Diesel Economics

Over the weekend I was thinking more about the diesel cars I test drove at the Washington, DC Auto Show last week. They certainly performed at least as well as their non-diesel counterparts--better if you count the big boost in torque from a diesel, compared to a gasoline engine of comparable size. The economic advantages of owning one weren't quite so obvious, particularly in light of the persistent price premium for diesel fuel over gasoline. While many see diesels as a less-expensive alternative to hybrid cars, I think it's more accurate to view them as offering an entirely different value proposition that must be evaluated on its own merits.

Diesel cars provide significantly better fuel economy than their gasoline-powered peers, but as with a hybrid, this comes along with a somewhat higher purchase price. Anyone contemplating buying one must go through a similar assessment of likely economic return, including the complicating factor of tax credits. I chose to make this comparison for the VW Jetta TDI diesel that I drove, which is conveniently available in a similar non-diesel version. According to the EPA's fuel economy website, and using a standard 55% highway, 45% city driving mix, the Jetta TDI averages 35 mpg, compared to 25 mpg for the standard 2.5 liter gasoline engine version, when both are equipped with automatic transmissions. Based on these figures, and despite diesel fuel currently costing nearly 20% more than gasoline, on average, this translates to 15.6 miles per dollar for the diesel model, compared to 13.2 mp$ on gasoline. At 12,000 miles per year of driving, the TDI would save around $140/year. VW's website indicates a base price for the TDI of $22,270, or $2,175 more than the most comparable non-diesel model, the Jetta SE. While that premium is about half as big as the typical hybrid/non-hybrid premium, the simple payout is a disappointing 15 years. Factor in the $1,300 tax credit for clean diesels, and it shrinks to about six years.

So much for the basic economics. Where the discussion gets more interesting is in the uncertainties involved. Someone buying a hybrid car today would be unlikely to cite current gasoline prices as a key influence. Hybrid sales fell dramatically at the end of last year, as gas prices plummeted. However, few people expect gas prices to remain this low indefinitely. Either they will rise in tandem with a recovering economy, or they will increasingly reflect the environmental and energy security externalities of oil, in the form of a higher gas tax, a carbon tax, or the pass-through of emissions costs under cap & trade. In effect, a hybrid car is a bet on future gas prices, combined with an assessment of the value of its reduced CO2 emissions. Diesels offer a similar bet on CO2; dieselization has been the EU's main CO2 reduction strategy for transportation for the last decade, facilitated by tax incentives at the pump in many countries. They represent a somewhat different bet on fuel prices, however.

As with gasoline, the price of diesel fuel varies with the price of crude oil. Since the phase-in to Ultra-Low Sulfur Diesel (15 ppm S, max) in mid-2006, the wholesale price of diesel fuel in the US has averaged about 120% of the price of light, sweet crude oil, based on futures prices on the New York Mercantile Exchange. Pump prices for diesel over the last two years have averaged around 170% of crude oil, but with a wider variation than for wholesale prices, ranging from a low of 150% at last summer's peak of oil prices to around 220% today. As oil prices go up, diesel prices go up, too, though not quite as fast. When oil prices fall, diesel prices fall, but not as fast or as far. Buying a diesel car thus provides a partial hedge against oil prices through improved fuel economy, though the diesel buyer is making another bet that the hybrid buyer isn't: that the gap between diesel fuel and gasoline won't expand and erode the cost benefit of diesel's fuel economy edge. On average, diesel sold for 17% more than gasoline last year, on par with the current premium. It's hard to gauge the prospects for that relationship in the current economy, when demand for everything looks weak. But with Europe still shifting its passenger car fleet toward diesel, and diesel becoming the fuel of choice globally--if not yet in the US--I certainly wouldn't bet on that differential narrowing appreciably any time soon, even if some big refinery expansions on the Gulf Coast are focused on improving diesel yields.

I continue to regard clean diesels as an attractive alternative, and I wish more of them were available in the US, including from GM and Ford, which offer some very nice diesel models in Europe. If I were considering buying one, I would make sure to look beyond its fuel economy benefits, which might end up little better than a wash, to consider its other pros and cons. That includes well-to-wheels CO2 emissions that are roughly 20% lower than from a comparable gasoline-based vehicle, improved range, which translates into fewer trips to the gas station, and demonstrated durability and resale value. Depending on where you live, diesel might be a bit harder to find than gasoline, though not nearly as hard as finding E-85. Rather than seeing diesels as a direct competitor to hybrids, I think they broaden the market for highly fuel-efficient cars, by appealing to a different segment that is more focused on value and perhaps less worried about a return to $140 oil.