# Presentation: 763718

## Can U.S. Supply Accommodate Shifts to Diesel-Fueled Light-Duty Vehicles?

**Joanne Shore**
**John Hackworth**
**Energy Information Administration**
**Hart World Refining and Fuels Conference**
**October 7, 2005**

***www.eia.doe.gov***

**Notes:**
This presentation will touch on several supply issues that are of concern for the potential increase in use of diesel-fueled light duty vehicles.

## U.S. Diesel-Fueled LDV Pressures

_**Encouraging Diesel**_
**Higher fuel prices favor efficient vehicles**
**State incentives to address greenhouse gas reduction**
**Favorable customer factors**

_**Slowing Diesel**_
**Diminished diesel fuel price advantage over gasoline**
**Potential fuel supply constraints**
**U.S. diesel fuel quality & emission issues**
**Starting from “no” base; supply and customer issues**

**Notes:**
A number of issues are at work both encouraging and discouraging increased market penetration of diesel-fueled light duty vehicles in the U.S.  

I will be addressing those price and supply issues highlighted in orange.

## Overview

**Diesel price advantage expected to diminish – but timing/degree uncertain**
**Europe is important influence on diesel prices, and provides insight into potential U.S. diesel-fueled LDV growth**
**Even under high growth scenarios, LDV impacts on diesel volumes minimal over next decade**
**Assuming U.S. does not move to separate quality LDV diesel fuel, growth in diesel LDV’s should not create refining constraints in near term**

**Notes:**
I will use the remaining slides in this presentation to discuss why the diesel price advantage over gasoline may be diminishing, and why Europe will be an important market to watch in this regard.

Europe’s experience with diesel-fueled light-duty diesel vehicles also provides some insights into the potential for growth in the U.S.

I will then explore two high growth scenarios for diesel light duty vehicles, and illustrate that at least for the next 10 years, increased diesel volumes from this market segment should not create any refinery problems.

And last, I come to the conclusion that in the short term (next 10 years), the growth in diesel-fueled light duty vehicles in the U.S. should not be the cause of any major refinery constraints.

## 2005: Continuation of High Product Prices – Especially Distillate

**Note: Gasoline is conventional regular**
**Source: Bloomberg**

**Notes:**
Up until this year, diesel fuel prices have been a selling point for consumers to consider diesel-fueled vehicles. Generally distillate prices exceeded gasoline prices for only very brief periods. 

But since last fall, we have seen the unprecedented situation in which distillate prices exceeded gasoline until late summer 2005.  
In past years, gasoline prices have exceeded heating oil and diesel prices, except in some fall and winter months. 
In fall 2000, distillate inventories were low, and distillate prices rose.  The winter proved cold, and resulted in one of the longer periods when heating oil prices exceeded gasoline, until the fall of 2004 and this year.

## In Response to Price, U.S. Distillate Yields Have Been Unusually High

**Source: EIA Weekly Data**

**Notes:**
With distillate prices remaining higher than usual as we moved from winter into the summer driving season in 2005, U.S. refineries responded.  U.S. refineries have been running with unseasonably high distillate yields – more like winter yields.  

As the chart shows, refinery, distillate yields this summer were about 2% above normal, which translates to about 300 thousand barrels per day more distillate production.

These high distillate yields allowed distillate inventories to recover from the winter.  And strong gasoline imports supported gasoline supply.

As the end-of-year high gasoline demand and then hurricanes tightened gasoline supply relative to distillate, the distillate yields began shifting down.

## Unusual 2005 Distillate Prices Internationally

**Source: Bloomberg NY Conventional Gasoline, No. 2 Heating Oil; NW Europe 0.2% Heating Oil and Regular Gasoline **

**Notes:**
Heating oil prices on both sides of the Atlantic and in Asia (not shown) exceeded gasoline prices through late summer. 

The provocative question is whether the unusual gasoline/distillate price situation in 2005 stems from a temporary situation or is the beginning of a more fundamental shift in the relative pricing of these primary light refined products.  

We have all been watching the growth in diesel demand, and at some point, price for diesel will have to rise relative to gasoline to produce the incentives needed to shift refinery investment towards more distillate production.  Is this the beginning of that situation?

The underlying question about the fundamental nature of that imbalance is still unresolved, but this year has provided an example of what to watch as we move ahead, and it does dampen the attractiveness of diesel light-duty-vehicles somewhat.  Still, in a world with high fuel costs, the potential high fuel efficiency and high performance characteristics of diesel-fueled light-duty vehicles should be attractive to consumers.

## Europe Is Unique In Degree of Shift to Middle Distillate & Affects World Market

**Source: BP Statistical World Review 2005 **

**Notes:**
One of the reasons Europe is key to distillate prices is that it has shifted dramatically towards diesel and away from gasoline, and much of that increased diesel demand is met from imports.  

This chart illustrates Europe’s shift in preference for distillates over gasoline relative to the rest of the  world, where the mix of gasoline and distillate demand has not changed much.  
The chart looks at the relationship between total distillate demand, which consists of diesel, heating oil, and jet fuel, and the demand for gasoline.  The change in distillates captured in the chart is driven mainly by changes in diesel demand.
Note that outside of Europe, the relative flat relationship between gasoline and distillate indicates that, while diesel is growing, so is gasoline.  

The chart indicates that in the short term, a major source of distillate pressure relative to gasoline seems to be coming from Europe. (While not shown on the chart, the U.S. share of distillate has shifted slightly higher, and the rest of the world has actually shifted a bit towards more gasoline.) 

## EU’s Contribution: Price is Not Just About Volumes, But Quality As Well

**Source: Bloomberg NWE Barge**

**Notes:**
As expected, European low sulfur diesel has been commanding a premium over heating oil.  That differential has averaged about 13 cents per gallon over the past year when Europe’s 50 ppm requirement took effect.

In the U.S., New York Harbor diesel spot values have averaged about 4 cents per gallon over heating oil.  

The high European prices for ultra-low sulfur diesel likely helped to pull other distillate fuel prices up as well.  

The question is whether the European differential is being driven more by transition issues than by longer term factors.  Will the U.S. see these kinds of price differences?  Or will the U.S. ability to supply ultra-low sulfur diesel help to ease the price difference and result in lower differentials between heating oil and diesel  fuel?  

## Implications for Future Distillate Prices

**Seen higher growth in distillates worldwide compared to gasoline in recent years**
**Europe is a key factor in growing shift towards diesel**
**May not have permanent distillate price parity with gasoline, but trends favor higher distillate prices**
**Frequency and duration of future distillate price strength will influence type of refinery investment**

**Notes:**
We have seen some recent strong growth in distillate demand and a growing imbalance in Europe – a region  that relies increasingly on distillate imports, and produces growing amounts of excess gasoline.   

While we may not have a permanent shift in distillate balance and price relative to gasoline, we have been trending this direction for some time.  Exactly how the distillate market might evolve is still up in the air, and the way in which it evolves will influence the types of refinery investments that are made as well – particularly in Europe.  

## Europe Provides Insights into Distillate Prices and Diesel LDV Penetration

**Europe not only affects Atlantic Basin prices, but is also a major player in world distillate market**
**Europe’s light duty vehicle growth provides insights for U.S. potential growth**

**Notes:**
Europe is not only a key factor for distillate prices, but the region also can provide some insights into the potential for U.S. diesel-fueled light-duty-vehicle growth.

## EU-15 Demand Mix Projected to See Declining Gasoline Demand

**Source: History IEA; Forecast Purvin & Gertz**

**Notes:**
Generally, total demand for distillates and gasoline in Europe is growing very little, which has been part of an ongoing effort to stem transportation demand in order to reduce CO2 emissions in response to greenhouse gas concerns.  

This chart shows European diesel and gasoline demand separately, illustrating how diesel fuel has been overtaking and replacing gasoline.  Today diesel-fuel demand in Europe exceeds gasoline demand.

Looking ahead, European diesel-fuel demand is expected by many forecasters to continue to grow, while gasoline demand will continue to decline.

## European Preference for Diesel Grew Quickly since Late 1990s 

**Source: ACEA  **_[www.acea.be](http://www.acea.be/)__ _

**Notes:**
The reason for diesel-fuel demand growth has been the result of a shift by car buyers from gasoline to diesel-fueled vehicles.  Diesel-fueled vehicles are about 35% more efficiency than gasoline-fueled vehicles, which allows Europe to help reduce its transportation-fuel demand.  

Using various tax and purchase incentives, Europe’s diesel-fueled vehicle sales have seen a rapid penetration in recent years.  European new car registrations went from just over 20% in the mid 1990’s to almost half of the new car sales today.  This compares to 1-2% in the United States.

However, the shift from gasoline to diesel has been occurring over many years, which set the stage for the recent surge over the last seven years.  That is, European customers were already accepting and using diesel-fueled vehicles and manufacturing and distribution facilities were in place.  

## EU Distillate Refining Yield Growing as Gasoline Yield Shrinks

**Gasoline Yield**

**Distillate Yield**

**Note: Distillate is heating oil and diesel.**
**Source: IEA **

**Notes:**
Europe’s refiners have responded to the change in demand by increasing their distillate yield – both by operating changes and by some investments.  

However, this shift has not been sufficient to match the demand shift from gasoline to diesel.

European refiners need additional process facility changes to further increase distillate yields and reduce gasoline production.

## Europe’s Growing Product Imbalance

**Source: IEA**

**Notes:**
This chart combines the gasoline and distillate imbalances in Europe.  Distillate products (diesel, heating oil, and jet fuel) are imported in increasing quantities, and excess gasoline is exported in increasing quantities

 Note that in 2004, distillate imports have grown less than gasoline exports. Is that a situation that is likely to continue? Does it reflect growing difficulty in finding economic distillate imports? Perhaps.  

Looking to the future, imports are likely to be more difficult to locate with the region’s low sulfur requirements.  This could mean a larger price incentive for diesel supply, and resulting push to produce more distillate at the expense of gasoline production.  Still, such European refinery changes may not happen quickly, and European needs for distillate imports will continue to affect Atlantic Basin prices, while European surplus gasoline supplies continue to increase for use in areas like the U.S.

## Europe Summary

**European diesel demand growth supported by recent strong growth in diesel-fueled LDVs**
**Recent diesel-fueled LDV growth was primed from previous base already established**
**European refineries investing for increased distillate yields, but demand mix changes away from gasoline continue to outpace supply shifts**
**Future: Still see increasing gasoline exports for some time – but will economic distillate imports be available?  Will large ULSD price premiums be the norm?  **

**Notes:**
Europe’s growth in diesel demand stemming from its emphasis on diesel-fueled light-duty vehicles has risen from Europe’s desire to reduce consumption.  It has been encouraged by tax and vehicle purchase incentives.  Furthermore, Europe’s particulate and NOx emission requirements for these diesel-fueled vehicles are less stringent than in the U.S.  

The most recent  surge in penetration was possible because the manufacturing and  distribution base for these vehicles was in place, and consumer acceptance was established.  That is, Europe had a firm base from which the recent growth could spring.  This is not the case in the U.S.

As we look to the future, Europe’s challenge will be how best to continue meeting its distillate demand growth.  It’s traditional  sources of imports (FSU and Middle East)  may be limited in their ability to increase supply, particularly now that Europe has moved to low sulfur diesel.  Europe is a major market force in the Atlantic Basin, and as its need for distillate increases, the relative price of diesel and gasoline may change, and any price pressure will be felt in the United States.  

## U.S. Demand Growing for Both Gasoline and Distillate

**Gasoline**

**Distillate**

**Source: EIA, Annual Energy Outlook 2005**

**Notes:**
Gasoline and distillate demand growth in the U.S. is very different compared to Europe.  Not only is gasoline demand higher than distillate (and diesel), but in the U.S. both products are growing at similar rates.  
U.S. distillate annual growth from 1995 to 2004 averaged 2.1% and gasoline demand increased annually at 1.7%. 
As a result, distillate’s share of the light product market increased slightly.  

In spite of similar growth patterns, the increased demand for gasoline and distillate was supplied in different ways.  About half of gasoline growth in recent years has been supplied with product imports, whereas distillate growth has been met through both increased capacity and increased yields.

Now we will  explore whether or not increased penetration of diesel-fueled light duty vehicles could face refinery production constraints for diesel fuel that might hinder such a path.

## Two Diesel Penetration Cases

**Source: EIA**

**Notes:**
I will explore 2 scenarios for increased diesel-fueled light duty vehicle penetration.

This chart shows the percent of new light-duty -vehicle sales that diesel-fueled vehicles represent in the AEO 2005 Reference Case – which has diesel light-duty-vehicle sales staying at about 4% share of total light-duty vehicle sales -- and two higher penetration cases. 

 The first alternative case has diesel share increasing to 8% of new light-duty vehicle sales by 2015, and the second has penetration increasing to 10% y 2015.

## Light Duty Vehicle Sales (Thousands)

|  | 2005 | 2010 | 2015 |
| --- | --- | --- | --- |
| Reference Total LDV | 16,416  |  17,215  |  17,658  |
| Reference Diesel | 716 | 710 | 749 |
| 8% Case Diesel | 716 | 839 | 1,338 |
| 10% Case Diesel | 716 | 915 | 1,818 |

**Sources: EIA**

**Notes:**
The vehicle sales are shown this slide.  

It illustrates the magnitude of annual light-duty-vehicle sales and just how small the diesel-fueled segment is.

## Demand Changes Relative to Reference Case

| Changes 
(Thousand Barrels Per Day) | 8% Case |  | 10% Case |  |
| --- | --- | --- | --- | --- |
|  | 2010 | 2015 | 2010 | 2015 |
| Diesel Demand | 10.8 | 82.5 | 14.9 | 139.0 |
| Gasoline Demand | -13.1 | -113.7 | -18.0 | -191.8 |
| Total LDV Demand | -2.3 | -31.3 | -3.1 | -52.7 |

**Sources: EIA**

**Notes:**
Just focusing on the high growth case, diesel consumption would increase 139 thousand barrels per day over the Reference case, while gasoline demand would fall 192 thousand barrels per day.  

Or from a refiners perspective, that 139 thousand barrel-per-day increase in distillate demand represents an increase in yield of 0.6%.

## U.S. Gasoline & Demand Changes With Light Duty Diesel 10% Case

**Gasoline**

**Distillate**

**Source: EIA, Annual Energy Outlook 2005**

**10% Case**

**Notes:**
From a fuel supply standpoint, the impact that the light-duty diesel-fueled vehicle high growth scenario would have over  the next 10 years is not even visible on this  graph.  

The growth in diesel demand from commercial vehicles is still overwhelmingly the most significant factor affecting distillate growth.

## Refinery Implications

**During next decade, refiners will see little shift in diesel/gasoline demand due to diesel LDV growth**
**Since the U.S. has a very small diesel-fueled LDV base, growth for U.S. diesel LDVs in the next 5 years will likely be slower than Europe’s recent penetration surge**
**Assuming the U.S. will not create a separate LDV diesel fuel in the near term, refiners should see little impact of a developing LDV diesel  market in the next decade**

**Notes:**
In summary, I don’t see U.S. growth in diesel-fueled light-duty vehicles having a large impact on the refined product slate during the next 10 years.  Further down the road may be another story, but refiners should be able to see it coming well in advance.

Since the U.S. is starting from a very small base, it simply takes time for enough vehicles to get into the fleet to make a big difference.

Note also, that I don’t see the petroleum industry creating yet another diesel fuel type for the distribution system any time soon.  

With these assumptions, I don’t believe the increased need for diesel fuel from potential light-duty vehicle sales will become a major constraint for diesel-fueled light duty vehicle growth – at least during the next 10 years.  

## Conclusion

**Diesel prices may not provide as attractive an incentive for LDV drivers as before – but high prices in general should maintain consumer interest in diesel-fueled LDV**
**Europe will remain a key area to watch regarding Atlantic Basin diesel market pressures **
**During the next decade, diesel-fueled LDVs should not affect overall U.S. gasoline/distillate mix significantly, and thus refinery supply should not become a constraint in the near term**

**Notes:**
I am optimistic that interest will continue to grow for diesel-fueled light-duty vehicles  in the U.S. – particularly if prices remain high.  Such vehicles have a lot to offer to consumers.

Europe will remain an area to watch in terms of diesel prices in the Atlantic basin and in terms of diesel vehicle trends.

Refiners should not become a constraint to growth in diesel-fueled light-duty vehicles in the next decade.  After the transition to ultra-low-sulfur diesel fuel in 2006, the automobile manufacturers probably face the largest diesel-vehicle challenges in the near term is they strive to achieve the Bin 5 emission standards.