Diesel price premium will continue in 2006

By James Haughey, Director of Economics, RBI -- Logistics Management, 12/5/2005

BOSTON—The oil market has finally settled into a near-normal balance with generally adequate supplies and reasonably stable prices. However, this is an unfavorable situation for diesel users that is unlikely to change significantly during 2006.

Diesel pump prices averaged $2.51 per-gallon in late November—$0.31 above gasoline. The diesel premium ranged from $0.20 in the largely isolated California market to $0.50 in the New England market, which is heavily dependent on imported supplies. This premium will persist through the next year with the same regional variation.

The diesel price premium over gasoline is being supported by three forces that boost diesel but not gasoline prices. The first is the political pressure to label more distillate heating oil instead of diesel. That contributed to the current generous inventories of heating oil which are 10% higher than a year ago.

The second is the loss of diesel fuel imports from Europe that was caused by the progressive shift to diesel cars in Europe. Half of the cars in Europe now have diesel engines, turning Europe into a modest net importer of diesel instead of a large exporter—and the preference for diesel engines continues to expand.

The third also involves engines and will be a significant price booster in 2006. The mandated 90% plus decline in the sulfur content of diesel next summer raises refiners production cost and reduces diesel mileage in the new engines required for this low sulfur diesel fuel. Remember that the new, emission-reducing engines required in 2002 used more fuel until they were retuned.

Diesel inventories are currently dangerously lean, more than 2% below a year ago, so prices could temporarily soar in the event of unseasonably cold weather—supplies diverted to heating oil. Fortunately, the heating season began unseasonably warm in September and October

For the long run, refiners in the U.S, the Caribbean, and Europe are working to produce more diesel fuel from each barrel of crude oil; but this will be a several year process which includes the addition of expensive, hydro-cracking capacity.