A Review of International Initiatives to Accelerate the Reduction of Sulphur in Diesel Fuel

prepared under contract for:
Oil, Gas & Energy Branch,, Air Pollution Prevention Directorate,, Environmental Protection Service, Environment Canada

Authors: Beatrice Olivastri, Miranda Williamson

December 2000

Table of Contents

1. Executive Summary

2. Introduction

3. An Overview of Measures in OECD Countries Applied to Reduce Sulphur in Diesel Fuel

     3.1 Regulations
     3.2 Industry Voluntary Initiatives
     3.3 Economic Instruments

4. Case Studies

     4.1 The United Kingdom
     4.2 Denmark
     4.3 Finland
     4.4 Germany

5. Concluding Observations from the Case Studies

    References

Appendices

 Appendix A - Summary of Regulations for Sulphur in Diesel Fuel in OECD Countries
 Appendix B - Summary of Industry Voluntary Initiatives for Diesel in OECD Countries
 Appendix C - Summary of Economic Instruments Applied to Diesel Fuel in OECD Countries

1. Executive Summary

Environment Canada plans to propose a regulation to reduce the sulphur content in diesel fuel in line with the final rule being developed by the US EPA. (The EPA has proposed a 15 ppm limit effective 2006). Currently, most OECD countries and many other countries regulate sulphur in diesel at the 350 ppm to 500 ppm level. Members of the European Union (EU), Australia and Korea are committed to sulphur levels in diesel fuel of 50 ppm by 2005 and many other countries have announced intentions or launched active discussions to move ahead of regulation to reduce sulphur in diesel through the use of economic instruments.

The European Union's (EU) target for 50 ppm by 2005, has been achieved well in advance by several of its member states who have utilized a tax differential measure to do so. Commitment to cleaner air has been the main driver for these measures although, recently, commitment to the Kyoto Protocol has become an additional driver to reduce emissions from vehicles by reducing sulphur in the fuel. As of March 2000, the EU commenced discussions on a further regulated reduction to 10 ppm sulphur in diesel.

Many countries apply excise taxes on diesel as a form of revenue generation, although fewer countries employ taxes specifically to reduce sulphur levels. In 1992, Sweden was the first country to apply an environmental tax on sulphur in diesel which has resulted in almost 100% market share for urban diesel fuel of 10 ppm. The United Kingdom, Denmark and Finland also have used economic instruments to accelerate the reduction of sulphur in diesel to 50 ppm several years in advance of regulation. The primary driver cited for reducing sulphur in diesel is the improvement of air quality for health and environmental benefits while another benefit is the introduction of improved vehicle and pollution abatement technologies.

Four case studies (the UK, Denmark, Finland, and Germany) on the use of economic instruments in accelerating the reduction of sulphur in diesel are reviewed.

Beginning in 1993, the United Kingdom (UK) government was motivated by a dual agenda for air quality and reduction of greenhouse gases to introduce a collection of fuel duty measures which, as of 1997, included a tax differential in support of Ultra Low Sulphur Diesel (ULSD). This measure was introduced at 2.2 cents/litre in favour of ULSD in 1997, was increased to 4.4 cents in 1998 and was again increased to 6.6 cents in 1999. The market shift was modest at 2.2 cents, and the increase to 4.4 cents began to impact on supply and demand. The increase to 6.6 cents resulted in ULSD accounting for nearly 100% of production and marketing for domestic use. At its current rate of 6.6 cents, the cost to the government for ULSD is estimated at over $887 million per year. This case underscores the importance of "getting the price right" for the measure to succeed. An accompanying factor for the successful market shift was the limited pipeline infrastructure to support a dual diesel supply system on a large scale in the UK.

Because a tax reduction of 1.5 cents for low sulphur diesel was introduced at the same time as a tax increase for 1.5 cents for higher sulphur content, the net differential is 3 cents/litre in Denmark. Denmark's commitment to improve air quality prompted the introduction of a tax incentive for diesel fuel with lower than 50 ppm sulphur as of June 1, 1999. The Danish Government incurs a cost for maintaining this measure which will be in place to 2005 when the 50 ppm sulphur level becomes mandatory for the European Union. Immediately upon introduction of the tax differential, literally overnight, the measure achieved 100% market shift to 50 ppm sulphur diesel. This may be, in large part, due to effective consultations with refiners and technical experts in the development phase of the measure.

In 1993, concern for air quality prompted Finland to offer a 3.3 cents/litre tax differential in support of diesel with 50 ppm at a time when the Europe-wide limit was 500 ppm. In the first year, the market shifted to 70% low sulphur diesel followed by market penetration of 80-100% in subsequent years. The measure was planned as revenue neutral and to place minimal additional administrative burden on all parties. Finland's Tax Department considers this the most efficient environmental measure they have introduced.

Germany is focused on improving air quality for health benefits and reducing greenhouse gas emissions from traffic through its fiscal incentive to introduce low sulphur fuels in advance of the EU schedule. It has specified November 1, 2001 to introduce both diesel and gasoline with 50 ppm sulphur and, subject to EU approval, proposes January 1, 2003 for 10 ppm. Fuel with a higher sulphur level is taxed an extra 2 cents/litre from November 2001 onward. The tax break for cleaner fuel applies to fuels with less than 50 ppm effective November 1, 2001 and to only those with less than 10 ppm effective January 1, 2003. The measure is planned to operate as revenue neutral.

The following are concluding observations from the case studies:

Measure of Choice- At least 11 OECD jurisdictions have implemented or announced the use of economic instruments in order to accelerate the introduction of low sulphur diesel fuel. The case studies examined show that these measures have been very successful. In each of the cases the economic instrument is backstopped by a regulated requirement taking effect at a later date.

Cost to Government- For two of the four case studies, the measures were designed to be revenue neutral with minimal cost of administration. The UK's measure was not, but needs to be considered in the context of the associated annual fuel price escalator.

Getting the Price Right - Pricing for an economic instrument in advance of a regulation seems to be a case of encouraging refiners to advance spending of capital costs that would ultimately be incurred by all refiners to meet the regulation. The UK and Danish example are the most instructive in this respect.

Projecting and Assessing Benefits - Communicating the human health and environmental benefits as well as measuring impacts are important components of designing the introduction of a measure. Denmark's air quality testing and the UK's assessment of environmental benefits of budget measures go a long way in showing the public benefit of tax differentials. Such measures to encourage the early introduction of low sulphur diesel might otherwise be construed as an economic benefit to refiners.

Emission Reductions Reported or Projected

• The UK projected that its fiscal measures to encourage the early introduction of low sulphurdiesel fuel would reduce particulates by 21% and by up to 2% of NO_x emissions.
• Denmark has projected a 13% reduction in fine particulate based on the use of 50 ppm diesel growing to 26% reduction once all city buses use this quality of fuel.
• Finland has reported emission reductions better than those achieved in the use of reformulated gasoline - therefore, the only comparison available is based on those results -carbon monoxide down by 10-20%, hydrocarbons by 5-10% and evaporation emissions by 13-17%.
• Germany projects the benefits of its measure to include reduced emissions of NO_x, CO, SO₂ and CO₂ emissions reduction of 20-25% from its current fleets along with a projected 4% reduction in fuel consumption.

Infrastructure - Distribution of two qualities of fuel may lead to cost and verification issues when attempting to accelerate reduction of sulphur in diesel.

Timing - An economic instrument can produce a rapid market shift in particular when the consultative process leading to its introduction is effective. Duration - All jurisdictions plan to keep the economic instrument in place until the regulation kicks in.

Voluntary Initiatives - Industry voluntary initiatives may create a market advantage for companies positioning themselves as leaders (BP Amoco). However, the longevity of the measure and verification of its effectiveness may be problematic. Voluntary leadership may not be ade

quate to motivate refiners to move in advance of regulation.

2. Introduction

Environment Canada plans to propose a regulation to reduce the sulphur content in diesel fuel in line with the final rule being developed by the US EPA. (The EPA has proposed a 15 ppm limit effective 2006). Through their trade association, the Canadian Petroleum Products Institute, many of Canada's refiners have indicated their willingness to match the U.S. EPA final levels and timing.

However, the European Union's (EU) target for 50 ppm by 2005, has already been achieved well in advance by several of its member states who have utilized a tax differential measure to do so. Commitment to cleaner air has been the main driver for these measures although, recently, commitment to the Kyoto Protocol has become an additional driver for reducing sulphur in the fuel. As of March 2000, the EU commenced discussions on a further regulated reduction to 10 ppm sulphur in diesel.

The report examines regulations, voluntary initiatives and economic instruments as they are applied to diesel in OECD countries. The situation in four countries is reviewed to gain insight from their experiences in applying measures to accelerate market shifts to lower sulphur diesel. Based on this work, a set of observations is put forward.

3. An Overview of Measures in OECD Countries Applied to Reduce Sulphur in Diesel Fuel

This section provides an overview of three kinds of measures used in OECD countries to reduce sulphur in diesel fuel: regulations, voluntary initiatives and economic instruments. See Appendices for the charts summarizing measures by country.

3.1 Regulations

Currently, in OECD countries and Hong Kong, sulphur in on-road diesel is regulated at the 350 to 500 ppm level. Many jurisdictions, including the members of the EU, Australia, and Korea are committed to reductions to 50 ppm by 2005 or 2006. However, discussions have commenced in the EU on the desirability of changing this target to sulphur-free (defined as less than 10 ppm). The United States and Canada are each engaged in considering reductions to 15 ppm for 2006. (See Appendix A)

3.2 Industry Voluntary Initiatives

Industry voluntary initiatives to reduce sulphur in diesel in advance of requirements may create market advantages for a company. However, there appear to be a small number of these initiatives. (See Appendix B)

Australia is negotiating with refiners for the introduction of lower than regulated levels of sulphur in diesel in particular for urban markets. At the beginning of 2000 or roughly six years in advance of regulation, BP Amoco began to progressively introduce diesel with 50 ppm sulphur starting in Western Australia and then moving into the remaining states. This will supply approximately 12% of the overall market.

In France in 1999, BP Amoco introduced diesel with 50 ppm sulphur at 40 inner-Paris service stations and then extended it to all their 240 stations with no additional cost to consumers. The same quality fuel was offered to commercial customers including bus and transport companies.

In Ireland , Kelly Fuels introduced Ultra Low Sulphur Diesel (ULSD) with 50 ppm sulphur on a voluntary basis in November 1998. Market share is not known.

The limited number of voluntary initiatives identified suggests that their use does not offer governments the strategic, measurable impact that can be achieved with economic instruments. Nevertheless, there does seem to be a market advantage for companies positioning themselves as leaders as is the case with the BP Amoco initiative in Australia and France. The durability or longevity of the measure and its verification may be problematic since it could be at the discretion of the company to revert to higher levels of sulphur. Possibly, such issues could be managed through some type of formalized agreement between or among the government, companies and other interested parties.

3.3 Economic Instruments

Diesel fuel is a common focus for revenue generation as seen by the range of excise taxes in the accompanying chart. Excise taxes are shown on the chart along side taxes explicitly focused on reducing sulphur. (See Appendix C)

Sweden is a leader; it first introduced an environmental tax on sulphur in diesel in 1991 with subsequent adjustments in 1992 and 1996 that resulted in an almost 100% market share for urban diesel fuel of 10 ppm sulphur.

Other countries that have applied an economic instrument to accelerate reduction of sulphur in diesel include:

Czech Republic with an air pollution charge on sulphur in diesel;

Denmark with its tax differential effective in 1999 (3 cents/litre ¹) and its 1992 incentive for public bus services to use Ultra Light Diesel;

Finland with its tax differential to promote low sulphur diesel (50 ppm) in 1993 (3.3 cents/litre);

Hong Kong with a current tax incentive of 17.6 cents/litre to encourage early introduction of low sulphur (50 ppm) through 2001;

Norway with a sulphur tax on diesel containing a sulphur content higher than 50 ppm; and,

the United Kingdom with its tax differential of 6.6 cents/litre to promote Ultra Low Sulphur Diesel (ULSD) (less than 50 ppm)

Other countries that have announced intentions or are engaged in active discussions to move ahead of regulation to reduce sulphur in diesel by using an economic instrument include Germany, with Austria likely to follow their lead, Australia, Japan and especially the Tokyo region, the Netherlands and Switzerland.

The Authors chose the four tax differential approaches for case studies - the United Kingdom, Denmark, Finland, and Germany.

1 Local currency converted to Canadian cents.