Low-sulfur Diesel will Cost a Fortune (Phillips Business Wire) September 19, 2000

EPA regulations that significantly reduce the amount of sulfur in diesel fuel by 2006 will result in severe shortages and huge price increase, a new survey has concluded.

A number of refineries have said they wont invest in the necessary upgrades because they are too expensive, and they are unlikely to recover the costs.

As a result, anticipate a 320,000 barrel per day shortfall in diesel supply, and prices that could climb by 50 cents a gallon, more in the Rocky Mountain region.

The survey, part of a new study by Charles River Associates (CRA) for the American Petroleum Institute (API), asked refiners what they intend to do to comply with the EPA's 15 parts per million (ppm) diesel desulfurization mandate.

The study also reanalyzed earlier studies on diesel desulfurization costs, and found major flaws in the EPA's claims that 15 ppm ULSD could be made for an average 4 c/gal.

Given the failure of U.S. refiners to recoup the high costs of "clean fuels" EPA mandates during the last decade, the new survey shows that U.S. refiners are reluctant to make the same mistake again with ultra low sulfur investment.

The resulting 320,000 b/d diesel shortfall and price spikes of 52 c/gal could be avoided if foreign refiners begin making plans to boost ULSD production dramatically, for what looks to become a lucrative U.S. diesel market.

This could spell tremendous profit opportunities for the emerging gas-to-liquids (GTL) diesel fuels makers. GTL companies can take advantage of huge natural gas reserves in remote regions, and turn it into low-sulfur diesel that will meet the new EPA regulations.

"Depending upon the extent, if any, of ULSD import availability, diesel prices could rise by 15 to more than 50 cents per gallon," the study concludes. "Physical diesel shortages and price premiums of this magnitude are fundamentally unsustainable in the long term, since financial incentives for further investment in desulfurization would exist for all but the highest-cost domestic refiners. Foreign refiners also may consider investing to supply perceived shortfalls in U.S. domestic diesel supply."

Consumer and political outrage over such huge price spikes could lead to temporary or even permanent waivers from the EPA's ULSD mandate, potentially wrecking the investments of those refiners who gamble on ULSD, the study says.

The study assumed that U.S. refiners would have to slash diesel sulfur limits at the refinery gate to below 10 ppm to comply with the retail level 15 ppm limit. It also assumed a 10 ppm sulfur refinery average for K1 kerosene, often used as a diesel blendstock, but normal sulfur levels in jet fuel and heating oil. However, all other off-road diesel fuel sulfur would be slashed to 350 ppm from current levels approaching 5,000 ppm; this is one option expected in the U.S. EPA's off-road diesel rules to be unveiled in 2001.

The CRA/API survey included 16 U.S. refiners comprising 61 refineries and more than 60% of aggregate U.S. crude capacity. About a quarter of refiners said they would avoid ULSD production at certain refineries, while a third plan to shift some or all on-road-diesel to off-road markets.

Most said they wouldn't purchase ULSD blendstocks from competitors, two of the 16 plan to reduce total distillate production, while two others plan to increase gasoline and diesel output at some refineries. Virtually no U.S. refiners have spare desulfurization capacity.

The CRA/API-surveyed refiners are larger on average and thus can better justify investments by spreading costs across a greater number of gallons. Smaller refiners, however, face even higher per-gallon costs, the study noted. As a result, small refiners may divert greater portions of distillate output to off-road markets rather than invest heavily for ULSD highway fuel.

Refiners in the survey weren't giving "definitive" but rather "indicative" ULSD investment intentions, CRA noted. "The industry has some amount of lead time to consider strategic and technical choices before committing to an investment," CRA said.

If refiners under-invest for ULSD in 2006, leading to shortages and price spikes, "the lead time for a second wave of industry investment in distillate desulfurization - absent a regulatory concession - would suggest a two- to four-year period of shortages, high diesel prices and consumer angst, with the potential for significant adverse economic impacts to the U.S. economy."

Already, 40 U.S. refiners have exited the highway diesel market rather than invest in low-sulfur diesel as the EPA required in 1993 (to 500 ppm sulfur cap). "It is anticipated that the number of refineries producing on-road diesel in 2007 will be reduced versus 2000, with generally the smaller refineries opting-out of on-road diesel production," the CRA study found.

http://www.smallcapcenter.com/story.asp?mysection=headlines&mypage=Energy%2C+Natural+Resources&storyid=9190

-- Martin Thompson (mthom1927@aol.com), September 21, 2000