Retail Diesel Outlook For 2008 AND 2009

OUTLOOK FOR 2008 AND 2009

Retail diesel fuel prices are likely to remain elevated as long as crude oil prices and world demand for distillate fuels remain high. According to EIA’s June 2008 Short-Term Energy Outlook, national average retail diesel fuel prices will peak in the third quarter of 2008 at $4.75 before falling to $4.11 per gallon by the fourth quarter of 2009, primarily due to the forecast for the price of West Texas Intermediate crude oil to average between $121 and $133 per barrel during this same period. However, the recent volatility seen in crude oil and petroleum product prices, if continued, may significantly alter these price projections.

The phase-in of the U.S. Environmental Protection Agency’s (EPA) sulfur standards for diesel fuels has the potential to continue to influence diesel fuel prices. The logistics of delivery of ULSD to retail service stations can be a challenge. Most ULSD travels through pipelines on the way to bulk terminals for final transfer by tanker truck to retail stations. Other diesel fuels and petroleum products with a higher-sulfur content in the pipeline, storage, and local distribution systems might contaminate ULSD (jet fuel, for example, can have 3,000 ppm of sulfur). If contaminated, it may not be possible to correct a ULSD fuel batch by blending with additional low-sulfur product, and contaminated batches have to be returned to a refinery for reprocessing, a difficult and expensive problem. Even without potential delivery problems, it costs relatively more to produce ULSD fuel.

Why are West Coast diesel fuel prices higher and more variable than others?

Diesel prices on the West Coast, especially in California (CA), are relatively higher than other regions of the country, partly because of taxes, but mainly because of supply issues. The State of California assesses a combined State and local sales and use tax of 7.25 percent on top of the 24.4 cents/gallon Federal excise tax and an 18.0 cents/gallon State tax. Washington’s tax of 34 cents/gallon is one of the highest in the country. Besides taxes, West Coast retail prices are more variable than others because there are relatively few supply sources: 21 of the 36 refineries located in West Coast states are in CA. California refineries need to be running at near full capacity just to meet in-state demand. If more than one refinery in the region experiences operating difficulties at the same time, the diesel supply may become very tight and prices may spike. The West Coast’s substantial distance from Gulf coast and foreign refineries is such that any unusual increase in demand or reduction in supply results in a large price response in the market before relief supplies can be delivered. The farther away the necessary relief supplies are, the higher and longer the price spike will be.