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Fuel School
Raise your diesel IQ
That stuff that's making our trucks, cars, planes go? The stuff that's sucking your pockets dry? You need to lean all you can about it.

By Terry Scruton
senior writer

Diesel prices have seen more ups and downs this year than a truck driving through a Colorado mountain pass. Well, OK, mostly ups.

If the calls we receive at Land Line are any indication, every trucker and his dog has a theory about why diesel prices rose so high in 2005. And they are some very interesting theories at that. We've heard everything from simple price gouging to a vast government conspiracy, possibly involving aliens from another planet.

But before you start looking for the men in black hiding behind the pump and Martians circling the Flying J, here's a look at some of the complicated, real-life forces that are at work every day, making diesel prices do what they do.

Why are diesel prices so high?
This is perhaps the biggest question on everyone's mind these days. In spite of a drop in November, diesel prices remained close to 60 cents higher than they were a year ago, as of press time.

According to the U.S. Department of Energy, diesel production was hit hard by Hurricanes Katrina and Rita in September and October, which caused a severe price spike.

Jake Bournazian, an economist with the federal Energy Information Administration, told Land Line that the refineries in the storm zones produce a significant amount of diesel.

"Refineries that were shut down along the Gulf Coast are mainly diesel producing refineries," he said. "The market lost about 600,000 to 700,000 barrels of diesel production per day when those were shut down."

But even before that, diesel prices were climbing, setting record after record during the summer and early fall of 2005.

Bournazian said that both diesel and gasoline prices have gone up during the past year because of increasing worldwide demand. China and India, in particular, have seen their demand for diesel skyrocket.

Why does it cost more in winter?
Diesel is made from the same petroleum distillate pool as home heating oil. A distillate is a purified form of crude oil, and in this form, diesel and home heating oil are very similar.

A typical barrel of oil is 42 gallons. According to the Department of Energy, about 10 gallons out of those 42 are used to produce diesel and home heating oil. Of the 10 gallons, roughly 7.5 gallons are used to produce diesel, while 2.5 are used for home heating oil.

Of course, that number varies as seasonal demand for home heating oil changes, but the annual average is usually the same.

Casey Tischner, an economist with the DOE's Energy Information Administration, said diesel and home heating oil are almost identical, which means that its fairly easy for the refineries that produce diesel to produce heating oil.

"The products are very closely related and can actually be used interchangeably in a lot of instances," he said. "You may notice some slight differences in performance, but for the most part they are the same product."

Diesel tends to see a price spike in the late fall because many refineries switch their production over to home heating oil as demand for that product increases during winter. Tischner said production of diesel will usually drop from October through March, though it can vary depending on a variety of factors.

"One, it depends on what the demand is for," he said. "And two, it depends how sophisticated is the refinery and how well can they break it up."

Why don't they build more refineries?
There have been no new refineries built within the United States since the 1970s. And, in fact, in the 1990s, a lot of them were shut down. According to the EIA, between 1985 and 2005, the number of U.S. refineries fell from 223 to 148.

The reason for the decline in refineries depends on whom you believe.

The oil companies claim it was because of the environmentalists. They maintain that, not only did they have to shut refineries down because of environmental concerns, but the hoops they have to jump through to build a new one are so tough that refinery construction came to a halt.

On the other side, some consumer watchdog groups claim that the oil companies shut down the refineries intentionally in order to create a shortage and drive up prices.

Regardless of the reason, there may be more refineries on the way. In October, a bill died in Congress that would have provided more financial incentives for oil companies to expand refining capacity. The bill may have been unnecessary, however, as most oil companies already had plans in place to expand.

Valero Energy Corp., the largest North American refiner, plans to spend about $5 billion to expand its capacity by 406,000 barrels per day during the next five years. And ConocoPhillips said it plans to spend $3 billion on expansion in the next four years.

Why does diesel cost more than gasoline?
This question goes to the basic issue of supply and demand.

The EIA officials said that, following Hurricanes Katrina and Rita, oil companies ramped up production of gasoline to meet increasing demand and shortened supplies. Exports were increased and the U.S. Strategic Petroleum Reserve was opened up. These things kept gasoline prices from staying too high, too long.

In addition, these supplies came in at a time of year when demand for gasoline usually drops. As the summer driving season came to an end, supplies of gasoline went up. Once refining production began to come back online, the price of gasoline went down.

Diesel, meanwhile, was hit by the triple whammy of decreased production because of storm damage at refineries, increased demand around the world and the switch to home heating oil production for the oncoming winter. It was a lose-lose-lose situation.

Why don't diesel prices drop when oil prices drop?
Mike Burdette, a senior analyst with EIA, said there is generally a 10- to 14-day lag between drops in crude prices and lower prices at the pump. That's why when crude oil slips, diesel and gasoline prices do not immediately follow suit.

Of course, that estimate on lag time assumes that nothing out of the ordinary - such as a hurricane - complicates the formula. In those instances, the prices at the pump can change drastically overnight as retailers, oil companies and traders on the oil market respond to the sudden interruption of the supply line.

Anomalies aside, Burdette said the reason for the 10- to 14-day gap is because that's roughly how long it takes diesel to get from the barrel to the pump, and the drop in price follows it along the way.

It starts with the spot price in the refinery, which drops almost immediately when crude oil goes down. From there, the diesel is processed and travels through the pipelines to the distribution terminals. The wholesale prices at the terminal will drop within a matter of days following a drop in crude.

Retail prices are where it gets a little tricky, Burdette said.

"As retailers pick up new truckloads of product and as they get the information about the wholesale price changes, they adjust their prices accordingly," he said. "That kind of filters through over a matter of days and weeks."

Are oil companies gouging?
Unfortunately, there is no simple answer to this question, mostly because there is no clear-cut definition of what gouging is.

While most people look at price gouging as simply unfair pricing, the actual legal terms that constitute gouging vary from state to state. There is no federal law that defines gouging.

Washington, DC, and 27 states have anti-gouging laws, most of which kick in when a temporary state of emergency is declared. Each of those laws, however, has a different definition of gouging.

Following the hurricanes, the attorneys general of 44 states got together and formed a working group to investigate claims of price gouging within their states. At press time, most of those investigations were still ongoing.

Meanwhile, at the federal level, a congressional committee called for a hearing in November 2005 and put executives from five major oil companies on the hot seat, demanding that they explain the record profits they posted for the third quarter.

terry_scruton@landlinemag.com

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