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Diesel Prices Soar Ahead of Olympics

Reprinted from The Wall Street Journal - May 2008

Ahead of the summer driving season, all eyes are usually on gasoline. This year, it's diesel that's going for a ride.

The rise of diesel, and more broadly, the category of fuel known as middle distillates, is driven by stockpiling in China ahead of the Olympic Games in August and the prospect of even more fuel needed to aid the rebuilding effort in Sichuan province after last week's destructive earthquake.

Prices are also supported by abnormally low inventories in Europe. And for the first time, the U.S. is playing a key role in supplying the global market because its diesel now is more palatable to the rest of the world.

The fuel's ubiquity in transportation and backup electricity generation means that a broader swathe of the world will face additional inflation pressures at a time when rising food and energy prices are already a concern. Crude markets are taking a cue from the strong demand for diesel, hitting repeat records on a stream of reports that nations are keen to secure additional fuel supplies.

In the U.S., retail diesel prices averaged $4.331 a gallon last week, up 56% from a year ago. Retail gasoline prices are up 20%.

As with so many commodities, China is playing a major role in the global diesel boom.

China imported 520,000 metric tons of diesel in April, up from 30,413 metric tons a year earlier, according to preliminary Chinese government data. Diesel imports for the first four months of the year rose more than eightfold. These volumes are expected to rise further in May and June as China's state-controlled oil companies build up stocks ahead of the Olympics.

China is hoarding diesel and other distillates in case the country needs to rely on its backup generators to smooth out hiccups in its unreliable power grid.

PetroChina Co., the publicly traded arm of government-owned China National Petroleum Corp., "has not only made a huge purchase of diesel for June but has also suspended exports of oil productions to meet domestic demand, exacerbated by the earthquake and, of course, the coming Olympics," said Mike Fitzpatrick, an analyst at MF Global in New York.

The United Arab Emirates and Indonesia have said they will boost diesel imports because of local supply problems.

In Europe, where a large share of vehicles run on diesel, scheduled refinery maintenance, unexpected production outages, late-winter cold and a change in fuel specifications have strained distillate inventories, boosting prices enough to attract imports from the U.S.

"The U.S. is now acting as a swing supplier in Europe," said Harry Tchilinguirian, senior oil market analyst at BNP Paribas in London.

Traditionally, Europe would import much of its distillate requirements from Russia, but stricter regulations on sulfur content make products such as ultralow-sulfur diesel, or ULSD, from the U.S. more attractive.

South America is relying on the U.S. for heating oil this winter, as the continent looks for alternatives to unstable natural-gas production, said Andrew Reed, an oil-market analyst with Energy Security Analysis Inc., a consultancy based in Wakefield, Mass.

"If you look at the U.S. in an isolated way, the market should be weakening, but because of what's going on in Europe and South America, it's a real bull market, and you can see it in U.S. prices," he said.

Heating-oil futures, which traders use to hedge distillate deliveries, on Friday settled 8.04 cents, or 2.2%, higher at $3.7028 a gallon, a record high on the New York Mercantile Exchange. Since the beginning of May, heating-oil futures are up 17%. Crude-oil futures have risen 11% in the same time period.

"Make no mistake, heating oil no longer means heating oil," said one Nymex trader. "Heating oil means diesel."

Date Last Updated: 05/22/2008

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