The Year of the Fuel Spec

Released on January 5, 2006
(Next Release on January 11, 2006)

The Year of the Fuel Spec
A year from now, as we look back on 2006, oil market analysts may call it, “The Year of the Fuel Spec” (“spec” being short for specification). Regulatory and industry changes to the composition of both gasoline and diesel fuel will be key issues affecting these markets in 2006. How markets behave during the transition to these new transportation fuel specifications will go a long way in determining how high retail prices may reach for these two fuels.

Specifically, five fuel specification changes, some due to mandates for cleaner-burning fuels pursuant to the Clean Air Act Amendments of 1990, others resulting from the Energy Policy Act of 2005 (EPAct 2005) and industry responses to it, will stress the fuel supply system in 2006. Two of these changes, the ultra-low sulfur diesel (ULSD) program, and the removal of methyl tertiary butyl ether (MTBE) from reformulated gasoline by many suppliers, are likely to be the most challenging to the market. Three additional fuel specification changes in 2006 are expected, individually, to have only minor impacts on gasoline prices and price volatility, but in total, to exacerbate an already tight market. They are: (1) establishment of a renewable fuels standard in EPAct 2005 that requires an increasing volume of renewable transportation fuel to be used each year starting in 2006; (2) implementation of an EPAct 2005 requirement that reformulated gasoline meet the same volatile organic compound (VOCs) emission standard in northern and southern regions, in an attempt to begin consolidating fuel types to increase fuel fungibility; and (3) implementation of the full Tier 2 low-sulfur gasoline requirements, resulting in average gasoline sulfur content of 30 parts per million (ppm), one-tenth the average sulfur content only three years ago.

As the ULSD program and the removal of MTBE from reformulated gasoline (RFG) have the potential to cause the most volatility in prices during the transitions this year, it is worth focusing on these two changes a little more closely. In both cases, following the operational changes and new equipment installation required by refineries and distributors, supply problems may arise from:

*Loss of production capability

*Loss of import supply sources

*Increased difficulty in delivering the new products (including the need for extra tankage)

*A one-time inventory pinch when inventories of old product must be drawn down and tanks prepared for the cleaner new product – both at wholesale and retail levels.

The ULSD program begins in 2006 with the requirement that at least 80 percent of on-highway diesel fuel being supplied must have no more than 15 ppm sulfur content at retail. Refineries are scheduled to comply by June 1. (The sulfur content of non-road, locomotive, and marine diesel fuel will be ratcheted down in subsequent years.)

Notwithstanding the recent hurricanes, refinery modifications to allow production of ULSD are largely on track. The biggest challenge is expected to be delivery of the product from supply source to retail. ULSD will travel with other petroleum products through pipelines on the way to bulk terminals from which it will be shipped by tanker truck to truck stops and retail stations. However, other petroleum products traveling in the pipeline system with a much higher sulfur content could easily contaminate ULSD -- jet fuel, for example, can have 3000 ppm of sulfur. If ULSD is contaminated, it may not be possible to correct the batch by blending with additional low sulfur product. Contaminated ULSD may have to be returned to a refinery for reprocessing, which can be difficult because petroleum product transportation systems are not designed to return product to refineries.
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