Tight supplies-in some instances spot shortages-of low sulfur diesel have boosted distillate prices in the U.S. just as a new low sulfur highway diesel fuel required by federal and state laws reached markets.
Recognizing the problems its new rule is causing, the U.S. Environmental Protection Agency has extended the deadline from Oct. 1 to Oct. 22 by which industry must switch to low sulfur diesel fuel. Under the 1990 Clean Air Act amendments, U.S. refiners as of Oct. 1 were to begin supplying highway diesel fuel with a maximum sulfur content of 0.05 wt % (OGJ, Oct. 4, p. 29).
EPA's-office of air and radiation, in a letter to diesel fuel distributors, marketers, and consumers, said, "Low sulfur diesel fuel may be unavailable in certain markets of the U.S." and added that various companies have asked for temporary relief from the regulations until supplies stabilize.
In California, with its own new specifications for diesel fuel that are tougher than the federal specs, wholesale diesel prices have soared by more than 50% in 2 months.
California government officials in particular have come under fire to investigate steep price spikes and spot shortages of diesel fuel in the state in recent weeks. The state senate's transportation committee held hearings on diesel price hikes Oct. 12, and California Gov. Pete Wilson requested hearings Oct. 10 at the California Air Resources Board (CARB).
CARB has gone to great lengths to assure the public of adequate diesel supplies, while state refiners have scrambled to meet the agency's new diesel specs by Oct. 1 (OGJ, Aug. 30, p. 21).
Meantime, one industry analyst sees the logistical and enforcement problems associated with providing the new spec fuels as providing an incentive to cheat.
EPA DEADLINE
EPA said it will exercise enforcement discretion until Oct. 22 in cases where low sulfur diesel cannot be obtained without undue hardship, written documentation shows numerous unsuccessful attempts were made to procure the fuel, or when "product delivered was only of a sufficient quantity to meet the immediate needs of the end user."
EPA said the waiver will apply to refiners, pipelines, and terminals to the extent they are presumptively liable for violations permitted under the three conditions.
"This exercise of enforcement discretion will not apply to parties who attempt to stockpile supplies of high sulfur diesel fuel for use in on-highway vehicles."
It added "This does not relieve refiners and pipeline carriers from the requirement to produce and transport low sulfur diesel fuel that meets the requirements of the diesel desulfurization regulations."
U.S. PRICE SPIKES
Strong prices in the U.S. for low sulfur, on-highway diesel in the first week of October pulled up prices for conventional grades of distillate, Pace Consultants Inc., Houston, reported in Pace PetroView newsletter.
However, Pace said price trends were less clear on California distillate markets, where a special low aromatics grade of low sulfur diesel mandated by CARB went on sale Oct. 1.
According to Pace's calculations for spot wholesale diesel cash prices, the price for on-highway diesel with 0.05 wt % sulfur at market close Oct. 6 was 56/gal on the U.S. Gulf Coast, 59/gal in New York, and 70/gal in Los Angeles. Gas oil and No. 2 oil closed Oct. 6 at 53.5/gal, 55.5/gal, and 52.5/gal, respectively.
By comparison, low sulfur diesel prices closed Sept. 22 at 53.5/gal on the Gulf Coast, 55.5/gal in New York, and 61/gal in Los Angeles, while gas oil/No. 2 oil closed at 50/gal, 52/gal, and 52.5/gal, respectively.
Although four California refiners have announced capability to supply low sulfur diesel with no more than 20% aromatics content, Pace said marketers' concerns about shortages have pushed prices to 12/gal premiums in the Los Angeles and San Francisco areas beyond those for the EPA grade that began selling across the U.S. on Oct. 1.
CARB diesel closed Oct. 6 in Los Angeles at 81/gal, compared with 70/gal for EPA diesel.
Pace said U.S. distillate prices have been strengthening since mid-August, about the same time gasoline prices started declining.
The company estimated U.S. production of low sulfur distillate in September averaged about 1.5 million b/d, about 100,000 b/d more than expected demand for low sulfur distillates. In addition, low sulfur distillate imports during the past month averaged another 100,000 b/d.
Although Pace does not anticipate any extended shortage of the low sulfur product, it said localized spot shortages could occur because of logistical problems resulting from last summer's widespread flooding in the U.S. Midwest.
CALIFORNIA WOES
The hearings last week in California were intended to determine the connection between problems in diesel markets and CARB's new diesel specs.
CARB and most state refiners maintain the problems are short term and unlikely to persist.
"We believe the situation was at its worst around Oct. 1," CARB Chairwoman Jananne Sharpless told the senate panel.
She attributed the problems to a combination of equipment failures at refineries and panic buying just before the new rules took effect.
"Late September demands on the state's largest diesel fuel producer
(Chevron) were 35% above normal," she said. "Actions taken to date have already produced significant improvement in the supply situation. The increase in supply should help prices decline substantially in the near future."
Although CARB's new specs kicked in Oct. 1, refiners started phasing in production of complying fuel earlier. Prices started rising in late August, about the time the new spec diesel began appearing in markets.
CARB had estimated a 6/gal increase resulting from the new specs. Federal excise taxes also recently rose by 4.3/gal. However, between Aug. 13 and Oct. 8, diesel prices at the rack in seven major California cities rose by an average of 32.4/gal for unbranded fuel and 31.1/gal for branded fuel, according to Lundberg Survey, Los Angeles (see table, p. 32).
The biggest price hikes occurred the week before the new specs took effect. During the week ended Oct. 1, prices rose by almost 10/gal on average for unbranded diesel and a little more than 9/gal for branded diesel. The following week, diesel prices rose another 3-4/gal, with the biggest jumps occurring in Sacramento and Fresno.
CARB insists the new specs had little to do with the price increases.
"Much of the difference between the cost of producing cleaner diesel fuel and selling it cannot be accounted for," Sharpless testified.
CALIFORNIA SUPPLY CONSTRAINTS
Despite efforts by CARB to head off supply problems, the California diesel market has been tighter than normal.
James Gigoux, executive director of the California Independent Oil Marketers Association (Cioma), contends there were severe outages, especially in northern California, in recent weeks.
There are also reports of shortages at terminals in Nevada and Arizona that are typically supplied by California refiners, Cioma maintains.
CARB attempted to prevent supply problems by granting several large refiners variances that permit them to produce noncomplying fuel until they are able to complete modifications to their facilities in 1994.
Just before the rule took effect, Chevron and Texaco experienced problems with their diesel hydrotreaters. CARB dealt with these problems with additional, brief variances, but acknowledges they contributed to spot shortages in parts of northern California. Compounding the problem, says CARB, was a high level of concurrent speculative buying and "a run at the racks" that increased demand three to four times higher than normal in late September.
Originally, CARB projected California refiners would be able to supply about 161,000-162,000 b/d of diesel during the transition to new specs this fall. Typically, demand runs about 155,006 b/d. After supply problems were reported, CARB asked refiners to step up output by 15-20%. The agency now says state refiners are well on the way to producing 190,000200,000 b/d of diesel.
"The shortages are as much perception as they are reality," CARB's Jerry Martin said.
Carl Thut, manager of product engineering for Chevron Products Co. U.S.A., also believes the problems are temporary. "It looks to me as if the market is settling down. I don't see this as a long term situation at all."
Thut also attributed the tight market in part to a large inventory build by customers just before the rule took effect. "People who had the capability immediately filled storage." This occurred at a time when some suppliers, notably Exxon Corp. and Shell Oil Co., had dropped out of the state's diesel market, he added. "It's been a very nervous market. Rumors of shortfalls alone can cause problems. It's almost a self-fulfilling prophecy."
According to Thut, Chevron's refinery problems didn't result in "that great a drop in supplies" because the company was able to make arrangements to get product from other sources. He said the company is able to supply all customers, although some may have to go to other terminals to get product.
Gov. Wilson, in a letter to CARB requesting the hearing, said, "Since some of the problem can be attributed to refining equipment breakdowns that have now been rectified, I fully expect additional volumes of fuel to be available in the next few days.
"However, there remain concerns that refiners may be unable to supply enough diesel fuel to avoid continued supply problems. Despite changing market conditions, these concerns should be addressed and resolved if necessary."
CARB's hearing is to provide up to date information on price and supply, as well as short and long term projections for both.
OTHER CONCERNS
CARB also has been asked to account for reports of increased fuel pump failures since the new, cleaner burning diesel came onto the market.
CARB specs call for the same reduced sulfur levels as prescribed under federal rules. However, CARB also requires steep cuts in aromatics.
California refiners have the option to develop alternative blends with less of an aromatics cut, so long as the alternative equals the overall emissions reduction CARB has mandated.
Severe hydrotreating of diesel has been linked with lubricity problems that triggered fuel injector pump failures in Norway, Canada, and Sweden.
In previous public statements, CARB has denied that fuel produced under the new specs can be decisively linked to equipment failures.
INCENTIVE TO CHEAT?
Downstream consultant Tony Szabo, president of Stone Bond Corp., Houston, said a lack of adequate enforcement capability coupled with difficulties segregating and distributing new low sulfur grades of on-highway diesel could create price differentials that prompt some cheating.
The greater the low sulfur-high sulfur diesel pricing differential, the more incentive some will have to cheat, he contends.
In addition, Szabo said the urge to cheat will be greatest while markets are sorting out supply and logistical factors and discovering new price levels, because it is not certain that a price differential will develop between on-highway and off-highway diesel adequate to allow low sulfur diesel producers to recover investments.
"First there will be arbitrary internal calculations-everybody is going to run internal economics," he said. "It is important to set a differential that allows people to recover their investments. But the markets will have to find some equilibrium."
Szabo estimated refiners on average will need a price differential of about 5/gal to recover costs associated with manufacturing low sulfur, on-highway diesel fuel.
Szabo said commercial and implementation challenges stemming from logistical problems could take some refiners and distributors as much as a year to solve.
Despite plans to dye off-highway, high sulfur diesel, he said federal compliance officials likely will have trouble confirming that various distillate fuels are being used legally. Many major suppliers of low sulfur diesel have expressed concerns over substitution of high sulfur fuel for low sulfur whenever the latter is not available, he noted.
"There are going to be loopholes, and certain players in the market are going to take advantage of the situation," Szabo said. "The major suppliers are very concerned that they have made the effort to comply, while intermediaries in the supply chain might do something that will entangle them in all kinds of nonsense."
Szabo said enforcement proposals inspecting diesel at retail fuel pumps during dispensing, for example-are technically enforceable. But early operations under the new requirements allow few other points to verify diesel sulfur content. Such a huge enforcement effort would have been impossible to implement fully Oct. 1, he said. "Enforcement may sort itself out later, but ... probably not even this year."
Copyright 1993 Oil & Gas Journal. All Rights Reserved.