ROME--Tax policies on the Continent have made diesel the primary transportation fuel in the European Union (EU). Demand for diesel fuel has accelerated rapidly after 1995.

In fact, Europe’s daily demand for diesel exceeds 6 million barrels, more than double gasoline demand of 2.7 million barrels per day. EU diesel demand has actually risen significantly--more than 20 percent during the past decade alone--while gasoline use has steadily declined. 

This is a convenient truth for the US.  As gasoline demand has fallen in Europe during the past few years, the EU actually finds itself with surplus gasoline production capacity. Meanwhile, the glaring lack of refining capacity in the US means that it’s unable to produce enough gasoline to meet domestic demand. The result: a burgeoning trade in gasoline between the US and Europe. The Energy Information Administration (EIA) estimates that roughly half the growth in US gasoline demand since 1995 has been met by imports, primarily from Europe and the Caribbean. Check out the chart below for a closer look.


Source: EIA

This chart contains actual import data from the EIA going back to 2003 and EIA projections out to 2030. It’s clear that not only are America’s imports rising rapidly, but there’s no projected change in that trend out to 2030. US demand for gasoline imports is actually growing significantly faster than demand for crude imports.

But there’s another side to this story: A global diesel shortage is developing. While many assume that the US doesn’t consume diesel, they’re incorrect. While gasoline may be the fuel of choice for passenger cars, distillates power jet airplanes, trucks and railway locomotives. Diesel demand in America is actually growing more rapidly than demand for gasoline.

And this isn’t just a US-EU story. In 2004 alone, diesel demand in China soared more than 350,000 barrels per day; longer term, China’s diesel demand should grow between 100,000 and 200,000 barrels per day every year. Overall, growing demand in the EU, US and Asia represents as much as 650,000 barrels per day in annualized growth in demand for diesel fuel.

To make demand even more difficult to meet, consider that more stringent environmental regulations are making it increasingly difficult to refine diesel fuels. In the US, the government is mandating that by this year 80 percent of on-road diesel fuel have a sulphur content of just 15 parts per million (ppm). Meanwhile, Europe currently mandates 50 ppm and is phasing in requirements for 10 ppm between 2006 and 2009.

And this isn’t just a developed-world story. India, for example, currently requires diesel of 500 ppm. Between now and 2010, that will be revised down to 350 ppm with some cities requiring as little as 50 ppm. China is following a similar path. Because processing ultra-low sulphur diesel requires additional refining capacity, this is further tightening what’s already a tight market.

For the US, the growing diesel fuel shortage won’t be as easy to fix as the gasoline shortage. The US won’t be able to import diesel fuel from Europe as it does with gasoline because Europe just doesn’t have sufficient capacity to meet its own demand. This is good news for US refiners in the long term. Because of lack of capacity and little competition from imports, US refiners should earn high margins for processing the fuel.

In Europe, the ultra-low diesel sulphur requirements will accelerate biofuels demand. The term biofuel refers to any fuel made from agricultural products; the two main types being produced and used in the world today are ethanol and biodiesel. Biodiesel is made from oils derived from crops such as rapeseed, soybeans or palm.

Europe is encouraging greater use of biofuels, particularly biodiesel. Just as the US has set targets for a massive jump in ethanol consumption, the EU has set equally ambitious targets for biodiesel use.


Source: European Biodiesel Board

Biodiesel production is already growing rapidly in the EU, having increased some six times since 2002 alone.

As I’ve outlined on several occasions, increased biodiesel production won’t replace crude oil. Even if we converted all the world’s crops into crude, the fuel produced wouldn’t even be close to enough to break EU or US dependence on crude. But biodiesel has one very useful quality: It contains essentially no sulphur. Thus, biodiesel may well become a very important blending agent for EU refiners seeking to meet more stringent on-road sulphur diesel requirements.

Increasingly, demand for agricultural products to produce fuel is colliding with demand for crops to produce food. China will, for example, soon become a major importer of corn; much of that corn will likely come from the US. Meanwhile, the US is diverting an ever-greater amount of corn to produce ethanol. That supply/demand squeeze spells a long-term bull market in many crops.

And it's not just corn. Sugar, soybeans and rapeseed are all finding uses as raw materials to make biofuels. All will be needed as the globe rapidly expands its use of biofuels during the next few years. Even more exotic is palm oil--a commodity that's finding increased use in Europe as a biodiesel feedstock.

In The Energy Strategist, I’ve long recommended a few different ways to play the biofuels boom. But many of the biggest plays are far from pure plays on biofuels. In next week’s issue, I’m going to delve more deeply into the sector, looking at a handful of smaller companies more leveraged to outstanding, government-mandated growth in the biofuels business. A handful of smaller, more aggressive plays, many trading in Europe, allow investors to buy into palm oil plantations, biodiesel plants and other biofuel producers.

As a result, I’m planning to approach the pure-play biofuel companies using a strategy very similar to how I recommend approaching the junior uranium firms. Instead of just recommending one or two pure plays on biofuels, I’m going to offer a table of my favorite high-risk, high-return recommendations--a sort of biofuels field bet. As the biofuels industry continues to grow and expand, these companies have the potential to generate truly impressive returns for investors.

© 2006 Elliott H. Gue
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