Refiners amp up diesel output, limit gasoline flows
6:12 p.m. EDT May 7, 2008
Diesel prices outpace gasoline as demand increases from Europe, elsewhere
SAN FRANCISCO (MarketWatch) -- U.S. refiners have been increasing their diesel production in recent weeks while limiting gasoline output, responding to an unusual price gap between the two fuels. But more diesel output can hardly dampen record-high diesel prices in the short term, analysts said.
Data from the Department of Energy showed Wednesday that motor gasoline production fell last week from a month ago, while distillates production, which is made up mostly of diesel and heating oil, increased.
Driving diesel output higher, retail diesel prices have climbed to more than 60 cents higher than gasoline prices, stoked by strong global demand, especially from Europe, where diesel use for autos is more common than in the U.S. While the production costs are almost the same, diesel prices are typically cheaper than gasoline due to less demand.
Higher prices for diesel and heating oil have encouraged refiners to produce more of these distillate fuels. A barrel of crude yields a certain amount of petroleum products, and refiners can replace some of their gasoline output with diesel, although in a limited range.
"Currently underway in the United States and around the globe refiners are investing to maximize diesel capacity...for obvious economic reasons," said Ryan Todd, an analyst at Deutsche Bank, in testimony prepared for a Tuesday House hearing. Lawmakers are ramping up scrutiny on the oil industry after higher diesel prices triggered outcries from U.S. truck drivers.
In the wholesale spot markets, regular gasoline traded at $2.84 a gallon in the Gulf Coast in the week ended May 2, or 25% higher than a year ago, while diesel surged nearly 70% from a year ago to $3.28 a gallon, according to the Energy Information Administration, the statistics arm of the Energy Department. Crude wholesale prices at Cushing, Okla., a key crude-oil delivery point, were at $115.42 a barrel.
The spread between wholesale crude and diesel prices, or the profit margin refiners can expect to make from producing one gallon of diesel, has widened to 54 cents a gallon in the week ended May 2. For gasoline, it's narrowed to about 9 cents. A barrel of crude yields 42 gallons of petroleum products, most of them gasoline, diesel and heating oil.
The huge spread difference has encouraged refiners to reduce gasoline production and increase diesel output.
In the week ended May 2, U.S. refiners produced 4.23 million barrels a day of distillates, or 250,000 barrels a day more compared with a month ago, EIA reported Wednesday. Gasoline output fell to 8.68 million barrels a day, or 220,000 barrels less than a month ago.
While rising diesel production should in theory reduce prices, it may fail to offset strong demand and tight inventories.
"Gasoline refinery margins are very weak," said Linda Rafield, an analyst at energy information provider Platts. "Therefore refiners will choose instead to increase distillates production rather than gasoline."
Still, "while refining margins favor distillate production over gasoline output, prices are not apt to retreat unless there is a major shift in supply/demand balances," she added.
Demand from Europe, China and India has been pushing up diesel prices, encouraging U.S. refiners to export more. That trend is likely to continue for the foreseeable future.
Europe's demand for diesel climbed 3% in the past year to 4.3 million barrels per day in February, compared with gasoline consumption of 2.3 million, according to the Paris-based International Energy Agency, an energy adviser to 27 developed countries.
And it's still expected to rise, thanks to efforts to build more cars with diesel engines that are usually more fuel-efficient.
High demand and prices in Europe have encouraged U.S. exports, furthering tightening domestic markets. In February, U.S. distillate fuel exports averaged more than 400,000 barrels a day, or nearly 10% of the country's production. Gasoline exports in the same month only accounted for about 2% of the output.
These exports have contributed to tight domestic supplies. Distillate stocks are near the bottom of the five-year range, according to EIA data. Gasoline inventories, though have recently fallen sharply, are still in the upper half of their five-year average range.
Meanwhile, diesel demand in China and India has also seen fast increases as the countries expand their economic growth, putting more diesel-power trucks on the road.
"Strong world demand is expected to maintain tight distillate supply-demand balances, thereby limiting U.S. imports and potentially encouraging more exports," EIA said in a recent report. "Hence, distillate prices may remain high due to both high crude oil prices and high wholesale prices relative to crude oil."
Diesel fuel retail prices are likely to average $3.94 per gallon this year, the EIA said in a monthly report released Tuesday. For gasoline, EIA projected regular-grade motor gasoline retail prices to average $3.52 per gallon this year.
On Wednesday, retail diesel prices touched $4.242 a gallon, while regular gasoline stood at $3.618, according to AAA's Daily Fuel Gauge Report.
Silver lining for refiners
Higher prices for diesel and expanded production are helping cushion refiners, which have seen profit margins evaporate as crude-oil prices pushed into record territory, outpacing the rise in gasoline prices.
Valero Energy Corp., the nation's largest refiner, reported at the end of April its net income tumbled 77% in the first quarter. But the company said higher margins on diesel partially offset weaker margins on gasoline.
"We continue to benefit from a very solid on-road diesel market," Valero said in a news release.
While it's difficult to expand diesel production in the short term, oil companies are investing to raise diesel capacity past the end of this decade. U.S. refiners "will respond [to higher diesel prices] with additional capital investment," said Deutsche Bank's Todd. "But it will take time."
Marathon Oil Corp., a Houston-based refiner, will continue to expand its diesel production capacity over the next few years, its chief executive said, according to media reports.
"In recent years we have been growing our diesel capacity at a higher rate than that of our peers and we will continue to through 2011," Clarence Cazalot Jr. said, according to Reuters last month.
In the past, diesel, named after its inventor Rudolf Diesel, contained higher quantities of sulfur. But Europe's new emission standards forced oil refineries to dramatically reduce the sulfur level. The European Commission also encourages lower taxes on diesel to expand diesel use from trucks to cars.
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