If you thought diesel fuel prices were volatile in 2003 and 2004, wait until you see what 2005 and 2006 bring. The future will have all of the elements that made crude oil prices gyrate in 2004, plus the added uncertainty introduced by a big change in the fuel that refiners must produce.

The average highway diesel price began and ended 2003 at around $1.50/gal., according to the Energy Information Administration's weekly retail survey. But in between, the price jumped 27¢ in just a few weeks, as Venezuelan supplies were disrupted by strikes and the U.S. prepared to attack Iraq. Once the strikes and invasion ended, prices swiftly dropped back to former levels.

In 2004, the average price approached the previous year's high in May, dipped a bit, then rose another 50¢ to a (so-far) record of $2.20/gal. on November 1. Several factors contributed to this run-up, including Hurricane Ivan, which ripped apart pipelines under the Gulf of Mexico, and strong world demand that created doubt the U.S. would have enough heating oil to meet winter needs. Short-term supply interruptions hit sources as disparate as Norway, Nigeria and Iraq.

A mild start to the heating-oil season, slight economic cooling, and gradual increases to supply from many sources led to a price retreat in the last two months of 2004. Nevertheless, it is clear that a multitude of factors can send prices soaring.

One additional factor will come into play in 2005 and 2006: low-sulfur rules. Refiners have been scrambling for the past few years to get more of the sulfur out of diesel fuel by June 1, 2006. That's the nationwide deadline for lowering the sulfur content in highway diesel fuel from 500 parts per million (ppm) to 15 ppm.

On November 18, the California Air Resources Board (CARB) turned up the heat another notch, adopting a requirement that intrastate locomotives and coastal vessels operating in the Los Angeles region will have to begin using low-sulfur diesel by January 1, 2006. The agency set a January 2007 deadline for the rest of the state.

For now, it appears there will be enough low-sulfur diesel available.

Similarly, EPA reported on September 23 that “highway diesel fuel production will be sufficient to meet demand; and 15 ppm sulfur highway diesel fuel will be widely available nationwide.”

Encouraging words, indeed. But prices soared the last time refiners had to make such a big change. In October 1993, EPA lowered the highway-diesel sulfur limit from 3500 ppm to 500 ppm. A combination of pipeline and refinery outages, high demand for heating oil, and last-minute stocking of the new fuel by retailers led to price spikes and spot shortages.

Congress took two small steps this fall that may ease next year's transition. First, small refiners will get an immediate write-off for investments in desulfurization equipment. Second, “biodiesel” and “agribiodiesel” will be eligible for substantial reductions in the 24.4¢/gal. federal excise tax. If enough diesel users switch to biodiesel blends, there will be less demand for low-sulfur diesel.

The bottom line: The transition to ultra-low-sulfur diesel fuel appears to be going smoothly, even ahead of schedule, so far. But the wild swings in crude oil, gasoline, and diesel prices of the past two years, and the price spike that occurred in 1993 when the current 500-ppm diesel was introduced, show that carriers need to prepare now, in early 2005, not when the new fuel becomes mandatory in 2006. You can try to get customers to share the risk through fuel-price adjustment clauses. And look into forward-buying or hedging of fuel purchases.