SThis presentation will touch on several supply issues that are of concern for the potential increase in use of diesel-fueled light duty vehicles.

SA number of issues are at work both encouraging and discouraging increased market penetration of diesel-fueled light duty vehicles in the U.S. 

SI will use the remaining slides in this presentation to discuss why the diesel price advantage over gasoline may be diminishing, and why Europe will be an important market to watch in this regard. SEurope’s experience with diesel-fueled light-duty diesel vehicles also provides some insights into the potential for growth in the U.S. SI will then explore two high growth scenarios for diesel light duty vehicles, and illustrate that at least for the next 10 years, increased diesel volumes from this market segment should not create any refinery problems. SAnd last, I come to the conclusion that in the short term (next 10 years), the growth in diesel-fueled light duty vehicles in the U.S. should not be the cause of any major refinery constraints.

SWith distillate prices remaining higher than usual as we moved from winter into the summer driving season in 2005, U.S. refineries responded.  U.S. refineries have been running with unseasonably high distillate yields – more like winter yields.  SAs the chart shows, refinery, distillate yields this summer were about 2% above normal, which translates to about 300 thousand barrels per day more distillate production. SThese high distillate yields allowed distillate inventories to recover from the winter.  And strong gasoline imports supported gasoline supply. SAs the end-of-year high gasoline demand and then hurricanes tightened gasoline supply relative to distillate, the distillate yields began shifting down.

SHeating oil prices on both sides of the Atlantic and in Asia (not shown) exceeded gasoline prices through late summer. SThe provocative question is whether the unusual gasoline/distillate price situation in 2005 stems from a temporary situation or is the beginning of a more fundamental shift in the relative pricing of these primary light refined products.  SWe have all been watching the growth in diesel demand, and at some point, price for diesel will have to rise relative to gasoline to produce the incentives needed to shift refinery investment towards more distillate production.  Is this the beginning of that situation? SThe underlying question about the fundamental nature of that imbalance is still unresolved, but this year has provided an example of what to watch as we move ahead, and it does dampen the attractiveness of diesel light-duty-vehicles somewhat.  Still, in a world with high fuel costs, the potential high fuel efficiency and high performance characteristics of diesel-fueled light-duty vehicles should be attractive to consumers.

SAs expected, European low sulfur diesel has been commanding a premium over heating oil.  That differential has averaged about 13 cents per gallon over the past year when Europe’s 50 ppm requirement took effect. SIn the U.S., New York Harbor diesel spot values have averaged about 4 cents per gallon over heating oil.  SThe high European prices for ultra-low sulfur diesel likely helped to pull other distillate fuel prices up as well.  SThe question is whether the European differential is being driven more by transition issues than by longer term factors.  Will the U.S. see these kinds of price differences?  Or will the U.S. ability to supply ultra-low sulfur diesel help to ease the price difference and result in lower differentials between heating oil and diesel  fuel? 

SWe have seen some recent strong growth in distillate demand and a growing imbalance in Europe – a region  that relies increasingly on distillate imports, and produces growing amounts of excess gasoline.   SWhile we may not have a permanent shift in distillate balance and price relative to gasoline, we have been trending this direction for some time.  Exactly how the distillate market might evolve is still up in the air, and the way in which it evolves will influence the types of refinery investments that are made as well – particularly in Europe. 

SEurope is not only a key factor for distillate prices, but the region also can provide some insights into the potential for U.S. diesel-fueled light-duty-vehicle growth.

SGenerally, total demand for distillates and gasoline in Europe is growing very little, which has been part of an ongoing effort to stem transportation demand in order to reduce CO2 emissions in response to greenhouse gas concerns.  SThis chart shows European diesel and gasoline demand separately, illustrating how diesel fuel has been overtaking and replacing gasoline.  Today diesel-fuel demand in Europe exceeds gasoline demand. SLooking ahead, European diesel-fuel demand is expected by many forecasters to continue to grow, while gasoline demand will continue to decline.

SEurope’s refiners have responded to the change in demand by increasing their distillate yield – both by operating changes and by some investments.  SHowever, this shift has not been sufficient to match the demand shift from gasoline to diesel. SEuropean refiners need additional process facility changes to further increase distillate yields and reduce gasoline production.

SThis chart combines the gasoline and distillate imbalances in Europe.  Distillate products (diesel, heating oil, and jet fuel) are imported in increasing quantities, and excess gasoline is exported in increasing quantities S Note that in 2004, distillate imports have grown less than gasoline exports. Is that a situation that is likely to continue? Does it reflect growing difficulty in finding economic distillate imports? Perhaps.  SLooking to the future, imports are likely to be more difficult to locate with the region’s low sulfur requirements.  This could mean a larger price incentive for diesel supply, and resulting push to produce more distillate at the expense of gasoline production.  Still, such European refinery changes may not happen quickly, and European needs for distillate imports will continue to affect Atlantic Basin prices, while European surplus gasoline supplies continue to increase for use in areas like the U.S.

SEurope’s growth in diesel demand stemming from its emphasis on diesel-fueled light-duty vehicles has risen from Europe’s desire to reduce consumption.  It has been encouraged by tax and vehicle purchase incentives.  Furthermore, Europe’s particulate and NOx emission requirements for these diesel-fueled vehicles are less stringent than in the U.S.  SThe most recent  surge in penetration was possible because the manufacturing and  distribution base for these vehicles was in place, and consumer acceptance was established.  That is, Europe had a firm base from which the recent growth could spring.  This is not the case in the U.S. SAs we look to the future, Europe’s challenge will be how best to continue meeting its distillate demand growth.  It’s traditional  sources of imports (FSU and Middle East)  may be limited in their ability to increase supply, particularly now that Europe has moved to low sulfur diesel.  Europe is a major market force in the Atlantic Basin, and as its need for distillate increases, the relative price of diesel and gasoline may change, and any price pressure will be felt in the United States. 

SThis chart shows the percent of new light-duty -vehicle sales that diesel-fueled vehicles represent in the AEO 2005 Reference Case – which has diesel light-duty-vehicle sales staying at about 4% share of total light-duty vehicle sales -- and two higher penetration cases. S The first alternative case has diesel share increasing to 8% of new light-duty vehicle sales by 2015, and the second has penetration increasing to 10% y 2015.

SIt illustrates the magnitude of annual light-duty-vehicle sales and just how small the diesel-fueled segment is.

SJust focusing on the high growth case, diesel consumption would increase 139 thousand barrels per day over the Reference case, while gasoline demand would fall 192 thousand barrels per day.  SOr from a refiners perspective, that 139 thousand barrel-per-day increase in distillate demand represents an increase in yield of 0.6%.

SFrom a fuel supply standpoint, the impact that the light-duty diesel-fueled vehicle high growth scenario would have over  the next 10 years is not even visible on this  graph.  SThe growth in diesel demand from commercial vehicles is still overwhelmingly the most significant factor affecting distillate growth.

SIn summary, I don’t see U.S. growth in diesel-fueled light-duty vehicles having a large impact on the refined product slate during the next 10 years.  Further down the road may be another story, but refiners should be able to see it coming well in advance. SSince the U.S. is starting from a very small base, it simply takes time for enough vehicles to get into the fleet to make a big difference. SNote also, that I don’t see the petroleum industry creating yet another diesel fuel type for the distribution system any time soon.  SWith these assumptions, I don’t believe the increased need for diesel fuel from potential light-duty vehicle sales will become a major constraint for diesel-fueled light duty vehicle growth – at least during the next 10 years. 

SI am optimistic that interest will continue to grow for diesel-fueled light-duty vehicles  in the U.S. – particularly if prices remain high.  Such vehicles have a lot to offer to consumers. SEurope will remain an area to watch in terms of diesel prices in the Atlantic basin and in terms of diesel vehicle trends. SRefiners should not become a constraint to growth in diesel-fueled light-duty vehicles in the next decade.  After the transition to ultra-low-sulfur diesel fuel in 2006, the automobile manufacturers probably face the largest diesel-vehicle challenges in the near term is they strive to achieve the Bin 5 emission standards.