Congress Likely to Sidestep Low-Sulfur Debate

With little time remaining in the second session of the 106th Congress, it looks like lawmakers will postpone having to deal with a major diesel fuel issue looming on the horizon that could have dire consequences for petroleum refiners, distributors, retailers and consumers. But it is only a matter of time before Congress will be compelled to decide whether new Environmental Protection Agency (EPA) requirements for diesel fuel are a full-blown threat to the nation's transportation system.

In a nutshell, the EPA this summer published a proposed rule that would drop the sulfur cap for on-road diesel from 500 parts per million (ppm) to 15 ppm. The rule could be finalized this year, and would take effect in 2006-2007. The agency trumpeted the new fuel requirement, saying it would cut air pollution caused by "dirty and annoying" diesel emissions. But it is not at all clear that the EPA has truly considered the severe economic disruption this rule would cause. "Chaos" is not too strong a word to use in this case.

Interestingly, the EPA claims that it has built sufficient lead time into its rule to minimize disruptions. That's ironic because one of the EPA's proposed options, the phase-in of the new diesel requirement, would be the direct cause of the disruptions.

The phase-in option would permit 15 ppm diesel to coexist in the marketplace with current 500 ppm diesel during a four-year period, from 2006 to 2009. But phasing in the new fuel would be entirely impractical for petroleum distributors and retailers.

As the National Association of Convenience Stores (NACS) pointed out in its comments to the EPA on the proposed rule, if low-sulfur diesel is put into a tank that previously contained the old 500 ppm fuel ? or other petroleum products ? the low-sulfur fuel will be contaminated by residual sulfur on the walls of the tank and pipes. That leaves one option: building separate systems to handle the two different grades of fuel.

Most retailers would have to sell just one kind of fuel or the other, because investing in new tanks could not possibly produce a reasonable rate of return. Even if some retailers did install additional tanks, what would they do with them when the 500 ppm diesel is phased out?

Naturally, distributors face much the same dilemma. If the EPA requires that the new low-sulfur fuel and today's regular fuel be kept entirely segregated, the entire distribution system could collapse under the weight of the EPA requirements. There are just not enough dedicated pipelines, storage tanks and cargo tanks to keep two separate grades of diesel fuel.

It is not difficult to imagine the kind of price volatility this rule would cause. On top of the massive up-front costs they would face, refiners, marketers and retailers would have no practical way to anticipate demand for either grade of diesel. And it's not as though this kind of regulation-driven market disruption is unheard of. Just look at what happened in the Midwest this spring when new EPA specifications for reformulated gasoline went into effect in certain markets. Certainly, tight supplies of fuel would trigger higher prices.

The EPA has held five public hearings on the proposed new diesel requirements and collected public comments, but public input is no substitute for a real-world analysis of how this rule would affect the market. Next year, it will be impossible for Congress to ignore the consequences of the EPA's ill-conceived rule. And it will be important for Congress to address the issue in a timely manner, because companies will have to make important decisions on how to respond to the new requirements. If Congress takes too long to act, many companies may have to swallow heavy costs, all for a rule that has been changed in the interim.

In its comments, NACS urged the EPA to carefully consider all the viewpoints of the refining industry, which is better equipped than a government agency to fully assess the price and supply impact of this proposed rule. The EPA has said it does not believe the sulfur change will result in significant disruptions. Given the importance of diesel fuel to the nation's economy, no one can afford to permit the EPA to guess wrong.