Jul-2008

Making the right investment choice

Gasoline or diesel? US market forces skew the product slate towards diesel, but each refiner’s target market and required configuration are unique

Joseph R Jacobs Jr, Robert A Ohmes and Scott Sayles, KBC Advanced Technologies Inc

Article Summary

What is the right investment choice for refiners: gasoline or diesel? New project investment evaluations are exploring the options surrounding gasoline and diesel flexibility. The optimum refinery configuration differs, depending on whether you are producing maximum gasoline or maximum diesel. And the flexibility to vary production between either product requires a further potential configuration. Hence, each production strategy may require a different investment strategy. The refiner’s answer depends on the future market, existing infrastructure, government policy, available technology, competing options, public opinion, and other site-specific requirements.

This article focuses on an example grassroots refinery in the US Midwest with a Canadian crude oil feed to provide some insight into these issues as part of a strategic evaluation process. Typical strategic review factors are examined and options highlighted to assist refiners in their decision between gasoline and diesel.

A successful strategic analysis starts with an examination of the market and the projected transportation fuel mix. A review of projected balances, forecasted demand patterns and environmental trends frames the problem for further technical consideration.

Balance
Based on information from KBC Market Services, the US projected supply/demand balance for gasoline and diesel is expected to close over the next decade as increased fuel economy demands and mandates for biofuels take hold.

As more refinery capacity comes online to meet growing requirements, diesel demand will be outpaced from 2010, while the country will still be short of gasoline through to 2015. Permitted capacity increases, announced refinery expansions and increased ethanol usage are all expected to increase gasoline production, thereby moderating the imbalance. Incremental gasoline demand is projected to slow down due to the recent changes in US regulatory fuel efficiency improvements (CAFE standards), which are included in this balance. The proposed fuel efficiency improvement rate is 4% per year. Since fleet turnover time is long (a new car purchased today will be in the fleet for 19 years),3 the impact of fuel efficiency improvements on gasoline demand is anticipated to gradually take effect over the next five to eight years. In time, the fuel efficiency impact may flatten demand growth to keep pace with the impact of increasing population and GDP growth.

The US gasoline shortfall is imported from Europe, Asia/Pacific and South America. The expected diesel surplus may be consumed in the US if demand patterns change, or it may find a market in Europe, as the dieselisation of Europe has made diesel the fuel of choice. The expected gasoline versus diesel demand pattern of the US looks somewhat different.

Fuel demand pattern
US fuel demand is projected to increase over the next decade, as illustrated in Figure 1. US gasoline consumption is expected to grow by 1.2% per year, while diesel is set to grow by 1.9% per year (EIA, 2007). The assumption inherent in these projections is continued economic and population growth. In addition, diesel growth is further driven by the expected increase in the diesel vehicle fleet. For gasoline, increased ethanol production is projected to meet the gasoline demand growth. Hence, the traditional fossil fuel component of gasoline demand will likely remain flat.³

Currently, diesel-powered passenger vehicles make up only 4% of new car sales in the US. By 2015, upside predictions by J D Power indicate diesel passenger vehicle sales are expected to increase to 15%.17 By 2012, some industry watchers are predicting diesel will outsell gasoline hybrids due to battery space requirements that reduce the effectiveness of a personal vehicle as well as the expected longer-term costs associated with maintaining two drive trains. Beyond 2015, the picture is unclear and depends on multiple perceived market influences and assumptions.

Many car manufacturers are planning to reintroduce diesel vehicles into the US market. GM, Honda and BMW have announced diesel options as early as 2010. Mercedes, Volkswagen and Jeep currently offer diesel options. Nissan, Audi, Mitsubishi and Subaru are also joining the competition with announced diesel offerings, and Ford may re-enter the diesel car market, too. US consumer perception is that diesel engine performance is poorer than gasoline, and this will take some time to overcome in the market. 

In summary, both transportation fuels are projected to have solid future growth. However, diesel’s higher energy content and lower carbon footprint will attract many consumers, thereby increasing its market demand. However, such a shift will need to be accompanied with additional development of the diesel infrastructure.

Infrastructure
The US is primarily a gasoline market. Its infrastructure is geared to gasoline, with over 180 000 petrol stations across the country. Only 40% of US petrol stations carry diesel fuel and these are primarily located along major trucking routes. The number drops to 30% for stations in residential areas. Diesel’s primary usage is currently for bulk transportation fuel, which accounts for over 80% of its demand. Some areas are adding biodiesel pumps as well, which will sell a 2–5% blend of biodiesel in fossil fuel-based diesel.

Fuel availability constraints will tend to limit the choice by some consumers for diesel-powered engines. Hence, significant infrastructure changes are needed to expand the availability of diesel within the US market. The costs for this are not trivial. Some of the costs of increasing diesel availability could be subsidised as part of energy legislation if coupled with biodiesel. 

In summary, current product demand and distribution infrastructure still favour gasoline over diesel. However, several factors will shape the future expectations of these transportation fuels, including government mandates, alternative fuel choices, new technologies and changing fuel specifications.