GLG News by Jeff Moser

Implications: EPA regulations in 2010 will require significant reductions in NOx emissions from diesel trucks.  SCR catalysts are the likely solution for most OEMs but Cummins and International have announced plans to proceed without SCR.   Significant fuel cost and performance tradeoffs are being made in the process.

Analysis: Eliminating NOx emissions from diesel exhaust is a major technical challenge since the lean air-fuel ratios of diesels make conventional catalysts useless.  EPA regulations will require major reductions in NOx emissions from diesel trucks in 2010.  Selective Catalytic Reduction [SCR] has been proven effective for NOx over years of industrial use in smokestack applications and is a leading candidate for diesel trucks in 2010.  Drawbacks to SCR are the need for injection of Urea into the exhaust and the lack of effective sensors to provide feedback control through the engine's ECU.  Alternatives to SCR are limited:  Exhaust Gas Recirculation [EGR] is effective but incurs significant fuel economy penalties, NOx adsorbers are being used in some light duty engines but have not been proven for Heavy Duty applications.  The NOx adsorbers in use also rely on expensive Precious Metals; Platinum is near $2000 per TOZ and Rhodium at $9000.

Cummins and International have stated that they will use aggressive EGR rates to control engine out NOx and eliminate SCR [Cummins will rely in part on credits earned through sales of the Dodge Ram pickup with a NOx adsorber catalyst since 2007.]  EGR works by diluting the air charge in the cylinder which in turn reduces peak temperatures but also reduces the efficiency of the engine.  According to SCR proponent Daimler the EGR heavy engines will suffer a 3% fuel consumption penalty vs. SCR [while Urea should only add pennies per gallon.] 

SCR systems are large, heavy, and expensive but they allow engines to be tuned for higher performance and fuel economy.  With diesel at record prices per gallon the fuel advantage may ultimately trump the Urea issue.  Once Urea infrastructure is established and fleet users have confidence in reliability and durability of SCR systems they may see the fuel penalty of EGR as an unsustainable cost.

Implications: Demand for sulfuric acid continues to grow in fertilizer and metals applications.  As prices skyrocket ethanol producers are finding their margins squeezed.  Sustained demand for acid in Ag and mining sectors may keep sulfuric acid prices at or above current levels for the foreseeable future.

Analysis: Coupled with high corn prices the economic model for ethanol profits has evaporated under pressure from chemical feedstock costs.   A  One-Million gallon ethanol plant uses 2000 tons of sulfuric acid, 1000 tons of caustic soda, 5000 tons of urea, and 600 tons of anhydrous ammonia per year.  Prices for the acid have doubled [and in the case of ammonia tripled] since 2002.  Demand for fertilizer in agricultural markets has driven this cost increase; over 60% of global sulfuric acid capacity is consumed in phosphorus fertilizer production.   Compounding the fertilizer effect is demand from metals mining where sulfuric acid is used in ore leaching extraction.

New sulfuric acid capacity is the obvious answer but large scale plant construction and long lead-time equipment orders dictate 12-24 month planning horizons for bringing new production on line.  The short term focus will be on upkeep and de-bottlenecking of existing acid plants; every incremental ton of acid will help relieve the supply gap but expectations for immediate price relief are likely wishful thinking.

Implications: Fuel efficient diesel engines have the potential to restructure the US auto industry.  Current US refinery capacity for diesel is tight during seasonal heating oil demand peaks.  For diesels to realize their potential share of the US auto market increased fuel capacity must be secured.

Analysis: Due to incentivized fuel tax systems the European new car market is >50% diesel today.  As Detroit strains to meet pending 35 mpg CAFE standards, looming CO2 emission caps, and survive $4 per gallon gas shock the prospects for diesels here has never been brighter.  Expectations from JD Powers and others are for 12% - 15% diesel market share by 2012-2015.   Major OEMs including GM, Toyota, Nissan, Honda, Mercedes, Audi/VW, and Chrysler/Jeep have all committed to new diesel platform launches in the next 12-24 months.   since diesels enjoy a 20% - 30% efficiency advantage vs. gasoline engines the prospects for reduced fuel [and crude oil] consumption are real.  The devil is in the details though - refinery capacity is tilted in favor of gasoline and would need to be rebalanced to meet diesel demand.

Diesel and #2 fuel oil for home heating are the same distillate, diesel fuel is typically same or less per gallon vs. gas in summertime but rises above the mogas benchmark in wintertime due to seasonal demand spikes.

Ultra Low Sulfur Diesel for on-road engines would need more hydrocracking catalyst capacity [vs. conventional FCC mogas plants] but would realize a net reduction in total gallon demand due to higher fuel economy.  The market may be in a Catch-22 for several years until the balance between vehicle choice, fuel costs, and refinery capacity is reached.

Implications: Producing ethanol from corn is an unsustainable and economically unviable long term proposition.  Future shifts to switchgrass or other cellulosic ethanol crop sources makes more sense but does not help today.  Diesel remains a logical choice for immediate impact in fuel economy and CO2 emissions.

Analysis:

In the rush to push Ethanol fuel to market many producers seem to have forgotten the fundamental economics of supply and demand.  With corn prices surging Ethanol producers have fallen victim to the same margin squeeze brought on many industries by rising crude oil prices.  It is a poorly guarded secret anymore that is costs more petroleum energy to produce a gallon of Ethanol than is saved by driving an E85 vehicle that pumps that gallon into its tank.  As farmers divert acreage to corn strains to satisfy ethanol demand prices for food grain has ballooned, compounding the ethanol feedstock cost issue.

Wall Street has responded by beating down Ethanol stocks and rewarding Agricultural plays in seeds and fertilizer.   Many ethanol conversion plants have scaled back or stopped expansion plans, leaving the short term future of corn based E85 in doubt.

If and when crops such as switchgrass for cellulosic ethanol production gain a major foothold E85 may prove to be a sustainable choice for alternative fuels.  Until then conventional choices like diesel make far more sense.   

Implications: The US Government has mandated increased fuel economy for future cars and trucks.  The 35 mpg CAFE standard is a daunting challenge for Detroit as it scrambles to redesign 12-18 mpg trucks and SUVs.  Diesel engines have been proven in the European market and could see the lion's share of future alternative powertrain share growth.

Analysis: By 2020 US automakers will have to meet a 35 mpg fleet average fuel economy standard.  This requires a 40% improvement over current models while still meeting stringent EPA exhaust emissions standards.  While diesels have always had a 20% - 30% fuel efficiency advantage they could, until now, not meet the tightest EPA emissions standards.

In an interim report released this week an independent expert panel working under the National Research Council has finally given modern 'Clean Diesel' engines the green light for future growth.  Updating a 2001 study in which diesels and hybrids both failed to make the cut, the report highlights prospects of 30% - 40% fuel efficiency gains from diesels.

In typical driving conditions for average consumers diesels deliver greater mpg than hybrids.  [If today's hybrids replaced their gasoline engines with diesels their efficiency would increase as well.]  The comparable cost of diesel vs. hybrid options tilts in favor of the conventional powertrain making the sticker price impact lower for diesels as well.  It is important to note that diesels add significant cost vs. conventional gasoline engines: $1K - $4K per vehicle is a common range for car/SUV systems including expensive exhaust emissions components.

Most major OEMs have already announced plans to launch new diesel models over the next 18 months; expectations are that in 5 years diesel share could exceed 12% - 15% of the US light vehicle market.

Implications: A bankruptcy court has denied Chrysler the right to pull tooling from  Plastech which filed for Chapter 11 protection after negotiations fell apart.  This new found bargaining chip may prove valuable to other Tier suppliers as they continue to be squeezed between rising material costs and shrinking parts prices.  Will more Tier suppliers look to the courts for relief as they seek to regroup under fire from customers, investors, and creditors?

Analysis: In decades of Detroit's OEM-supplier relations there have rarely been exceptions to one-sided negotiations between the Goliath automakers and their suppliers.  This week Chrysler encountered a new barrier to bullying tactics: Plastech won a protective order from the bankruptcy court barring Chrysler from moving molds to another supplier.  The court noted that even though Chrysler would suffer financial harm Plastech was shielded from such actions by the law.  While granting a stay of execution the court encouraged both parties to continue negotiations toward a mutual resolution.  Coming on the heels of CEO Bob Nardelli's promise to shut Plastech out of future Chrysler business this was a harsh wake up call to OEMs that the courts can and will put smaller suppliers on much firmer bargaining ground.

As bankruptcy courts get more crowded with distressed suppliers the OEMs may have to swallow their pride and negotiate more accommodating contract terms.  The industry has now seen how supply disruptions can bring even the biggest players to their knees and back to the table.  This may be a much-needed epiphany for Detroit as they realize the long term benefits foreign OEMs have gleaned from more constructive supplier relations. 

Implications: As automotive Tier suppliers struggle to survive in today's brutal cost environment the OEMs are threatened with supply disruptions due to bankruptcies and volatile price negotiations.  With new contract terms that cut new UAW hires' wages  in half and reduce oppressive retiree legacy costs, Detroit is looking at insourcing more component production.  After decades of outsourcing the tide may turn and see a reintegration of the automotive manufacturing supply chain.

Analysis: In the first half of the 20th century Henry Ford built one of the great wonders of the industrial age on the banks of the Rouge River near Detroit:  a manufacturing complex that brought in iron ore, lumber, and gum rubber and shipped out finished cars.  Thousands of men labored in hundreds of integrated operations to produce every component required:  from steel foundry to sheet metal rolls to stamping presses the ore never left the grounds until the car rolled through the gates.

This plant was the site of one of the darkest days of the UAW labor movement at Ford when company security men savagely beat union organizers in front of newspaper cameras.  Ford was shamed into signing its first collective bargaining agreement with the UAW leading to decades of prosperity for workers who made parts and assembled vehicles.  By the 1970s wage and benefit packages had grown so lucrative that Detroit could not compete with the wave of inexpensive Japanese imports that hit the market.  Over the next 30 years the Big 3 gradually outsourced more and more of their integrated component production including the spinoffs of Delphi and Visteon from GM and Ford respectively.  As of 2007 parts production in a Big 3 UAW plant was a rarity - everything from seats and bumpers to axles and exhaust pipes was purchased from third party component suppliers.

As market share has dropped many assembly plants are idle or at a fraction of capacity; this capital infrastructure could be easily converted to parts production if desired.  In what many see as a harbinger of doom for Tier suppliers Ford announced that they will once again make instrument panels for the Taurus in their Chicago plant.  Now that structural and labor costs have been reduced via downsizing and contract concessions with the UAW, Detroit finds itself reevaluating the make vs. buy decisions for more key components.  With the uncertainty of key suppliers' financial health, a weak dollar, and cheaper in-house labor the Big 3 may repeat history and begin making more of their own components in the US again.  

Implications: Raw material costs for metals and plastics are squeezing profits out of Tier suppliers in the auto industry.  Locked in to firm part price contracts with OEMs, suppliers cannot pass on rising commodity costs to stay profitable.  The cash drain has forced many into bankruptcy and presents strategic supply chain issues for the domestic OEMs.

Analysis: Just hours after Chrysler and Plastech agreed in court to resume normal business operations CEO Bob Nardelli announced that Chrysler would terminate all future business dealings with the troubled supplier.  Chrysler's tough talk was a painfully visible shot across the bow of the automotive Tier supply base as it tries to pass rising commodity material costs on to the OEMs via component part price increases.

As prices of oil and natural gas have jumped the plastic resins made from these hydrocarbon feedstocks have risen by double digit percentages.  With component part margins already near breakeven this has pushed molded plastic parts suppliers into an abyss of red ink.  With part prices below raw material costs the drain on cash flow is immediate and dramatic; as more suppliers seek bankruptcy protection the cost burden will ultimately shift to the OEMs as alternate suppliers get opportunities to re-bid the parts contracts at market price.

Analysts speculate that losing Chrysler could be a mortal blow to Plastech, leaving GM and Ford in the lurch as well.  Although Ford and GM have provided millions to prop Plastech up in the short term they would be faced with writing off that goodwill and accepting higher parts prices from the competition.

In the long term more suppliers will adopt 'market price' material cost pricing terms allowing relief if commodity prices remain volatile.  Under such terms prices would be quoted for the per pound value of the plastic resin separate from the value-added molding.   Similar terms would be appropriate for cast or machined metal parts subject to spikes in steel and aluminum markets.  While OEMs will push back on this they may be left with few options as the traditional supply base dwindles through financial attrition.

Implications: US Automotive Tier suppliers have been squeezed between rising material costs and unrelenting pressure from OEMs to lower prices.  As more major Tier 1 and Tier 2 suppliers seek bankruptcy protection OEMs must consider drastic changes in long term supply chain management to ensure their industry's future.   The weak Dollar, Just-in-time inventory, and cheap offshore parts sourcing are all key forces driving the supply base toward an uncertain future.

Analysis: Plastech is the latest in a long line of US automotive component suppliers to declare bankruptcy as prices fall and costs rise.  Commodity costs of plastic resins have risen steadily with the price of Oil and Gas based Hydrocarbon feedstocks while OEM supply contracts typically demand annual price reductions of 1% - 5% for the molded parts.  Despite kicking in Millions of dollars to help the distressed supplier, Chrysler finally sought to pull mold tooling and have their parts made at other suppliers.  Plastech reacted with their final desperate move - a drastic but inevitable bankruptcy filing that forced Chrysler to idle several vehicle assembly plants.  Ford and GM continue to receive parts from Plastech, indicating that Chrysler adopted a harder line in financial negotiations.  The courts will now decide if Chrysler can pull the tooling or if Plastech must continue to ship parts.

Such adversarial relationships are the result of decades of one-sided negotiations with Detroit coupled with recent waves of offshore parts sourcing form China, Eastern Europe, and India.  If the OEMs require local supply to support their Just-in-time inventory delivery systems they will have to reconcile with domestic suppliers to ensure long term viability of US component manufacture.  As costs rise in China and the US Dollar continues to weaken the US may become a preferred low-cost manufacturing base once the costs of logistics are factored in for a 10K - 12K mile long supply line.

With Chrysler in private hands their long term focus may be trumped by short term priorities - Plastech may be just the first in a gauntlet of supply base challenges for the smallest of Detroit's Big Three.

Implications: Automotive OEMs are scrambling to introduce new diesel models that offer the needed 35 mpg while meeting the same strict emissions standards as the gas powered competition.  Advanced emission control technologies make modern diesel cars as clean as gas while lowering greenhouse gas emissions and increasing fuel economy.  These emission controls come at a cost and consumers must compare cost/benefit vs. hybrids and E85 options.

Analysis: As of 2007 the EPA emissions standards for new cars eliminated any distinction between gasoline and diesel engines.  The so-called 'Tier 2, Bin 5' requirements mean that dramatic reductions in Particulate [soot] and smog-causing NOx emissions are required on new diesel cars and trucks.  All trucks sold in 2007 and beyond now are fitted with Diesel Particulate Filters that remove over 90% of all soot from the exhaust.  These DPFs are coated with Precious Metal catalysts, driving the sticker cost up near $100 per engine liter plus associated electronic controls and sensors. 

Larger trucks will not require special NOx catalysts until 2010 but cars must meet the Tier2/Bin5 limits now.  Mercedes has been marketing their 'Bluetec' systems which feature Selective Catalytic Reduction [SCR] catalysts in addition to the DPF.  SCR normally requires addition of Urea to the exhaust; cars will likely use a refillable Urea canister that is serviced at oil change intervals.  Today's Bluetec system on the E-series Mercedes eliminates the need for separate Urea supply by combining an additional NOx Trap catalyst.

Modern diesels offer tremendous driving satisfaction with their low-end torque performance and higher fuel economy.  Sticker prices are typically $1K - $3K higher than comparable gasoline models and consumers must decide if the fuel savings is worth the price.  [Compared to hybrid cost adders diesels fare well in most scenarios.]  

More OEMs plan to introduce Clean Diesels with 30 - 40 mpg; market share is sure to follow once consumer acceptance spreads.

Implications: Production disruptions in South African mines coupled with growing demand for diesel emission control catalysts has pushed Platinum over $1500.  As supply side mine production issues are resolved demand should continue to grow due to tighter emission regulations and increased diesel penetration in Europe and, most notably, the US auto markets.  Many automotive OEMs have committed to plans for new diesel launches, all of which will require significant Platinum content in the exhaust emission control catalyst system.

Analysis: Modern diesel engines are quite clean compared to those of only a few years ago.  The distinctive diesel exhaust smell has been greatly reduced via Diesel Oxidation Catalysts [DOCs] while the plumes of black smoke have been eliminated with the use of Diesel Particulate Filters [DPFs.]   Both DOCs and DPFs typically use Platinum catalyst coatings with excess of the Precious Metal required for comparable gasoline engines.

While Europe enjoys ~50% diesel car market share today the US market is under 5% [almost entirely larger pickup trucks.]  With >$3 per gallon gas prices and 35 mpg CAFE targets the industry is forced to look at expanding diesel penetration in the US market.   OEMs including GM, Chrysler, Ford, Toyota, Honda, VW/Audi, Mercedes,  and Nissan have all announced new diesel launches for the US in 2008-2010.

In addition to DOCs and DPFs diesel passenger vehicles in the US require additional catalysts to reduce NOx emissions.  The popular solution today is Selective Catalytic Reduction [SCR] systems with Platinum-free zeolite coatings.  SCR's drawback is the need for a separate Urea tank on the vehicle with the associated refilling issues.  Alternatives to SCR include so-called 'Lean NOx Traps' [LNTs] or other NOx adsorber systems.  The Dodge Ram pickup uses such an LNT today and will continue post-2010 when the US truck market will phase in SCR for most Medium and Heavy Duty engines.  While LNTs eliminate the Urea problem they are not Pt-free.  If LNTs and similar substitutes capture share from SCR they will compound the ongoing demand gap for Precious Metals and keep the heat on Pt prices.

Implications: Consumers desire fuel efficient, environmentally friendly vehicles but most are unwilling to pay the sticker price premium for advanced technologies.  Automakers have many options including hybrids, E85, diesels, and advanced Direct-Injection gasoline powertrains.  Alternative powertrians should double in share in 4 years; segmentation across the various engine technologies may follow existing geographic and demographic boundaries.

Analysis: According to JD Power less than 6% of all US vehicles sold last year were 'alternative powertrains' - mainly small hybrids and large diesel pickup trucks.  That share is expected to grow to over 13% by 2012 as OEMs add more diesel and hybrid choices to the car and SUV segments coupled with aggressive marketing.  Complicating efforts to grow these segments are the so-called 'selective contributors' - buyers who want eco-friendly vehicles as long as it does not cause them any inconvenience or extra cost.  Looming 35 mpg CAFE regulations will force the industry to adopt more of these alternatives for the required fuel economy gains.

Automakers are ramping up marketing and education campaigns to increase consumer awareness and break down the barriers for growth of hybrids, diesels, and Ethanol powered vehicles.   'Green' vehicles may not realize their full potential until there are sufficient options to satisfy regional demographic needs:  ie E85 for the Midwest Corn Belt, hybrids for urban areas, and diesels for long-haul interstate drivers.  Each of these options presents different sticker price, fuel economy, and driveability issues.  As OEMs fill their pipelines with these options in each market segment the market should respond with increased acceptance and share growth.

Implications: Converging forces of high oil prices, increased CAFE mpg regulations, and looming EPA CO2 emissions standards will provide fertile ground to grow diesel market share in the US passenger vehicle market.

Analysis: The dramatic falloff in large truck and SUV sales has put a pinch on Detroit's profit margins.  Like it or not the Big 3 have to address the need for smaller, more fuel efficient engines to drive future sales.  In Europe lower fuel cost and higher mpg has driven diesel engine share over 50% of the passenger car market.  The US automakers have all announced plans to introduce new diesel models to grow share domestically.

Diesels offer 20% - 30% better fuel economy, 15% - 20% lower CO2 emissions, and improved torque output vs. comparable gasoline engines.  Faced with future 35 mpg CAFE standards and fuel prices over $3 per gallon diesels make perfect sense for the US market.  All major OEMs have developed car engines for the European market; these designs can easily be transplanted the US models.  For larger trucks and SUVs new engine designs are already being put into production - by 2009/2010 all of the Big 3 will offer a diesel option for light trucks and/or SUVs.  Honda, Nissan, Mercedes, and VW/Audi have all committed to diesel models in the US as well.

Diesels cost more to produce and require more expensive emissions systems; sticker prices will likely be $2K - $3K higher vs. current gasoline models.  Depending on fuel prices and miles driven the payback can be realized in 3-5 years; resale value will increase accordingly.

There may be no better solution to Detroit's long term needs than to match the diesel share that exists in Europe today.

Implications: High fuel prices, Greenhouse Gas emissions, and pending CAFE mpg increases are increasing focus on advanced powertrains and fuels for the US light vehicle market.   While Ethanol fuel [E85] is a step in the right direction it may not be cost-effective vs. other options including hybrids and diesel engines.  Hybrids may be the most efficient in certain conditions but lower cost and better performance may tip the scales in favor of advanced light duty diesel engines.

Analysis: RAND Corp. has recently published a new study comparing and contrasting the cost/benefit tradeoffs of Ethanol, Gas-electric Hybrids, and Diesels as solutions for the current energy and emissions crisis in the US automotive sector.  Conclusions are that while hybrids may enjoy slight advantages of maximum fuel efficiency, diesels should capture significant market share growth due to lower costs and better performance [ie engine torque.]  Corn-based Ethanol E85 showed lower overall value than either the hybrids or diesel.  It should also be noted that using a diesel engine in a hybrid drive system would further improve the efficiency, also in highway driving over longer trips the hybrid approach is actually less efficient than a conventional engine.

Diesels already enjoy over 50% market share in Europe due to fuel tax structure; the advanced technologies on Mercedes, Audi, BMW, and other OEM vehicles will soon be available in the US for initial sale to American consumers.  Lower end models from Nissan, Honda, and VW will also be on sale in 2008-2009 here.  Diesel engines are fundamentally more fuel efficient than gas, consuming 20% - 30% less fuel per mile driven and producing 15% - 20% less CO2 emissions.  The advanced pollution control systems on modern diesels make them as clean as a comparable gas vehicle under strict EPA certification guidelines.

The drawback to diesel cars in the additional cost to manufacture the engine and emission control system; estimates are an extra $2000 - $3000 per car or SUV respectively.  As fuel prices remain high the payback period for this extra purchase cost shortens and the resale value of the diesel vehicle increases, both of which should help alleviate the pain of the higher sticker price.

While the US market may never see the 50% diesel penetration that the European automotive industry has today 15% is certainly a reasonable expectation long term, especially in SUVs and light trucks.

Implications: In 2010 EPA regulations significantly reduce allowable NOx emissions from diesel truck engines.   To date Selective Catalytic Reduction [SCR] is the only proven solution for compliance with the tighter NOx emission regulations.  Cummins and International have announced plans to go without costly SCR systems in 2010 but have not disclosed the use of credits which allows this interim maneuver. 

Analysis: In 2007 EPA regulations forcing the use of Diesel Particulate Filters [DPFs] on diesel trucks pushed prices up $3000 - $5000 in the Class 8 segment.  In 2010 EPA NOx emission regulations will force the use of Selective Catalytic Reduction [SCR] systems on most diesel trucks in the US.  The specific standard is 0.2 grams of NOx per brake-horsepower-hour [0.2 g/bhp-hr] which represents a near 90% reduction vs. previous levels. 

In the interim OEMs may accumulate credits by certifying some engines to the tighter standards.  These NOx credits are banked and can be applied against the 2010 standards, allowing engines that emit more than 0.2 g/bhp-hr to be sold in 2010 and beyond.

Neither Cummins nor International has publicly disclosed their strategy for relying on NOx credits to 'eliminate' SCR from their 2010 engines but have not demonstrated any technology that can meet the 0.2 gram standard without it.

Competitors including CAT and Volvo would be at a major disadvantage if they cannot match the 'no-SCR' engines for 2010.  SCR is expected to again add significant cost to heavy truck prices in addition to the higher operating costs due to SCR's need for supplemental Urea fuel additive.

It is unclear exactly how many credits are available but preliminary estimates are that Cummins may have as much as 3-7 years worth while International may only have 1-2 years.

As major fleet buyers seek to lock in SCR-free trucks for 2010 the industry may not see a 'pre-buy' in 2009 but certainly will see purchase agreements locked up for supply in 2010 and beyond until the NOx credits are depleted and SCR is installed.

Cummins and International will likely enjoy higher prices and share as long as they are able to keep SCR off of their engines with credits that competitors are unable to match.

Implications: Cummins Engine has announced that their 2010 Heavy Duty diesel truck engines will not use Selective Catalytic Reduction [SCR] to control NOx emissions.   This is a significant competitive advantage if the competition [CAT, Daimler, etc.] cannot meet 2010 EPA NOx emissions regulations without SCR.  SCR adds significant cost, weight, and complexity to heavy trucks; fleet customers would certainly pay a premium for non-SCR engines.  Analysis of Cummins' approach however shows that their strategy depends on the use of 'banked' paper emissions credits and not breakthrough engine technology.

Analysis: Effective in 2007 all diesel trucks in the U.S. are now subject to stringent EPA particulate emissions regulations that require the use of a Diesel Particulate Filter [DPF.]  Effective in 2010 EPA regulations for NOx emissions tighten dramatically to 0.2 g/bhp-hr from the comparable 2004 level of 2.4 g/bhp-hr.  The majority of the diesel engine market is expected to use Selective Catalytic Reduction [SCR] to control NOx emissions in 2010.  DPFs and SCR add significant cost and can also impact engine power and fuel economy.

SCR has been proven for years in stationary [ie smokestack] applications and is very effective in reducing NOx emissions.  SCR requires the addition of urea to the exhaust gas in order to work; on trucks a separate tank of urea solution will be needed on-board the vehicle.  Refilling the urea tank is an EPA requirement, an empty tank would cause the engine controller to go into 'limp' mode so truckers could not ignore it.  Urea consumption is expected to add ~$.03 - $.05 per gallon to the cost of diesel fuel.  In addition to the urea issue SCR catalysts are large; typically 1X - 2X the size of the engine.  For a Class 8 truck with a 12L - 15L engine this could mean an SCR catalyst of appx. 20L or more.   The size, weight, cost, and complexity of SCR systems make them an undesirable but necessary evil in the eyes of truckers and fleet operators.

Cummins supplies 6.7 L engines to Chrysler today for the Dodge Ram pickup truck.  The 2007 model is equipped with a DPF and a 'NOx adsorber catalyst' that meets the 2010 EPA 0.2g NOx standard.  This is the first production truck that is certified to the 2010 NOx standards without SCR.

Recently Cummins announced that their 2010 Heavy Duty engines would NOT use SCR to meet NOx emissions.  Cummins stated that  2010 heavy-duty engines will use no NOx aftertreatment, relying on technologies such as 'the XPI High Pressure Common Rail (HPCR) fuel system, next-generation cooled Exhaust Gas Recirculation (EGR), advanced electronic controls, proven air handling and the Cummins Particulate Filter'.   Missing from this announcement was the significant fact that Cummins must use banked NOx credits from current production engines to offset NOx emissions from the 2010 engines that will in fact exceed 0.2 g/bhp-hr.

The EPA regulations allow OEMs to bank credits if their engines exceed current NOx limits.  These credits do not expire but are devalued to 80% of the current NOx reduction.  Credits are measured in estimated tons of NOx that will be reduced over the expected life of the engine.

The Dodge Ram engines are NOT the ones that generate credits today; they fulfill separate phase-in requirements towards the 0.2 g standard and allow Cummins to use their other engines to generate NOx credits by exceeding the higher 2.4 g standard.

It appears Cummins has found an opening in the regulatory framework that will allow them to sell HD engines in 2010 and beyond with the major competitive advantage of no SCR.  Some estimates are that Cummins could bank enough credits for 4-6 years of future sales; ie it may be 2015 or later before they run out of credits.  Of course if this translates into higher sales volumes credits will run out sooner.  

It may not be good for the environment but is will certainly be good for business - Cummins looks like they may be the king of 2010 HD engine sales.

Implications: Investment in new biodiesel capacity continues to increase with the market this year expected to exceed $1 Billion.  With investment in conventional petroleum refining capacity lagging biodiesel appears to be poised to capitalize on tight supply.  As more diesel vehicle options are offered to American consumers the demand for diesel fuel should continue to drive investment in increased investment.

Analysis: The market for diesel vehicles in the US is expected to approach 2 Million in the next 6 years.  Mercedes, Audi, VW, Honda, Nissan, GM, and Chrysler/Jeep have all announced new diesel engine options for cars, SUVs, and light trucks by 2010.  In rough numbers diesel engines get 20%-30% better fuel economy while producing 15% - 20% less CO2 than comparable gasoline engines.  The regulatory prospects for increased CAFE mpg standards and reduced CO2 emissions appear highly probable, further bolstering the attractiveness of diesels.

Diesel fuel is the same petroleum distillate as #2 fuel oil used for home heating in many parts of the US.  Seasonal supply constraints historically push diesel prices higher in winter as refining capacity is limited and must satisfy both residential and motor vehicle demand.  Incremental capacity for biodiesel fuels could help alleviate this supply constraint and reduce peak fuel prices. 

Long term crude prices above $60 - $70 per bbl will continue to drive consumers to more fuel efficient vehicles with diesels at the top of the list.  Biodiesel fuel demand has doubled annually since 2004 and will exceed $1 Billion this year.  Total biodiesel production increased from 25 million gallons in 2004 to 250 million last year.  Even at that level biodiesel accounts for less than 0.5 percent of the total U.S. diesel fuel market.   Almost 100 new plants are still under construction; including a 20 Million gallon Chevron facility in Texas.

While most ethanol produced in the United States comes from corn, biodiesel has many options including soy and canola seeds, french-fry grease and animal fat.   One firm has even started making biodiesel from genetically modified algae.

The outlook for investment opportunities in biodiesel appears bright with several IPOs expected as more growers and producers seek  market channels and pursue required capital.

Implications: Capital investment in large scale CTL plants is unlikely without firm commercial commitments for fuels produced from coal.  To resolve this impasse Government price guarantees and/or subsidies could be bundled into military supply contracts.  Justification for this could be argued on national security grounds; i.e. ensuring domestic supplies of fuel for military needs.

Analysis: CTL is proven technology which is limited commercially by the need for major capital investments in production scale plants.  With the long-term historical price volatility in crude oil markets end users are reluctant to commit to long-term contracts which would be required by investors before capitalizing CTL production. 

At current crude prices >>$50 per bbl CTL is economically viable, but future swings in commodities markets could push crude down again to levels where CTL is less attractive or near breakeven at best.  To insulate against this uncertainty CTL producers have discussed government guaranteed price floors for CTL fuels and/or guaranteed supply contracts for military fuels.  One or both of these could provide the needed kickstart for CTL investment.

As a concession the government would likely demand fixed price ceilings independent of market driven crude pricing.  If large scale CTL plants could be base-loaded under such a scenario the US market could see marginal capacity used for free-market supply of fuels for home heating and motor vehicle demand.

CTL appears to be 7-10 years away from significant free-market production levels in the US.  Government subsidies in the guise of military procurement contracts appears to be the best bet for accelerating investment in large scale CTL capacity.

Implications: The regulatory drivers of increased fuel efficiency and lower emissions are channeling major R&D investment in HCCI engine technology worldwide.   Coupled with consumer demand for higher mpg vehicles due to $3 - $4 U.S. gasoline prices OEMs are scrambling to maximize the efficiency of all new engines.  If perfected HCCI could significantly reduce the cost and complexity of advanced emission control systems. GM recently demonstrated a prototype HCCI gasoline engine with advertised 15% fuel efficiency gains but admitted it is several years away from production.

Analysis: Homogeneous Charge Compression Ignition [HCCI] is an advanced combustion technology that increases the thermodynamic efficiency of Otto Cycle [4-stroke] engines.  HCCI has been applied to both gas and diesel engines in light and heavy duty.

Current state-of-the-art status in the industry is that significant improvements have been made under steady state operation at moderate speed/load conditions, but HCCI remains difficult to control at peak power conditions.  In short, HCCI engines cannot yet operate properly under conditions where they would provide the greatest benefit.

In most automotive applications highway cruising at normal speeds does not require much horsepower and HCCI may be effective.  However under acceleration, at higher speeds, or if towing a trailer HCCI remains problematic. 

For heavy diesel trucks much of the duty cycle is under higher load conditions where HCCI presents the greatest challenge.

One of the greatest benefits of HCCI is that ideally it will greatly reduce emissions of NOx from the engine.  On diesels this would eliminate the need for large, complex, and expensive NOx abatement systems such as Selective Catalytic Reduction [SCR.]  On gasoline engines it would reduce the amount of Precious Metals [Pt and Rh] that are used in NOx catalysts.

Given that diesels are already 20% - 25% more efficient than gasoline engines GM's claimed 15% fuel efficiency gain seems modest at best.  The true breakthrough in HCCI would be found on diesels with the elimination of NOx emissions.  Diesel OEMs including Caterpillar, Cummins, Daimler, etc. are continuing to expand work on HCCI but major challenges remain.  Some in the industry refer to HCCI as a technology that 'is always 10 years away from production.'

While the promise of HCCI remains tantalizing, the reality is that meaningful gains in automotive fuel efficiency will likely continue to come from advanced diesels in the near future.

Implications: High fuel prices, limits on CO2 emissions,  and >30 mpg truck/SUV CAFE standards will likely drive more of the US vehicle market to diesel engines.  With stringent emission controls on diesel engines already requiring Ultra Low Sulfur Diesel fuel [ULSD] US refining capacity is already constrained.   A major shift from gas to ULSD fuel demand could outstrip available refining capacity and limit the growth of automotive diesels.   Seasonal demand for home heating oil also may crimp supply of ULSD for motor vehicle use. Coal-to-Liquid [CTL] technology offers the prospect for sulfur-free diesel fuel without disrupting the current US crude refining infrastructure.

Analysis: Coal-to-Liquid fuel production technology has been known for over 80 years.  Germany relied on it during World War II and South Africa has used it commercially for decades.  Coal is gasified and then liquified using heat and catalysis to produce hydrocarbon fuel suitable for vehicles and aircraft. 

Because of the gasification/liquefaction steps any sulfur is eliminated from the resulting fuel.  Conversely diesel fuel refined from crude is typically very high in sulfur [500 - 5000 ppm] and must be hydrogenated to yield the <15 ppm ULSD fuel spec required for US vehicles today.  This 'desulphurization' step is costly and adds further to the refining bottleneck.  Not all diesel distillate is ULSD; off-road fuels may still be 500 ppm and home heating oil [#2 fuel oil, the same distillate as diesel] is unregulated.  Therefore current ULSD capacity is sized for existing on-road fuel demand.  Any significant growth in ULSD fuels would require additional refining  and/or hydrogenation capacity.

By 2014 all off-highway diesel engines will also require ULSD to accommodate emissions controls.  The prospects for an additional 1 MM diesel passenger vehicles would further exacerbate the ULSD supply gap.  Most major automakers have announced firm plans for new US diesel models including SUVs, luxury cars, and light pickups.

Since ~95% of domestic energy reserves are coal, CTL offers tremendous potential for a crude alternative.  Drawbacks are CO2 production that must be offset by sequestration, etc. and a reluctance of capital markets to finance CTL plants without proven commercial applications.  The prospects for Government military contracts and/or price subsidies could provide the first beachhead for commercial CTL plants.

CTL appears economical with crude prices in the $50-$60 range and could provide long-term relief to constrained ULSD refining capacity.