Diesel Fuel Offers An Interesting Play

By Aaron Levitt | October 19, 2011 AAA

As the world's population continues to grow and expand, its energy demands continue to rise exponentially, as well. With some analysts and policy makers predicting that global energy use will jump by 53% or more by 2035, investments in the energy sector have become popular choices for investors. Funds like the First Trust Energy AlphaDEX ETF (NYSE:FXN) have become portfolio staples, as investors capitalize on this trend. Most investor attention is focused on crude oil, coal and natural gas demand growth. However, one former "dirty" fuel source is seeing its star shine throughout the emerging world and could be an interesting side bet in the energy sector.

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The "Go-To" Fuel
While diesel fuel maintains a poor reputation here in the United States, the rest of the world is going gaga for the energy. According to a report by the International Energy Agency (IEA), global consumption of the fuel type increased by 23% from 2000 to 2008. This trend is expected to continue, as emerging market economies are among the heaviest users of diesel and distillate fuels, with diesel fuel becoming the preferred transportation energy source in these countries. Nations like China and India are seeing car ownership jump and Latin America continues to import more of the fuel.

In addition, diesel is finding its place as an electricity generator. Israel's use of diesel fuel for electricity production nearly doubled during the first eight months of the year, versus the same period a year ago. Similarily, Indian diesel demand surged this past summer, as government subsidies made it cheaper to burn in power plants and factories. Analysts estimate that power shortages throughout China could add as much as 300,000 barrels per day to the nation's diesel demand.

It's not just the emerging world that is embracing the fuel source; developed nations have been shifting towards using more diesel, as well. Europe continues to import more low sulfur diesel, and in the United States distillate fuel is seeing a renaissance. The Corporate Average Fuel Economy (CAFE) rules require auto makers to design more fuel efficient vehicles, however the standard doesn't mandate how they improve that mileage. While hybrids and PHEV are estimated to be a bigger part of the pie, diesel engines, which can go about 25% farther per tank than their gasoline rivals, are expected to contribute as well. Analysts expect the CAFE rules will help grow the diesel engine market share to 8% by 2025.

Running a Portfolio on Diesel
With global consumption of gasoline only increasing by 7% during the 2000 to 2008 period, the shift has been made. For investors, the overlooked diesel market may offer an interesting side play in the energy sector. Unlike fuels such as natural gas, which have a variety of funds tracking it, like the United States Natural Gas (NYSE:UNG), diesel investors aren't so lucky. However, there are a few ways to play the shift, here are a few picks.

Recent refinery spin-off Marathon Petroleum (NYSE:MPC) could be a good bet for the growth in diesel fuel. In 2009, the company completed a $3.9 billion expansion of its Garyville, La., refinery and is now better equipped to produce diesel fuel. The firm's operations are in a prime location for export to South America. Marathon trades for a forward P/E of five and yields 2.5%. In addition, other refiners, including Valero (NYSE:VLO) and Shell (NYSE:RDS.A), are expanding their diesel export capacity and the pair could make interesting buys, as well.

The manufacturers of diesel engines will continue to benefit, as the shift towards the fuel source continues. Industrial firms Cummins (NYSE:CMI) and Caterpillar (NYSE:CAT) offer investors a way to play both the engine side, as well as the power generation side, of diesel. In addition, Parker Hannifin (NYSE:PH) offers a variety of filters and products for on-highway diesel engines.

The Bottom Line
As the world's energy demands continue to grow, investors have embraced the trend. However, much of that attention has gone towards natural gas, coal and crude oil growth. An opportunity exists in the global shift from gasoline to diesel fuel. The previous stocks along with mega-diesel exporter Exxon Mobil (NYSE:XOM) make ideal selections to play the shift. (For additional reading, see A Guide To Investing In Oil Markets.)

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