiling diesel fuel to run their power plants and factories months in advance of the Olympics to help clean the air there. That's kind of a one-time shot." Schild says while she hasn't heard of this, China is a ubiquitous major player in international bidding. "They are trying to do everything they can to ensure their citizens have product," she says. "So every time you see a new bid for something, China is there, whether it's in Latin America, Canada or anywhere else."

Also this year there was a five-year low in inventory for distillate fuels coming out of the home heating oil season, and Schaeffer says anomalies coming out of normal distillate fuels production and consumption, coupled with the economic conditions overseas and drive for more distillates, has led to diesel demand going through the roof when supply is not at its full potential. Schild says in mid-July U.S. refiners were utilizing 91.4 percent of their production capacity. "That's actually pretty high," she says. "For most manufacturing industries the norm is 80 [percent] to 84 percent. Ours being above 90 percent is really high." Earlier this year productive capacity utilization was lower though. "When people were asking why utilization was so low, it was like, well, a squirrel jumped into one thing, lightning hit another, so it was an odd year for those kinds of Mother Nature events," Schild says.

At this point, the added cost to produce ultra-low sulfur diesel (ULSD), which EPA predicted would cost between 6 and 10 cents per gallon to make the switch, is imperceptible. "If you look at historical diesel fuel prices you'll see an up-tick around the June 2006 time frame, which would make sense because that's when refiners were required to put ULSD in the pipelines," Schaeffer tells Biodiesel Magazine. "Certainly ULSD fuel does cost more and if you've pegged it at 10 cents a gallon more, that's still a long way from where we are today with the premium over gasoline." According to Schild, U.S. refiners produced 13 percent more ULSD this year than last year and they have had to supply 80 percent of domestic on-road ULSD as opposed to importing a majority of the more-refined fuel oil. "That's increased prices as well," she says.

White House Addresses Permitting Issues
A policy memorandum from the White House in mid-June states there are 149 refineries operating in the United States today, and some of those are undergoing expansions or extensive modifications to adapt to changes in demand and changes in fuel output. "Demand for petroleum-based gasoline is expected to decline by about 7 percent over the next 15 years while demand for diesel is expected to increase about 12 percent over the same time," the policy document states. It goes on to address concerns about permitting to expand refinery production. "[Multiple authorities and requirements] leads to excessive and uncertain timeframes for permit reviews, and the potential for conflicting permitting requirements," according to the documents. "Completing the permitting process can take three to five years. Permits that are approved may be the target of lawsuits. The protracted appeals process introduces additional timing uncertainty. Uncertainty and delay adds further strain on supply and can lead to increased costs to consumers." The memorandum then suggests Congress pass legislation to expedite judicial review of energy projects by directing legal challenges to be brought before the U.S. Court of Appeals in Washington, D.C., within 60 days of the issuance of a permit decision.

"From our standpoint the industry has been producing record amounts of diesel this year, it's increased over last year even while having to make ULSD, and we have plans in place to try to bring more on line to meet those needs," Schild tells Biodiesel Magazine. "At the same time we keep facing challenges at every turn, whether it's on a pipeline or refining expansions even though we're meeting the applicable regulations, so there's an effort by the industry to bring more capacity on line and there are projections for it to happen-they've just got to allow it to happen." The "they" she refers to are the bureaucratic regulators, claimants and protesters holding all the hoops through which the oil companies must jump to move ahead with refinery expansions and modifications.

What's Being Done?
While no new refineries have been built in the past 30 years, expansions at existing refineries continue despite the aforementioned regulatory concerns. It costs approximately one-third less to expand an existing refinery than to build a new one, according to the Industrial Commission of North Dakota. The following is a taste of what oil companies are doing in the United States to increase the diesel fuel supply.

ConocoPhillips Co. has plans to increase coking operations at its Borger and Wood River refineries in Texas and Illinois, which would boost diesel fuel production.

Marathon Oil Corp. has indicated it plans to step up diesel production at its refinery in Garyville, La., on the eastern bank of the Mississippi River. According to the company, the project will add 180,000 barrels per day (bpd) of refining capacity boosting total capacity to 425,000 bpd. Slated for completion by the end of 2009, the project will cost $3.2 billion. The company says it's expanding its production because the European refinery system will not be able to meet the projected demand for diesel. Schild says in addition to these projects by ConocoPhillips and Marathon, Motiva Enterprises LLC has a coker hydrocracker project that would increase diesel production.

Valero Energy Corp. is undergoing expansion at its St. Charles, La., refinery 15 miles from New Orleans, to expand ULSD production by 49,000 bpd. In May, CountryMark's Mount Vernon, Ind., refinery completed a $20 million renovation to produce an additional 45 MMgy of fuel, a total production increase of 12 percent-most of which is diesel fuel. "We're committed to increasing the supply of diesel fuel since there's a real, growing need," says Matt Smorch, CountryMark refinery manager. "Diesel fuel is a big part of our business, especially our ag and off-road business. Anything we can do to get more diesel fuel into the marketplace benefits everyone."

In Mandan, N.D., Tesoro Corp. is expanding its refinery to produce more diesel fuel. "Tesoro is using sales tax incentives to improve its reliability and increase low-sulfur diesel fuel production at the Mandan refinery," according to the NDIC North Dakota Pipeline Authority. Schild says overall Tesoro plans to increase its distillate yields by 19 percent this year alone. "The money right now is in distillate products," Schaeffer says, which is why refineries are expanding to produce more diesel-making distillates the undeniable king fuel.n

Ron Kotrba is a Biodiesel Magazine senior writer. Reach him at rkotrba@bbiinternational.com or (701) 738-4942.
 
 
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