Mama Said Knock You Out

Headlines coming across the pond from Europe could lead one to believe that the future for diesel engines and fuel was bleak – but nothing could be further from the truth. While there are serious headwinds that must be addressed, diesel is likely to continue to reign supreme as the fuel of choice for heavy duty commerce and there are very few market ready alternatives with a chance to take its crown. And despite the repeated attacks launched at this juggernaut of an energy source, it just keeps on smiling, trucking and shouting “I’m gonna knock you out.”

Following diesel-gate, many started to write the obituary for the diesel engine. And while that story line has had a major impact on the availability of diesel-powered passenger cars in the U.S., it has not even touched the heavy-duty sector. Like LL Cool J (recently covered by hard rockers Five Finger Death Punch – awesome!), the diesel engine is not going to back down:

Don’t call it a comeback
I’ve been here for years
I’m rocking my peers
Puttin’ suckers in fear

That said, it is worth taking a look at the state of the diesel market and the challenges that are mounting.

Demand is tied to the economy

More than any other transportation fuel, demand for diesel fuel is directly related to the strength of the economy. The impact of diesel-gate has been minimal in the U.S., largely because the light duty vehicle market consumes such a limited amount of diesel fuel. Over the past several years, diesel-powered light duty vehicles have remained below 3.5% share of new vehicles sold. The primary driver for demand is in the freight market, which ebbs and flows with the economy.

According to the U.S. Energy Information Administration (EIA), freight trucks consume about 77% of all distillate-provided energy on a Btu basis. By contrast, the light duty fleet consumes less than 1% of distillate-derived energy. And within the freight truck market, heavy duty vehicles (classes 7 and 8 trucks) account for 83% of energy consumption. These vehicles are responsible for long-haul distribution of the products consumers buy every single day.

Don’t you dare stare, you better move
Don’t ever compare
Me to the rest that’ll all get sliced and diced
Competition’s payin’ the price

When we think about the future, EIA seems relatively bullish on the potential growth of the economy. Through 2035, the administration’s forecast projects a 14% increase in diesel vehicle stocks in the U.S., with diesel vehicles maintaining a 98% share of the heavy-duty sector. This means that EIA does not anticipate any alternatives encroaching on diesel’s market share over the next 20 years. (This forecast is consistent with that provided to the Transportation Energy Institute by Navigant Research in the 2017 publication, “Tomorrow’s Vehicles.”) In addition, EIA projects a 4.4% increase in diesel freight sales through 2035 and a 23% increase in diesel-driven miles traveled.

Assuming the economy continues to trudge along predictably, it seems like diesel should fare quite well.  But there are headwinds that could affect the future.

Headwind 1 – The Economy

Many economists suggest that major economies typically experience a correction or some degree of recession every eight years or so. If this is the case, then the U.S. is overdue.  Take a look at the deliberations at the Federal Reserve and the jitters expressed by Wall Street whenever economic performance reports are issued for evidence of the level of concern about the health of the economy.

If the diesel market is predominantly related to the health of the economy, a recession could exact a significant toll on truck sales, vehicle miles travel and diesel demand. Clearly, it is a headwind hanging out around the corner, but no one really knows when we will round the corner or how significant of a correction might be waiting.

Headwind 2 – Efficiency Regulations

Europe is not the only market focusing on reducing diesel emissions. North American regulators also have imposed fuel efficiency/emissions control requirements on the sector. EIA projects that the average fuel efficiency of new diesel-powered vehicles will improve about 30% through 2035 resulting in a net reduction in diesel demand of about 6.7%, despite the expected increase in VMT.

Headwind 3 – Modern Engine Design

In order to gain more miles per gallon, modern diesel engines are equipped with new technologies that are more sensitive to fuel impurities.  In the past, a diesel engine feasted at all you can eat buffets – throw into it whatever you wanted, it would crunch it up, take what it needed and spit out the rest. Today’s engines, however, are dedicated to a much tighter dietary regimen – say, a Keto diet.

In 2016, 80% of new medium and heavy-duty diesel engines sold in the U.S. were equipped with high pressure common rail fuel injector systems. These devices have increased the pressure at which diesel fuel is injected into the piston chamber from 5,000 psi to more than 40,000 psi and the particulate tolerances have dropped from 3 – 4 microns to 1 micron or less. The systems are significantly more efficient and critical to satisfying efficiency objectives. But it also means that any contaminant found in the diesel fuel can wreak havoc on these new systems.

The diesel fuel market, meanwhile, has not undergone the same aggressive evolution to remove contaminants and deliver a fuel that matches the exacting needs of the modern diesel engine. To complicate matters, the removal of sulfur (which enabled advanced aftertreatment emissions control devices on vehicles) seems to have been a precursor to accelerated corrosion in diesel storage tanks. These two realities exacerbate the situation.

There is a strong ongoing debate about how to provide a fuel these modern engines desire and who should be responsible for operations. The answer is not yet evident, but the Transportation Energy Institute’s Diesel Fuel Quality Council is working collaboratively to collect data that might help lead to an agreeable solution for all parties.

Headwind 4 – Lower Emissions for Longer

There are ongoing negotiations to enact an ultra-low NOx standard for diesel engines. While this alone represents a significant challenge to engine and fuel engineers, it is further complicated by the fact that the plan is to not only reduce NOx emissions but to also extend the regulatory useful life of a diesel engine from about 435,000 miles to as many as 1 million. This means that diesel engines must be certified compliant with the new NOx standards for much longer. It is estimated that within this lifecycle, the typical heavy-duty diesel engine could consume as much as 166,000 gallons of fuel.

When this headwind is taken into consideration parallel to headwind 3, the challenge facing the diesel fuel market becomes much more daunting. Not only do modern engines desire cleaner diesel fuel, these more sensitive systems will need to satisfy increasingly stringent standards while consuming a lot more fuel.  Collaboration across the industry is critical in these efforts.

Headwind 5 – IMO2020

On January 1, 2020, marine going vessels will have to meet new sulfur emissions standards imposed by the International Maritime Organization (IMO).  These standards require vessels to either use a fuel that contains no more than 5,000 ppm sulfur (compared to current standard of 35,000 ppm), install sulfur scrubbers or convert to an alternative fuel source like liquified natural gas. Some analysts have suggested that this regulation represents the greatest disruption to the market in decades and have predicted it could result in oil prices of $200 per barrel or more and societal costs of more than $1 trillion. Others have suggested the impact will be akin to Y2K – no big deal. The actual impact is likely to be somewhere in between.

After reviewing dozens of analyses, the Transportation Energy Institute published a literature review summarizing the potential impact of IMO2020 on the fuels market. That review concluded that a majority of the reports state the impact on the market could range from 25 to 75 cents per gallon for diesel fuel and gasoline and that the impact would likely be limited two or three years. While this cost factor is nothing to ignore, it is a far cry below what would occur should oil hit $200 or more per barrel.

More recently, Bloomberg published an article entitled “An Oil Market Crisis Looks Averted, for Now,” in which they report that the market has taken steps to mitigate the potential catastrophe associated with IMO2020 by using greater volumes of sweet crude oil (naturally lower in sulfur) and installing more scrubbers than previously anticipated. This report, taken into consideration with a Wall Street Journal article in early August that suggested global oil supplies could exceed demand by more than 1 million barrels per day throughout 2020, indicates that the end of the world is unlikely to befall the industry January 1 – but the potential disruption of IMO2020 should not be overlooked.

Conclusion

The headwinds facing the diesel market are significant, but in the absence of a credible alternative poised to take market share away from this economic powerhouse, it is unlikely that major dislocation within the diesel market is pending in the near future. There will be bumps and bruises as the market adjusts to accommodate new regulatory requirements or potential economic volatility, but the future for diesel appears strong – just like the fuel.

I’m gonna knock you out
Mama said knock you out
I’m gonna knock you out
Mama said knock you out
I’m gonna knock you out
Mama said knock you out
I’m gonna knock you out