(Corrects oil price in second paragraph.)

July 7 (Bloomberg) -- Soaring fuel prices are damaging the U.S. economy, and the government should be doing whatever it can to slow or stop their astonishing ascent.

Demand for diesel, according to energy economist Philip K. Verleger, may be driving much of the run-up in crude oil, which reached $145 per barrel on July 3. Truckers and other users of ultra-low-sulfur diesel fuel -- the newly improved, cleaner version of the gasoline alternative -- are being hit particularly hard by rising prices at the pump.

It's becoming clear the U.S. should dip into its Strategic Petroleum Reserve for the light, low-sulfur crude that is most efficiently turned into diesel.

Demand for diesel is rising in both the U.S. and Europe, and its price has been shooting up much faster than that of gasoline. Over the past 12 months, the average price per gallon of all grades of gasoline rose $1.12, to $4.15. The price of diesel -- which a year ago cost less than gasoline -- increased by $1.81 a gallon, to $4.66, according to the U.S. Energy Information Administration.

Verleger said in an interview that operators of refineries are responding to the rapid increase in diesel prices by bidding more and more for light, low-sulfur crude. The U.S. could increase the available light-crude supply -- and thus damp the surge in prices -- by putting some of its reserve supply on the market.

Upgrade Refineries

Most crude, when refined, produces both diesel and gasoline; the lighter the crude, the bigger the share of diesel. Efforts to upgrade refineries to get more diesel from heavier crudes could take two years to relieve the pinch, Verleger said.

Until then, refiners don't want to produce more diesel from the less costly heavier crude because that would also mean more gasoline -- sales of which have dropped in response to prices.

Which brings up another step the U.S. could take to ease the diesel squeeze: adjust the federal requirement that 9 billion gallons of ethanol be blended with U.S. gasoline supplies this year.

The ethanol mandate is accomplishing its mission, reducing how much gasoline gets used in the U.S. Gas prices in excess of $4 a gallon are doing the same. As we've seen, however, the side effect of less gasoline use is less production of diesel -- and more pressure on crude-oil prices.

Easing the ethanol mandate might help consumers in another way, by slowing the increase in food prices. Ethanol, a biofuel, is made mostly from corn, the cost of which has also been soaring.

Floods and Corn

On April 25, Texas Governor Rick Perry asked the Environmental Protection Agency to cut this year's ethanol mandate in half, to 4.5 billion gallons. At the time, corn cost about $6 a bushel. Last week it topped $7.50 after the extensive flooding in the corn belt in the Midwest.

The EPA has until July 24 to issue a decision. The agency ought to lower the mandate to relieve some of the pressure on both corn and crude prices.

This entire situation has been exacerbated by the loss of about 100,000 barrels a day in Nigerian crude production due to attacks by militias in the Niger River delta, where many wells are located. There have even been attacks on production platforms in the Atlantic Ocean 75 miles offshore. That's one problem no government outside Nigeria can do much about.

Under pressure from Congress, the Bush administration reluctantly agreed recently to suspend putting oil into the U.S. Strategic Petroleum Reserve, which has just over 700 million barrels of crude stored in underground salt caverns along the coast of the Gulf of Mexico. About 2.8 million barrels of crude already purchased will be added this month before the suspension takes effect.

Withdraw or Swap

More than the suspension is needed.

Since light, low-sulfur crude is most critical, the Department of Energy could propose either an outright withdrawal from the reserve or a swap of light crude for heavier crude. Swaps have occurred in the past.

The DoE's Web site says the reserve ``exists, first and foremost, as an emergency response tool the president can use should the United States be confronted with an economically threatening disruption in oil supplies.''

It's not hard to make a case that the current situation is economically threatening. The country was coping with the collapse of the housing industry and the related financial market turmoil before crude prices took off. Now we have a triple whammy, which, among other things, is doing great damage to the auto industry by killing sales of sport-utility vehicles and pick-up trucks.

There's no way to be sure how much reducing the ethanol mandate and releasing light crude from the strategic reserve might have on world oil prices. Nevertheless, in this critical situation both steps should be taken soon.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: July 7, 2008 04:27 EDT