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Water and diesel fuel emulsions containing 13% and 26% water by volume were investigated in a modern diesel engine with relatively early pilot injection, supercharging, and cooled EGR. The heat release from the pilot injection with water emulsions is retarded toward the top dead center due to the poor ignitability, which enables larger pilot and smaller main injection quantities. This characteristic results in improvements in the thermal efficiency due to the larger heat release near the top dead center and the smaller afterburning. With the 26% water emulsion, mild, smokeless, and very low NOx operation is possible at an optimum pilot injection quantity and 15% intake oxygen with EGR at or below 0.9 MPa IMEP, a condition where large smoke emissions are unavoidable with regular unblended diesel fuel. Heat transfer analysis with Woschni's equation did not show the decrease in cooling loss with the water emulsion fuels.