The jaws of more than one vacuum truck driver, not to mention just about anyone else who depends on diesel-powered equipment and trucks to make a living, have dropped in disbelief as fuel prices zoomed sharply and steadily upward the past year.

From July 2007 to July 2008, the national average price of a gallon of diesel fuel in the United States soared 65 percent, from $2.89 to a record $4.76 before dropping by a nickel a week or so later.

Even the traditional price advantage that diesel users once enjoyed over gasoline buyers has been turned on its head. During mid-summer peak demand for many septic haulers, the average retail price of diesel was 66 cents higher than the average retail price of regular gasoline.

So what in blue blazes is going on?

It’s all about supply and demand. Supplies are limited by diminished refinery capacity and areas of strife in oil-producing regions across the globe. And demand is up all over, especially China and India, which are guzzling diesel like never before as they ramp up construction and more of their citizens drive cars. And diesel demand, specifically, is growing over gasoline as the fuel of choice for autos in Europe and other countries.

And while experts say you might see a little price relief, it’s not just around the corner. Fuel prices will probably never drop to where they were a few years ago, but they might slack off as supply issues start getting resolved in 2009.

A CLOSER LOOK

Appearing before a U.S House of Representatives hearing on retail gasoline prices in May, Lucian Pugliaresi, president of the Energy Policy Research Foundation, stated that: “Over the last 10 years, the world oil market has clearly experienced an unprecedented number of new and sustained impediments to development. At the same time, global oil demand has grown robustly.”

“It’s basically a matter of supply and demand forces at work,” adds Ben Montalbano, a senior research analyst for the foundation. “But, the main point to realize is that demand for diesel is being met. There have been no shortages.”

If there’s any other good news about diesel fuel economics, it’s that analysts with the U.S. Department of Energy’s Energy Information Administration, or EIA, expect the rate of increase in diesel prices — which shot up about 40 percent during the first half of 2008 — to begin tapering off significantly between now and the end of 2009. But that’s barring further changes in crude oil supplies or demands — a big if these days.

WHY THE RISE?

Diesel is one of several middle distillates refined from crude oil. The price of No. 2 distillate, the main source of motor diesel fuel in the U.S., is affected by a number of factors. The primary one is the price of crude oil. It accounts for nearly two-thirds of the retail price of a gallon of diesel. “The rule of thumb is that every $1 change in the price of crude results in a 2.4-cents-per-gallon change in the price of diesel,” says Tancred Lidderdale, a senior economist with the EIA.

Even then, the EIA points out, diesel prices on the West Coast tend to be higher and more variable than elsewhere in the country. That reflects higher state and local taxes, relatively few refineries (which can lead to tight supplies and higher prices, if more than one experiences operating problems) and long distances from the Gulf Coast (source of nearly half of the diesel produced in the U.S.) and foreign refiners.

The price of crude oil, in turn, is affected by a number of other factors, as well:

Growing demand

World oil consumption continues to grow despite seven consecutive years of increasing prices, the EIA reports. Rising incomes in many areas of the world, including India and China, have increased the demand for diesel significantly. In fact, most other countries rely more heavily on diesel fuel than the U.S.

“There’s been a huge worldwide increase in oil demand, particularly in developing countries,” says Tavio Headley, staff economist with the American Trucking Associations.

This increased demand is also being fueled by other factors, Headley reports. China, for example, has stockpiled diesel to power backup generators to provide electricity for this year’s Olympic Games in the event of power grid problems. The country has been using diesel fuel to power equipment used for repairing damage in central China’s Sichuan province caused by an earthquake in May.

Government subsidies for gasoline and diesel have also sparked increased demand for crude oil. “These fuels are heavily subsidized in many countries,” says Montalbano. “In Venezuela, motorists are paying 12 cents a gallon for gasoline. In a lot of the oil-exporting countries in the Middle East, the pump price for gasoline is about 40 to 50 cents per gallon.”

However, elsewhere, he notes, countries including China, India, Indonesia, Malaysia and Nepal are starting to reduce these subsidies, which have taken a large chunk out of the government budgets.

Tight supplies

The oil market remains tight, as shown by rising prices, low surplus production capacity and concern that global supply growth may not keep pace with demand growth, at least in the short run.

Two years ago, the U.S was consuming 20.7 million barrels of petroleum products a day, 60 percent of which were imported. Almost half of these imports came from the Western Hemisphere.

That compares to the current world supply of crude oil, which the EIA estimates at about 86.5 million barrels per day.

“The market these days is calling for just about all of that supply immediately,” says Montalbano.

What’s more, Montalbano notes, current world oil supplies are about 2.5 to 4.5 million barrels per day less than were predicted at the beginning of this decade. He attributes this shortfall to a variety of factors over the past several years. They include attacks by rebels on Nigeria’s oil infrastructure; fighting in Sudan, which has slowed development of new production in many oil fields; declining oil production in Argentina since the country’s oil sector was nationalized in 2004; forced renegotiation of contracts with foreign oil companies by Kazakhstan, which could hinder investment in oil production in that country; declining oil production since 2004 in Mexico, where lack of funding for the country’s state-owned oil monopoly, Pemex, prevents exploration and development of new fields.

“The refining capacity for diesel and other middle distillates is just about maxed out,” says Montalbano. “There will be significant new capacity in the next two years, which might — depending on crude oil prices — ease the refining burden.”

In 2002, OPEC-member countries had an excess oil pumping capacity of 5.8 million barrels per day. Today, that number has shrunk by nearly two-thirds to around 2 million, according to Montalbano.

“Saudi Arabia has increased production twice in the past few months and fuel prices still continued to go up, partially because Middle Eastern demand for crude has risen quickly,” he says.

Risks to production

The price of diesel is also tied to the risks — both actual and perceived — of a reduction in supplies of crude or refined oil. Those risks range from war and weather-related threats to production and transportation facilities to government policies affecting development of oil resources. The higher the risks, the more money demanded by oil investors and buyers.

“These risk premiums are more of a factor than they were several years ago,” Headley notes.

In fact, the various risk factors have conspired in the past few months to cause crude oil prices to swing wildly. Over a three-day period in July, the price of a barrel of oil spiked up 8 percent from $136 to a record $147. The factors included fears of possible disruptions in oil supplies caused by rising tensions between the U.S. and Iran, the threat of a strike in Brazil and another drop in the value of the U.S. dollar against other major currencies. Five trading days later, the crude oil price had tumbled by almost 11 percent for the biggest one-week drop ever to $131 as these same fears subsided.

Cleaner-burning fuels

The phase-in of U.S. Environmental Protection Agency standards to reduce sulfur content of diesel fuel, implemented in 2006, helped pressure diesel prices upward, according the EIA. These standards required that 80 percent of on-highway diesel fuel sold in the U.S. had to be Ultra-Low Sulfur Diesel by June 1, 2006, increasing to all on-highway diesel by Dec. 1, 2010. Phasing in of clean-fuel requirements for off-highway began last year. Nearly all diesel fuel used in the U.S must be ULSD by the end of 2014. In the meantime, the costs of preventing or correcting any contamination of ULSD with higher-sulfur content diesel and the higher costs of production ULSD could continue to influence diesel fuel prices, the EIA reports.

Market speculators

Soaring crude oil prices have prompted calls in the U.S. Congress for closer scrutiny of trading in oil futures contracts and limiting the role of speculators. Critics charge that speculators are manipulating oil prices.

As the value of the U.S. dollar has fallen, says Headley, investors have been buying petroleum futures contracts as a hedge against inflation. “The big question is how much this is contributing to the run-up in crude oil prices. The federal Commodity Futures Trading Commission is looking into the matter.”

DIESEL OVERTAKES GASOLINE

Historically, the pump price for diesel has been lower than that of regular gasoline, except during some winters when demand for heating oil was high. However, since fall 2004, diesel prices have generally been higher than gasoline prices. One reason is an increase in federal tax on diesel fuel. Another has been the steadily increasing demand for diesel around the world.

European countries, for example, have used taxes to encourage use of cleaner-burning diesel over gasoline. This has resulted in excess production of gasoline in that part of the world, notes Montalbano.

“When you refine crude oil into diesel, you also produce a certain amount of gasoline,” he says. “There’s not enough demand in Europe for all this gasoline, so they export it to the U.S. Those imports have helped keep gasoline prices in the U.S. from rising as much as they would have otherwise.”

NO SUDDEN PRICE DECREASES

As of July, EIA analysts were projecting the rate of increase in the average spot price of West Texas Intermediate, or WTI crude oil, to moderate over the following few months, peaking at $140 per barrel in the fourth quarter of this year, before declining to $127 by the fourth quarter of 2009.

At the same time, analysts expected a similar trend in the refinery price of diesel fuel, rising from $3.67 per gallon in the second quarter of this year to $4.01 in the fourth quarter. That price is then predicted to fall to $3.53 by the fourth quarter of 2009.

In their July, 2008, Short-Term Energy Outlook the analysts reported, “WTI prices, which averaged $72 per barrel in 2007, are projected to average $127 per barrel in 2008 and $133 per barrel in 2009. Diesel fuel retail prices in 2008 are projected to average $4.35 per gallon, up from $2.88 per gallon last year, and increase to an average of $4.48 per gallon in 2009.

“We don’t see the global forces pushing up oil prices over the past four years letting up immediately,” says the EIA’s Lidderdale. These higher prices reflect strength in diesel demand, particularly in emerging markets, which has significantly increased the margins between diesel prices and crude oil costs from those of last year, the analysts noted.

Lidderdale attributes the slowing rate of price increases through the rest of this year and into early next year to increased production in the United States as two oil platforms in the Gulf of Mexico come on line and to new production in Brazil and the Siberian region of Russia.

However, he advises caution in viewing this forecast. “There’s always a certain degree of uncertainty in the world oil market,” he says. “So many things can happen to prove us wrong.”